INTRODUCTION - BUSINESS REVIEW AND PLANNING
In order to commence a business review and planning process there are 5 key areas which a small business operator should focus on in order to establish the current position of the business and key areas to focus on to maximise the return on your investment.
These 5 areas are:
- Profitability
- Cashflow, liquidity and Solvency
- Efficiency
- Business Planning
- External Issues and Trends
PROFITABILITY
Profitability is the key to the success of every business and needs to be monitored to ensure that the profitability is maintained in order to provide a return to the shareholders, that the assets are not eroded and there is sufficient working capital to continue to grow the business.
Some of the best tools for evaluating the profitability of a business include:
Gross profit Margin (Gross Profit/Net Sales x 100)
Gross profit is the percentage of sales dollars left after deducting the direct costs of the sale (e.g. materials, stock, production wages etc) and shows how much is left to meet the general overheads of the business.
A small change in the Gross Profit margin can bring about the biggest change (good or bad) to the profitability of a business and reflects changes in issues such as pricing, productivity and general efficiency.
Mark-up (Gross profit/Cost of Goods Sold x 100)
Generally used in a retail/wholesale business the mark up is the percentage difference between the actual cost and the selling cost.
Mark up is a good rule of thumb in setting pricing in order to ensure there is sufficient gross profit to meet the costs of the sale and running the business
Earnings before Interest and Tax (EBIT) margin (Net profit before interest and Tax/Net Sales x 100)
This EBIT margin is the percentage of sales dollars left after deducting the cost of goods sold and all expenses except interest and income tax.
As interest and tax costs can vary from business to business depending upon the personal circumstances of the owners this ratio is often used to compare profit results with other similar businesses.
Breakeven Analysis (Fixed overheads/Gross Profit Margin)
The breakeven analysis provides the level of sales required to meet the overhead costs of the business and before any profits are generated for the shareholders. This analysis is useful for the business owners to gauge readily if the business is generating enough business to at least break even. Another similar analysis includes a target profit margin and is extremely useful in setting sales targets for staff.
The next article in the series will be on Cashflow, Liquidity and Solvency.
