By Sue Hirst, CFO On-Call

If this or the previous financial year isn’t as good as you’d have hoped, then it’s a good time to start setting a plan to make your next year in business better.  So if you want to improve future results then you need a target to aim for, and a system for monitoring progress.

Here are a few questions to ask yourself:

  • How were your results against your target for last year?
  • Did you have a target for last year?
  • Are you happy with the results for last year?
  • How accurate are the results for last year?
  • What do you want to achieve this year?
  • What can you learn from last year to improve this year’s results?

It can be difficult to find the time to consider these issues when you are busy, but a small amount of time spent now, can pay big dividends to your profit and cashflow results for next year.

Here are a few ‘key issues’ you need to consider, and get control of:

Compare Results

Most businesses have lots of transactions happening and it can be difficult to keep track of them all.  By having a budget i.e. something to compare actual results against, you have a regular procedure for checking income and costs are on track.

You can see very quickly if margins are slipping, find out why and take corrective action.

Identify Over-Spending

If you don’t have a monthly budget, you may not find out until way after the financial year (sometimes eighteen months later), that you have over-spent on some items. Imagine if you had a small number of items of over-spending that added up to say $1,000 per month.

If you left it until tax accounts are prepared it could cost you $18,000 in lost profits. With a monthly budget you can identify overspending quickly and take action to fix it.

A budget can be entered into most accounting software systems and a ‘Budget versus Actual’ Profit and Loss can be printed, so that you can easily see any variances and manage them every month.

Spending Limits

A budget lets your staff know there are limits on spending.  It’s amazing how some staff will keep spending if they don’t have a limit. A great way to implement spending limits into your business is with the use of purchase orders.

In some businesses no spending above $50 is allowed without a purchase order first being signed.  This may seem like a bit of a pain, but it can save a business thousands of dollars.

An example of an honest mistake is where a new product is imminent and staff order new ones just prior to the release.  They may not always know that an upgrade is imminent, but you as business owner probably do.

Some suppliers will not refund your money and you can find yourself stuck with obsolete goods.  It’s also a good way to keep your mind focussed on spending as well as earning.  Every time you sign a purchase order you can ask yourself the question “Do we really need this or is there a better/cheaper alternative?”

This is an extremely valuable habit to get into, especially when business grows and you have more staff ordering things.

Resources

A budget helps you to plan what resources will be required to achieve the sales you plan.  It’s important to match the outgoings with the income and plan what resources will be necessary.  Thus avoiding ‘Crisis Management’, which is no good for morale.

Funding

If you want to acquire business funding you will definitely be required to produce a Budget and probably a Business Plan.  A lending institution needs to be confident you have ‘thought through’ your business and funding requirements. If they can see that you regularly measure actual versus budgeted results, they will feel much more comfortable with you as a borrower.

Break-Even

Some people say “It’s too hard to do a budget because I can’t predict what I will sell”.  This should not be an excuse! Most businesses know what their direct costs and overheads are, so it should be possible to calculate the “Break-even” point.

‘Break-even’ means the level of income you need to cover costs and overheads i.e. not making a profit or a loss but a $0 result.  Once you can manage the business to a ‘break-even’ point any sales above that are a bonus.

If you know how to do a spreadsheet, that’s a great start.  You can set up as many rows as you like to contain various types of income, costs and overheads.  You may need to start with the overheads, as these are generally the best known numbers.

Here is an example of a really simple Break-even analysis:

 

Break

even

$‘000s

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Total
Income 50 50 50 50 50 50 50 50 50 50 50 50 600
Direct

Costs

30 30 30 30 30 30 30 30 30 30 30 30 360
Gross

Profit

20 20 20 20 20 20 20 20 20 20 20 20 240
Over

heads

20 20 20 20 20 20 20 20 20 20 20 20 240
Net

Profit/

(Loss)

0 0 0 0 0 0 0 0 0 0 0 0 0

 

The Direct Costs (costs that only occur if a sale is made) have been calculated at 60%, so the difference, being the Gross Profit, is 40%.  This means that the monthly break-even income point, with overheads (indirect costs that occur even if no sales are made) of $20,000 per month, would be $50,000.  i.e. 40% of $50,000 is $20,000.

The business owner now knows what they have to achieve in sales and Gross Profit to cover overheads to break-even point.  Each month they can measure these numbers whilst also keeping an eye on Overheads to ensure they are averaging at $20,000.

If sales increase they would need to be measuring the Direct Costs to ensure they are remaining at 60% in order to maintain the Gross Profit of 40%.

If the business wants to expand and increase sales, whilst maintaining a Gross Profit of 40%, they will most likely need to increase overheads to achieve growth.

The first thing they need to calculate is the likely overheads, then work back to calculate what sales are required to maintain the Gross Profit percentage.  Obviously the aim isn’t to break-even, but to make a healthy profit.

The challenge is to improve both the Gross Profit and Net Profit.  The obvious answer may seem like increasing sales, but savvy management of Direct Costs and Overheads can have as good an impact on the Net Profit, often requiring much less effort.

Anything you can do to increase your Net Profit can have a big impact on the value of your business.  As many businesses are valued on a multiple of EBIT (Earnings Before Interest and Tax), it makes sense to increase this result.

Many businesses have been run in the past with the aim being to minimise tax, but this isn’t a good strategy if you want to sell your business in order to retire or do something else.  Multiples of EBIT vary depending on the industry, but say it is three – this means that for every extra dollar you can add onto Net Profit, that would be three dollars added onto the value of the business.

If you could increase your profit from $100,000 to $200,000 you would add an extra $300,000 onto the sale price and potential contribution into your superannuation fund on retirement or exit from the business.

If every business owner/manager spent a little time reviewing the Profit and Loss and all expenses, I’m sure they could find unnecessary spending, sometimes thousands of dollars each month.

We had one example recently where we did an analysis of the Profit and Loss for a client and came up with $8,365 worth of savings every month!  Benjamin Franklin said “Beware of little expenses.  A small leak will sink a great ship.”  Here’s a list of just some of the savings we discovered:

 

Expense Current Target Saving Comment
Office Rent $ 4300 $ 2400 $1900 Close half office
Advertising $ 4000 $ 2400 $1600 Change format
Consultant $ 1000 $  200 $ 800 Terminate one consultant
IT $  800 $  400 $ 400 Reduce users – left company
Electricity $  200 $  100 $ 100 Due to half office closure
Merchant Fees $  600 $      0 $ 600 Charge to clients
Photocopier $  240 $  150 $   90 Reduce colour copying
Postage $  400 $  200 $ 200 Reduce amount of mailouts
Printing $  600 $  400 $ 200 Shop around suppliers
General $  300 $  200 $ 100 Economise
Subscriptions $  200 $  125 $   75 Terminate two publications
Telephone $ 1800 $ 1200 $ 600 Reduce lines, change supplier
Travel $ 3300 $ 2000 $1300 Better forward planning/more skype
Website $   700 $   300 $ 400 Transfer site hosting
Total $18440 $10075 $8365

 

Some comments on these savings:

  • The office was the obvious one, as there was a lot of unused space.  There was a training room that was only being used for about seven weeks a year, so they can do this off site at a much reduced cost.
  • Travel was another large expense that wasn’t being very well managed. We asked those undertaking the travel to provide a plan for the next financial year and found we could reduce the number of visits to some areas.
  • Advertising was not giving a good enough return for the cost when we analysed the enquiries.  We changed over to digital marketing, which was more effective and cheaper.
  • Merchant Fees was one that crept up quietly over the years.  Most of the credit card payments are being made on a web site, so we got the web developer to add the merchant fees onto the payment.  Clients are now advised of this at the time of invoicing, so they know there will be a charge.
  • Some of the savings appear small, but they all add up.  The staff of the business were all informed of the cost reduction exercise and asked to assist with savings wherever possible.  The client has already had helpful feedback and ideas from staff for even more savings.

The bottom line effect of this exercise will be $100,000 on to the profit for this business next year. Importantly it’s also potentially $300,000 onto the value of the business, if you use an EBIT (Earnings Before Interest and Tax) multiple of three.  That could be $300,000 extra into this business owner’s superannuation fund if they sell the business!

It makes sense to invest a little time planning for the profit you want to make in your business and reap the increased business value benefits down the track.

If you would like more pragmatic tips on ways you can improve, feel free to download our E Book ‘9 Smart Strategies To Set Your Financial Roadmap’