Can turnover be changed by business owners?
The question of turnover and size are often treated as things which can not be affected or changed by business owners, just as importantly many businesses are unsure of their profit break even figure. More concerning still is the assumption that more sales means more profits, as this is often not the case.
In the past many companies have suffered from over trading, where larger and larger orders are taken on, to the detriment of the profit margins and overhead costs which in turn can lead to overall losses and a bottleneck in cashflow. Last year many companies had the opposite problem where the turnover dried up overnight with the Global Pandemic and they had to close doors or dramatically change the way they traded in order to survive. Many companies did not survive, but those who did, found new markets and used the grants and loans available, and this leads to the next issue many will be facing which is how to manage cashflow and repay the loans? Just as importantly, how can we repay ourselves for the money that we have invested and spent on our own businesses over the last year?
How Do you manage the cashflow and pay back the loans?
Hopefully when applying for COVID and Bounce Back loans, you will have had a business plan in place which made sense. You will also have been able to retain the right staff, pay the redundancies to those you couldn’t keep, and keep your other creditors satisfied that any debts will be repaid in good time.
Now of course we are having to put those plans in action, in a different landscape to pre lockdown. Not only is travel harder to plan, new tax and COVID rules are in place for offices and retail centres, but importing or exporting stock to Europe now has far more issues for UK companies. In short it is brave new world which is opening up, we are each finding our feet, and learning what works and what doesn’t.
We are finding ourselves in a brave new world
So how can we make running a business easier to navigate? How do we know what we could be doing to become both profitable and be able to repay our creditors, without overtrading and creating more problems for the future?
One way is to try and simplify what we are doing and work with the numbers in a way that makes sense.
Three Calculations to remember to make yours business make sense
1.What’s Your Capacity?
How much can you sell of your product, or how many hours of service can you and your staff do to make money? It is worth knowing the answer to this question, and you would be surprised at how many people don’t. This is also the question that has been effected most by the pandemic, and which has stopped so many businesses from succeeding.
For instance if you are a floor layer and you charge by the hour, your earnings for a day will your hourly rate for be a maximum of 8 hours. If you charged £30 per hour you can not earn more than £240 a day, unless you take on more staff.
If, you are a floor layer and you charge per square foot or flooring, you can charge more for the job depending on the room sizes, but you are still restricted to how much you can do in one day. The maximum you can do and charge for is your capacity.
Another example is a shop that sells soaps and candles; the maximum that the shop can purchase at one time is the maximum that the shop can sell. If the product is suddenly unobtainable from the shops’ supplier, as has happened this year with cargo held up from Europe, the sales capacity drops dramatically, unless another supplier can be found. Again it is a good idea to have alternatives available in case of issues, after all it wasn’t the first time that trucks have been held on the M20.
The point of this, is to know what your maximum sales can be, so that you can then determine what you want them to be in order to cover your costs and make a profit. After all who wants to work 6 days a week 8 hours a day only to find out that they aren’t earning any money after paying all the bills?
2. Profit Ratio
Also known as the Profit Margin, this is arguably the most important of all business calculations, and as every plumber and shop owner will tell you it makes the difference between taking on a job, or not.
Turnover – Cost = Gross Profit
Gross Profit/ Turnover = Profit Margin(%)
You need to know how much you will gain from each sale, as this will cover your overheads and other costs. The issue is often that new business owners can get a little confused with Gross and Net profit, Gross Profit is what the sale earns you directly. Net Profit is what you are left with after running costs and taxes.
3. General Overhead costs
Unlike direct costs, overheads are incurred everyday whether you sell a lot, or nothing at all. Over the last year, companies have been cancelling their lease rentals for premises and equipment in droves, as they have had to downscale and their employees have been working from home. Even profitable businesses have been assessing their options for office space as they want to keep their overheads low.
The easiest way to assess your overheads, is to look at your last years trading records, or to count up your monthly direct debit costs or supplier payments on your software.
This group needs to be separated into two piles, what do you have to pay no matter what, such as software licences or staff wages, and the other group has the costs that you benefit from, but can change if you need to, such as cold water machines and cleaning companies. Who goes into each pile depends on your business structure and the trade you are in.
You work out from here what overhead costs you have each month, no matter what and after you add the loan repayments you have, this becomes your break even costs. When you know what are essential costs, you also know what is not essential and can be cut back on if sales are low.
4. Cutting Your Cloth
This is an old saying, but well worth remembering right now, because it is what we do with the information we have just worked out.
We find our capacity, such as we have 100 bars of soap we can sell, or we can work for 5 days, and earn £200 per day, or better still we have orders for 200 bars of soap or an order to work on floors for a customer for a month.
When we know our expected revenue, or capacity, we can work our direct costs for the project, such as what we paid for the soap, or our materials to lay the flooring. We then know what our Gross Profit will be for the period in hand, and likewise what will be left to cover our overheads.
If the profit for the soap sales covers the shop overhead costs, we have a profit. If however the soap sales give a Gross profit that is less than the overheads, we will need to sell something else as well to make up the difference.
Knowing these figures in advance of taking on a new lease, entering into loan agreements or buying machinery will mean that we know whether we can rent the BIG soap selling shop with the lovely window display, or whether we should rent a slightly smaller shop and wait for a bigger capacity before renting the larger premises.
Likewise, the floor layer will take on the jobs which will mean he and his staff can work a 5 day week and take home a sensible wage, rather than take on the bigger job, with longer payment terms a smaller profit margin.
A client of mine had found in the past that even though they were achieving a high turnover each year, because they were not clear on their margins they were only breaking even each year, and sometimes making a loss. After assessing their business and systems, we realised what the problem was and now they only take on projects which have a sufficient profit margin to cover their overheads. As a result their turnover has fallen slightly, but their Net Profits after Tax are back up to where they want them.
It isn’t always the big companies who make the most profit
As we have seen over the last 12 months, it is the larger firms who have bigger overheads and who were not able to move as quickly with the Pandemic who suffered the most. The business owners who saw the issues arising from Lockdown and who were able to change their business to accommodate the ‘new normal’ were able to survive and thrive.
I have often heard how business owners and their staff were better off being small, profitable and able to adapt. We now have another change as Lockdown lifts and now is the time, if you haven’t done so already, to take stock of your business and see if you are still heading down the right path, or if new changes need to be made.
Ella M Doherty FCCA
Please get in touch and find out how Aviatrix Accountancy Limited can help.
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