Running a small business can often feel like a mouse on a wheel. Lots of activity, lots of money in and then lots of money out. So, how do you know if your business is actually profitable?
Here we take a look at how to give your business a bit of a financial health check and determine just how profitable your business is. There are several indicators which you need to review.
1. Sales Revenue
Sales provides the income into the business. Revenue into the business is critical and without it the business can’t be profitable. However, unless other factors are managed high sales revenue doesn’t automatically equate to high profit. However, it is certainly important so tracking sales on a monthly basis and putting in considerable effort and resources to increase revenue is important to profitability.
2. Merchandise expense
The cost of sale or cost of goods sold in relation to the revenue is important. The lower the merchandise expense the higher the gross margin on each product. Gross margin is calculated by the sales revenue minus the cost of goods sold. For example if the sales revenue for a product was $100, and the cost of goods sold for that item was $10 then the gross margin for that product would be $90. This is important because the business has other operating expenses other than just the cost of goods sold. If the gross margin is high then there is more chance of the business being profitable.
3. Operating expenses
These are all the other costs of running the business. This includes everything from office supplies, rent, depreciation, staff costs, and even litigation expenses or regulatory fines. Businesses need to spend money, and often to grow the business these expenses may need to increase, for instance they may need to invest in additional marketing, or lease a larger premises. However, managing and monitoring these expenses is critical. In order to be profitable these costs need to be as low as necessary.
4. Net Income
Net income is the number that matters! Net income is the revenue received minus all the merchandise expenses and less the operating expenses. Therefore if a business received $500,000 in sales revenue, but spent $350,000 in merchandise and operating expenses then their net income or profit would be $150,000.
Speak to your accountant or have a look at your books and give your business a quick health check by reviewing these 4 key figures in your business. This may then highlight for you the areas that you need to work on to help you become more profitable. It might also highlight some areas that you are doing really well in and open up some ideas and capital that you can spend in areas that will help you increase sales revenue to grow your business. The key factor here is to understand how profitable you are before you try and grow the business. You want to ensure that you aren’t perpetuating bad habits or or unnecessary costs further as you scale up.
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