Case Study: How one small business added $100,000 in profit through margin analysis
As you learn to utilize your financial statements to optimize the earning potential of your business, a good place to start is with one simple step. Stop thinking in terms of dollars and start thinking in terms of percentages.
If your bookkeeper is not already doing so, have them add a column to every financial statement that calculates relevant percentages. On a profit and loss statement (aka, income statement) you will generally have all items on the page shown as a percentage of gross or net revenues. In other words, it is very helpful to know what your total cost of goods is as a percentage of either gross or net revenues. Likewise knowing your rent or payroll as a percent of revenues is more useful than knowing the raw numbers.
For an example of how helpful this can be, lets look at gross profit margin and net profit margin for the enterprise.
Gross profit margin = gross profit before overhead/revenue
You sell apples at the Farmer’s market. You can buy the apples for 25¢ each on most days. You usually price them at 50¢. You can determine your “sales margin” by dividing 25/50 or 50%. But life isn’t that easy. Some days you have to pay 30¢ due to shortages, and other days you find the suppliers all competing for your business and you negotiate a 20¢ cost.
In similar fashion at the Farmer’s Market, you have days with no competition, and other days with two other apple vendors. So your sale price fluctuates. You keep track of all revenues for the month and find that you have $10,000 in sales. You keep all your receipts from purchases and find that you have paid $5,500 for the apples for a net profit of $4500. Your gross profit margin is 4500/10,000 or 45%.
Now you have certain costs. The rent of your space is $500 a month. Your truck expenses are $600. You pay a helper $1000 a month. For simplicity sake, we will say these are all of your expenses related to the sales of apples. Your total overhead is $2100. You subtract this from your gross profit of $4500 to find your net profit before tax of $2400. To determine your net profit margin, you divide 2400/10,000 and you have 24%
By setting up that special column on your P and L (Profit and Loss) to see everything as a percentage of total revenues, you can also quickly see that your rent is 5% of revenues, your payroll is 10%, etc.
The margins that matter are:
Sales Profit Margin – Profit on sales of any specific product or group of products /Revenues on sales of those same items
Gross Profit Margin – Gross Profit/Total Revenues
Net Profit Margin – Net Profit/Total Revenues
You might also want to know your net profit margin including taxes.
Here is a P & L Statement that shows one method of laying out this information. You will see that you can easily tell the percentage associated with each and every cost of doing business.
In our next blog post, we will begin to look at how to use the information that margin analysis provides. It could change everything for you and your business.
We can help you create the monthly P & L for your business that will arrive in a timely fashion so that you can see how the business is doing and make corrections quickly. We can also provide you with an analysis of your various financial statements with recommendations about what you can do to increase your profits. Call ATPP today to get started – 818-436-2775.