Counting the cost ... a beginner's guide to business maths
You don’t have to be a maths master, with a few easy steps you can track costs, monitor gross profit margins and understand trends
While technology can help, understanding the numbers can give entrepreneurs insight into the health of their business. Photograph: Alamy Stock Photo
If you want to generate more cash flow for your business or break even faster, a basic understanding of business maths is going to really help you.
However, getting to grips with the numbers can be one of the biggest pain points when running a business – particularly if you feel it’s not your forte. As well as the dreaded figures, there’s also the jargon that accountants, tax officials and “useful” software packages delight in using.
To understand how your business is doing and how you can better steer it to profitability, you just need to know three things:
Income and expenses.
What the business owns and owes.
This information is contained in three reports – the profit and loss, the cashflow forecast and the balance sheet – all of which can be created via accounting software using your transaction history.
The good news is modern generation accounting packages such as Xero, QuickBooks and FreeAgent are much easier to use than the desktop software they replace. If you can use MailChimp or Eventbrite, you will be well placed to tackle online accounting software.
Once you have your numbers, what are you looking for? Rather than being reassured that sales and profit are increasing, you should look for trends to reveal what’s really going on with your business.
The power of trends
Most eyes will naturally be drawn to the gross profit figure. This is profit after cost of sales (basically after the cost of your raw materials) but before your overheads like rent, marketing and accounting. In this example, we can see that sales and gross profit are rising. However, if you express gross profit as a percentage of sales – or gross profit margin – what is the trend?
To calculate this figure, take the gross profit for the period and divide that number by sales over the same timeframe. Then multiply by 100 to make it a percentage.
In the case of the above example, the gross profit of year three is 60% (£120,000/£200,000 x 100 = 60%). Now do the same for years one and two so that you can compare.
We can see that although gross profit is rising in money terms, gross profit margin is falling each year. That means the business is making less gross profit per sale. While sales are rising, the cost of sale is rising faster.
Being aware of such a downward trend is the first step towards identifying whether or not your business has a problem that needs to be solved. Investigate – ask yourself, why is this? Do these numbers make sense? Maybe you decided to reduce the price to boost sales or you gave an important client a significant discount; maybe the ingredients are costing more, or there are portion control issues, or instances of fraud.
Tracking the gross profit margin is crucial if you are to understand how much value you have retained in the business. It is this gross profit that goes towards covering your overheads.
You can also track net profit (profit after all costs including overheads), or particular expenses in the same way to reveal other issues within the business. For example, if you track labour costs as a percentage of sales across a number of months, this will show you if your team are becoming more or less efficient.
Mastering business maths and tracking trends will help you to drill down to the nuts and bolts of the business and make informed decisions about pricing, costs and revenue.
The challenge is setting time aside to review your business numbers. My best advice for this is to create a financial routine. Make every Friday a finance day and spend it reviewing the numbers. Time spent on the business maths side of your business will pay dividends – literally.