Understanding Business Finances and Results - Part 1
Steps to Knowing the Score
Picture this, you sit down to watch your favourite sport event part way through the game. Your team scores and the crowd cheers. You want to get excited but there is no score displayed on the screen. You don’t know if your team is behind or in the lead. You don’t know how long the game has to go.
Imagine the frustration as the game plays out and you don’t know what your team needs to do to win.
Now imagine you are playing that game and you don’t know the score. There is 20 minutes to go and you don’t know if you are in front or behind. You don’t know the margin in the score. How do you determine what strategy to play out, should you go full on offensive or defend tooth and nail?
Should you play for time to wind out the clock or do you need every second available to ensure a win?
This all seems rather silly though doesn’t it? Because the score and the clock are always there or are always being communicated to the players. They can make informed decisions on how to play out the rest of the game to get the victory.
So, now imagine that you are sitting at your desk in your business. Your team are seeking instructions on what to do next. You are thinking about the next week, the next month or the next year and what direction the business needs to take.
If that is you, right now in this moment, can you honestly say that you know what the score is for your business?
How often have you made decisions not knowing what the score is?
How often have you set off in a new direction not knowing the current status of your finances?
For many businesses this occurs far too often. Thankfully there is something that you can do about it. Over the next few weeks we will guide you on how to measure, monitor and analyse your score so that your business achieves success. Let’s kick things off with the first step to knowing your business score.
STEP 1: Understand the financial model of the business
This starts with the business revenue and how it is generated. For simplicity let’s take the example of a fully automatic car wash that only has two wash options, standard and deluxe. The following are the factors that we will use to build the revenue aspect of the financial model:
- Average customers per day – 20 Standard and 15 Deluxe
- Pricing – Standard $25 per wash and Deluxe $40 per wash
- Operates ever day of the year
Based on these numbers the Revenue will be $401,500 using the formula (20 x $25 + 15 x $40) x 365 days.
Next, look at the costs that will directly fluctuate with the rise and fall of the number of services/products sold. Using the automated car wash example, these items will include cleaning and washing agents such as soap, detergent, waxing and rinsing aids. Taking the revenue number and deducting these direct costs will result in the Gross Profit.
The second last step is to determine the Overhead Expenses for the businesses. These are the expenses that are either fixed regardless of turnover or are only loosely tied to the level of turnover. An example of loosely tied to turnover is water rates. This will fluctuate based on the number of washes sold however, with the fixed service fee component and the very low usage rates, the fluctuation for each additional car washed is too small to be a meaningful factor in the Gross Profit calculation.
An example of an expense that is fixed is Rent, this amount is the same regardless of how many car washes are performed. Other overhead expenses can include:
- Accounting Fees
- Bank Fees
- Office Expenses
- Repairs and Maintenance
- Salary and Wages
- Telephone and Internet
Finally take the Gross Profit and deduct the Overhead Expenses to arrive at the business Net Profit.
Now that you understand the business financial model, take a look at our video here which explains how to use the business model to determine the profit that your business needs rather than taking the profit that it gets.
Hanrick Curran has many years of experience supporting SME business owners to improve their business performance. If you would like to review how your business is currently performing and discuss strategies that can have a significant impact on your business please do our online business improvement assessment, speak with your usual Hanrick Curran advisor, or alternatively call Robert Pitt on 07 3218 3900.
Stay tuned for our article, Key Performance Indicators.
Please note that this publication is intended to provide a general summary and should not be relied upon as a substitute for personal advice.