Knowing the numbers in your business is one of the most important aspects of success. However, most small business owners don’t take the time to understand their financials. You can be the best salesman, produce the best work, be a marketing genius and the list goes on but if you don’t know how to price your services to be profitable you will struggle and the business will ultimately fail or be unable to grow due to financial constraints. 90 percent of business decisions should be objective and made based on analytical information. Often times business owners go purely based on how they “feel” the business is doing or soley just by looking at the balance in their checking account. Understanding the financials of your business allows you to know the health of your business.
Business owners love to talk about how much there business “makes” which is usually their GROSS REVENUE. This is an important number to know but if that’s all you know there’s a few more to numbers to understand. Only knowing your gross revenue is like going to the doctor and only telling them your height and expecting them to tell you how healthy you are. . Your gross revenue is your height!
The second most important number is your gross profit. GROSS PROFIT is what your company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services. For example, if you are a landscaper this number is the profit left over after you pay for the materials on the job, labor, fuel, etc. Basically any cost that was associated with producing the job. Gross profit is extremely important because setting your gross profit percentage on your service is how you determine your pricing. Your gross profit is what you use to pay your expenses (aka overhead). Rent, insurance, cell phone, owners salary, office manager, etc.
The third is NET PROFIT. This is the actual profit after working expenses not included in the calculation of gross profit. Net profit tells you how the businesses expenses align with gross profit and total sales revenue. If your expense load is to high or your gross profit is too low then your net profit will be directly impacted.
And lastly the 4th most important number to know is your DEBT SERVICE COVERAGE RATIO. This is the cash flow available to pay current debt obligations. The ratio states net operating income as a multiple of debt obligations due within one year, including interest, principal, sinking-fund and lease payments. If your debt obligations (loan payments, lease payments, etc.) on an annual basis are $25,000 and your net operation income is $37,500 then the debt service coverage ration is 1.5x. Most banks require at least 1.2x coverage for commercial loans.
Your annual budget will be based on these these 4 numbers. This will help you track your progress and the health of your business.
Have any questions? Feel free to reach out to us for more information!
By Corey Sedrel
