Determining Profitability: How Do You Know You’re Making Money?

Every small business owner has a lot of energy to succeed and in the first few years, every challenge is taken head-on. However, you can only survive for so long, purely on passion and perseverance.

Eventually, you will need to rely on your ability to track and monitor your finances. The facts reveal the truth and the numbers don’t lie. If you’re not turning a profit, you have a flawed business and it’s only a matter of time before it goes under.

At the same time, you may also have a great business model, and you are making money, but there’s so much leakage that you could be making up to twice as much.

This is a brief primer for what you need to accomplish, so you can know if your business is making money, consistently.

 

 

Profit Margin Basics

Even if you’re new to the world of business, you can understand the basics of expense and profit. In other words, how much did it cost you to make something, how much did it sell for, and what was the difference gained or lost? Simple right?

But here’s where it gets complicated, your expenses won’t stay the same, not even for a week. You may lose money because your material costs rose, or during the production process, some products become defected.

It could also be that your box packaging had to be improved and thus, it’s cost rose too. Using accounting software will allow you to track your weekly expenses. Although it’s mainly to keep track of your profits, you can study where your expenses are fluctuating too greatly and then use the evidence to implement smart policy changes, to inject more stability in the costs.

 

 

Operating Expenses

Expenses come in many different forms. You could have expenses for product production, material procurement, and even travel. But what about the day-to-day operating costs, i.e. what it takes just to stay in business?

This includes the utilities, the electricity that powers your computers, lights, office building, and more. What about the heating in the office, so employees don’t feel cold? What about the rental cost for the commercial property you work from?

How much are you paying your employees? Check the payroll to see what the monthly expense is to hold onto your skilled staff. Operating expenses can begin to outpace your revenue because the turning of the profit isn’t as fast or as consistent.

Operating income is deemed to be included in the ‘total expenses’ of your business. Make sure that you’re looking at the month-by-month operating expenses your business incurs, and try to cut costs wherever you can. Your business may require extra operating capital from investors if you believe it will begin to eat into your revenue-making ability.

 

Receiving money from partnerships

If you’re in a business partnership of some kind, you will be receiving money from the contract you signed with them. Working with a distributor, they will normally give you a lump sum every month from the money they have made, from selling your product. If you have signed a long-term exclusivity agreement with a wholesale company, they will also be paying you for the privilege, every month as well.

After you receive the payment amount, you should put it into your accounting software, so that it can be included in the final summary at the end of the month, or financial quarter. Cash-based accounting is better for small businesses, because it breaks down what you’re earning, by month.

However the data can also be extrapolated into a yearly-spread, so you know how well or badly your business performed overall seasonal periods.

 

 

Fluctuating markets?

What about if you are a business in a market that continually fluctuates? Many of the tech industries tend to have this sort of instability, but no more so than in the oil and gas industries. To put this into context, oil prices per barrel, slumped to incredible lows in 2015, going from $150 a barrel to around $80-100.

However, during the lockdown, there are oil-producing companies that were literally paying others to take the oil from them as they had no room to store the barrels. This brought the price to -$20 for a day or two.

This sort of industry is difficult to track for small business owners. That’s why you should increase your knowledge of revenue accounting from an expert like  https://www.copas.org/shop/principles-of-revenue-accounting-boot-camp/. This boot camp will cover the history of petroleum so you understand what drives the market. It will also cover things like oilfield operations, oil leasing, gas operations accounting, gas plant accounting, and other similar topics.

In fluctuating industries, it can feel like you can never really gain an accurate picture of your profit margin every month. But with this kind of training, you know what to look for, what indicators matter most, and therefore, compile an accurate report of your business’ performance.

 

 

Sales and Figures

Not every profitability indicator is going to be all about the finances. Your business will need to rein in a continuous body of sales in order to remain profitable. This means, studying the sales figures. What number of average sales do you make every month?

What is the average price of the sale that is made? What kind of sales margin do you have, before you can discernibly say you are in danger of losing money for the month?

Yes, it’s not finite and not as accurate as of the study of the profit itself, but you can gain a good vibe for when things are going great. Let’s say you make 200 sales a month, and the average sale price is $20. In order to break even, you need to be making $3,000 a month.

Right now you’re making $4,000. If you were to make 150 sales at that same average sale price, you would break even. Make fewer and you’d be making a loss. However, if you made 250 or 300 sales at the same average price, just by looking at the sales figures you know you’re making a profit. How much you’re making, is found by diving into the weeds of accounting.

 

Seasonal Relevancy

Small business owners are rightfully afraid that their business will be beaten out by large competitors during seasonal sales opportunities. With a great marketing campaign, you can roll with the big dogs and show that you have what it takes to turn a profit during the most competitive times of the year.

But sales indicate discounts, coupons and price cuts. How do you know if you’re making money when you’re offering such incredible bargains? It’s all about making ‘package’ deals. Bundling smaller, less expensive products with larger products, will help you to meet the profit threshold and even beat it.

Let’s say a pair of jeans cost you $10 to make, and you were selling them for $25. You could cut the jeans half price and you would still be making $2.50 of profit. However you could sell them as part of an outfit, where the most expensive products to make are cut less, but the lesser products are cut more drastically in price.

The bulk of your profit wouldn’t be harmed and you would be spreading your name during a very competitive time.

The most basic way to know if you’re making a profit is by figuring out the margin. How much does it cost to make a product and how much do you make from selling it? However, then you need to include operating costs, such as overheads, employees, utilities, rent, etc.