Do you have “Financial Control” part 2
by Colin Linke on 10/02/10 at 9:10 pm
2. Gross Profit.
Every business has a set of expenses that relate directly to the revenue derived. They rise and fall depending on what level sales are at and they identify the costs that go into directly attaining that revenue.
If you are a real estate agent then the commission paid to sales people and property managers is part of this expense item. If you are a law firm then the costs of your staff who directly bill clients is part of your COGS and if you are a medical practice then the doctors employed or contracted are also costs relating directly to your revenue.
The problem is that very rarely do I see this set up correctly. People often just lump these costs in with their overheads. So why is this such an issue?
Well your COGS and associated gross profit shows you very quickly how you have performed in your core activities. If your gross profit has always been 30% but this month it is 50% then something is wrong and it needs review. Geting this margin right is critical for EVRY business. Slightly increasing your sales price or reducing the core expense items here will return a greater amount of gross profit that may very well add straight to your bottom line.
3. Your 5 key expense lines
The 5 biggest expenses in your business are irrelevant – unless you can control them. Yes you may be paying $100,000 in rent but if you are locked into a 5 year lease then what changes can you make that will reduce the cost – very little.
You need to know what items in your expenses are the largest that you can effect quickly if business conditions change. That way you can review your supply contracts and prices and ensure that you are getting the best deal. Furthermore, if you realise that you represent a really good annual sale value to your supplier then you may well have some leverage to realize a better buying price.
4. Do you have enough working capital?
The question that I usually get asked when referring to working capital is: what does it mean?
Working capital is basically having enough cash coming in to meet your financial commitments. That cash will be in the form of cash and assets that can be easily turned in to cash – so debtors and stock. Without this key ingredient in your business you will not be successful.
So how much working capital is the right amount?
There is no right answer here and every business will have their own “right” level. Again a budget constructed properly will highlight what you need. You need enough to allow short term issues or unforeseen glitches to be covered. I would normally like to see somewhere between 6 and 12 weeks coverage but some businesses may need only a couple of weeks as their sales will be virtually guaranteed.
If you do not know your working capital requirements then you need to – and fast.
5. The value of your Business.
Everyone in business should be continuously thinking about their exit strategy. Do not think that just because you are ready to sell that you can do so whenever you like. It is a long drawn out process in most cases and needs planning and forethought to ensure you get the best result.
You cannot do that without the knowledge of what your business is worth at any point in time. Now businesses are worth only what someone is prepared to pay today. No valuation method provided by a broker or valuer will ever be 100% accurate. In fact most brokers that I have worked with are well off the mark except in specialist industries.
However knowing what businesses sell for in your area is important and you should be measuring that. At the very least use a conservative multiple on your earnings – say 3 to 5 times net profit for the year, and track that over time – probably once a quarter in enough. You will then know whether you are in fact moving towards your exit strategy or not.
Conclusion.
The things that i have outlined are by no means the entire list of tools that you need to have a handle of in order to have control of your business. There are many more around cash flow – such as debtors days and stock turns – that should also be measured. However the above shows that you are looking at what your business is doing and how you can effect the outcome. These will probably create a thirst for more key data but in every business in Melbourne the above is certainly attainable.
