In this series on the elements of your financial statements we’ve looked at the income, cost of sales and gross profit, all parts of the selling aspect of your business. Today, we’re going to look at the operational side – the costs associated with the infrastructure that enables you to sell your product.

In the olden days, the travelling salesman’s operating costs consisted of his mode of transport and his suitcase full of products. Nowadays, the costs of running a business are much greater, and grow as your business grows, to support the increased sales volume. Operating costs can fall into one of the following categories:

• Physical infrastructure – costs relating to the office, the warehouse or the shop, costs relating to vehicles and other assets, as well as the costs associated with running the machines and equipment used to produce your product or service
• Human infrastructure – the people costs, not just salaries, but welfare and development as well
• Protection of the infrastructure and assets – such as insurance, security, data storage, liability cover
• Compliance requirements – the cost of complying with accounting requirements, labour laws and SARS legislation, as well as governance rules
• General running costs – the cost of items consumed by the process of running the business, such as telephone, data, stationery, food, amongst a host of others
• Growth activities – costs associated with plans to grow sales and the business could include marketing, consulting, and anything else that the strategy requires

Operating costs are the first area to come under the microscope when the business profits need improvement. While there are sometimes a number of areas that can be reduced, there are also some critical elements. It is short-sighted to skimp on the maintenance of the equipment to save on costs when replacing the equipment is a much higher cost, for example.

Do you know what it really costs you to run your business? Do you know what the monthly operating costs are that need to be covered without fail? If you’d like a better insight into your business give us a call to walk you through the information available.

Profit is a fond topic for most business owners, but do you know the difference between gross profit and net profit? Gross profit is the net result of your sales and your cost of sales, in other words, the profit on the sale of your product. Net profit, is the larger gross profit less all other operating and financing costs, usually a fraction of your gross profit!

Gross profit can be calculated for various elements that make up the total sales of your business, such as the gross profit per product or product category. The total gross profit in your financial statements depends on the number of products you sell but doesn’t show you the amount of profit you are making per item sold. Most accounting packages have this information in one of the stock/item reports. It is very helpful to analyse the gross profit per stock item, as you can see which products make you the most money, and therefore what you should focus your sales effort on.

The same principle can be applied to business divisions. By calculating the gross profit per area you are able to see who is pulling their weight and who is not contributing enough towards the running costs of the company. For service businesses, it is also possible to calculate the gross profit per service by including the salaries of the staff, and other costs, into the calculation. Typically service businesses keep some form of timekeeping, where it is possible to see how much of a person’s time (and therefore cost) can be allocated to the various services they perform, even better if individual staff members can be allocated to a specific service. Accounting packages are not set up for this level of analysis, so a spreadsheet is often necessary.

It may be easier to understand the gross profit as a percentage of sales rather than a rand value. Knowing that a product makes an R5 gross profit doesn’t have as much meaning as knowing that the gross profit is 75% of the sales price. Using percentages, you are also able to compare products and the value that they add to the operations of the business.

It may be necessary to dig a little into the accounting information to get a real picture of the gross profit of the business. Should you need a spade or a little help digging, let us know.

 GP – service GP, per product, overall, per division – % vs rand

Last week we looked at income and the various types of income as part of our mini-series on the elements of your financial statements. Today we’re looking at a very misunderstood area – the cost of sales.

Many people think that cost of sales is the cost of the goods you have bought (or made) to sell to customers. It is not – the cost of sales is the cost of each product that has actually been sold. This means that if you have paid a supplier for stock, that is not yet sold, the cost won’t be included in the cost of sales.

This is important because of where the cost of sales is reflected in the financial statements. Cost of sales is an expense which reduces your profit, and therefore your tax. Thus it should not be overstated, by reflecting all the purchases during the year. The cost should match the sales, in other words, if you sold 10 items, the sales price for those items shows as income, and the cost of those 10 items shows as an expense. The cost of any unsold items sits on the balance sheet as stock on hand.

What if you don’t sell stock, what if you offer a service? Then according to the accounting definition, you DO NOT have any cost of sales. However, this is where pure accounting and the needs of management differ.

The real cost of making the sale may include any number of expenses depending on your business. For example; a service business may consider their technical staff to be a cost of making sales. What about travel and entertainment? Management reporting could include all of these expenses as the cost of sales to help understand how the business makes money and how well it is doing that. No-one said that the management reports needed to be in the same format as the annual financial statements. The accountants can re-classify the expenses for compliance purposes, as long as management has the necessary information to make decisions.

Next week we’ll look at the net result of sales and cost of sales, gross profit.

If you’re not getting the information you need from your management reports, perhaps they read too much like an accountants report, give us a call to help you re-format them into something useful

Over the next few weeks, we’ll be looking at the various pieces of the puzzle that are the financial statements, so that you understand where to look for something, where information should go, and what you can get out of the information presented. Today we’ll look at INCOME, which is at the top of the income statement, usually the place people start.

Not all receipts (into the bank account) are income. This is important to understand, especially if you are managing your business from your bank account. Some receipts are the payment from your customers for your product/service, but receipts may also be of interest earned, repayments of a loan you’ve given, or reimbursement of expenses you’ve paid. The last two should be set off against the original payment and not recorded as income in your financial statements.

In accounting terminology, there are 3 main categories of income:

• Sales of your product or service (which is obviously the most important for most businesses)
• Passive income generated on your assets, this includes interest on your bank accounts, interest charged on loans given to others, dividends on investments, charges for using your equipment or vehicles, amongst others
• Other income, this is income that is not generated by the business, such as grants or donations or profit on disposal of assets

In your annual financial statements, there will be a line for each of these, if relevant. However, from a management point of view, you may want to break them down further and reflect a number of lines for sales in your management statements. You may have separate product lines, divisions, or locations. It can be useful to see the sales at this level to understand what is working in your business. Many accounting packages allow you to print a report showing the sales per product/service, which can be very helpful to review regularly.

Although income will be summarised in your annual financial statements, management should be engaging with the income at a more detailed level on a regular basis to assist in making business decisions.

Next week, we’ll look at cost of sales and the meaning of gross profit.

‘Cash is king’, says everyone to a small business owner. It’s not a platitude, it is true. It doesn’t matter what your sales are if your customers haven’t paid you.

As a business owner, you have it down to a fine art the ability to pay your creditors at the last minute, while chasing your debtors furiously. You’ve mastered the art of putting people off just a few more days so you can pray earnestly that enough money comes in, just in time. You are the King/Queen of last minute and stretching the last cent.

Imagine, it’s one of THOSE months, and you get a call from your accountant reminding you that your provisional tax is due in 2 weeks’ time. After you’ve sat down, had a zanex or a cup of coffee, you scroll through your contacts list to see who you can call, what plan you can make, how you can scrape to get the cash ready in time. As you know, SARS are the worst creditors, they really make you pay if you are late!

Is this your reality? It shouldn’t be. You know exactly what you need to have in the bank to make it through the month, but do you know what the annual (once a year) costs are, and when to expect them? Things like subscriptions, licence fees, membership fees, provisional and income tax, annual financial statements, etc. The annual costs should be included in your diary at least a month in advance to avoid any surprises.

It is also important to plan for these large amounts. Seldom do you have the spare cash lying around just when you need it? It is important to set aside a contribution towards the cost each month. If you provide for it now, regularly and without fail, the money will be there when you need it. And put the provision in a separate bank account so you’re not tempted to use it!

Give us a call if you need some assistance establishing what costs you need to keep track of and how much you should set aside for them.

How do you define performance in a business; more specifically how do you define financial performance? Good performance is very easy to recognise for sports people or athletes. There is a target that they are working to beat; say their last marathon time, or their personal best, or the world record, or even just their rival’s score. It is obvious when they have performed well and when they have underperformed. It’s also obvious from the celebration – the fist pump in the air or the lap with the flag.

What can we learn from the world of sports when it comes to the financial performance of our companies? The most under-rated lesson is to CELEBRATE good performance or even just better performance. We are motivated to achieve more, to do better, when we recognise the work that has already gone into our performance and identify the things that have gone right or are working well. Celebrating also gives us a moment to stop and reflect on what we have changed/improved that has made all the difference, and imagine how to do more of that thing.

Another lesson from the world of sports is how to tell if performance is good or bad. There is always a TARGET that the person is trying to reach. In business we often consider performance to be the profit of the company. In fact, the income statement (showing the profit) is now called the Statement of Financial Performance. Setting a target for the profit of the company is a good idea. However, it is also important to look at the variables/elements that generate that profit, as they all need to work together to reach the target you have set. Consider setting realistic targets for your costs, for your turnover, for specific products. What about the management teams, sales people and internal processes that are necessary to achieve your goal performance?

Set up a meeting with our financial management team and we will help you to identify the cause and effect relationships in your financial flow, to establish where you should set targets for improved financial performance.

When you are asked for your financial information, most business owners think TAX, which is very pertinent at the moment, since there was a tax deadline at the end of January and there is a provisional tax deadline coming up at the end of February.

But financial information shouldn’t only make you think about your taxes and complying with SARS’s requirements. There are so many other important reasons to understand the finances of your business. If you’ve ever watched an episode of Dragon’s Den, you’ll know that Peter Jones always wants to know the numbers of the business, and it is fatal if the business owner doesn’t have the right information at their finger-tips!

You might not be entering Dragon’s Den any time soon but it is still important to know your numbers; what your turnover is so far and in the last month, what profit you’re making, which are your most successful products, who are your worst paying customers.

As creative entrepreneurs, we often shy away from the numbers, but the information tells a picture and sometimes a picture (or graph) can tell the story. We are using graphs more and more when communicating financial information to clients, as it is easy to see what happened and where you are going, without engaging with the numbers.

If you are not getting a clear picture of your accounting system and financial reports, give us a call and we’ll use the numbers to help you tell your story.