The Bottom Line from International Beauty TV - Understanding turnover & profit
The Bottom Line
Understanding turnover & profit
John Forbes
John is a Chartered Accountant, focused on his and clients Bottom Line! Founder and owner of Forbes, Chartered Accountants, based in Essex for the past 10 years; current Probiz sole Practitioner of the year. Probiz is a network of over 300 accounting firms providing specialist solutions and products to its members’ clients. John specializes in general accounting and strategic tax consultancy for owner managed business in Essex and Nationally. 20 years Industry experience as Group Finance Director, including mergers & acquisitions and Joint Ventures. Non executive director of small multinational. Wide international experience on a world wide basis. Experienced in acquiring, quick profit turnround and subsequent tax efficient sale of a significant accounting practice whilst continuing to run his own.
T: 01371 876640
Introduction
It has never ceased to amaze me how what an Accountant may see as too basic to even begin to explain – maybe for fear of insulting a client’s intelligence – is completely beyond the grasp of most non-accountants! So all they get is a load of meaningless jargon rather than the basics they wanted. Or maybe the Accountant is too busy writing up the books to even understand these basics, let alone take any interest in them.
I will try and clarify some basic accounting terms and give some ideas as to how you might work to improve your business performance.
Turnover – what is it?
This is simply your sales of goods and services – what you take through the till – after deducting any VAT element if you are VAT registered.
People go on about their Turnover – easy to measure, easy to target and concentrate on – but the old saying is
Turnover is vanity, Profit is sanity
For good reasons. Turnover can require a lot of financing – premises, equipment, working capital, marketing costs – and if you give credit, increased exposure to bad debt. The more you chase Turnover growth for the sake of it, the more pressure you may get on margins, reducing profit …..
Profit – what’s that?
Profit is your turnover less all costs and expenses. If you’re a sole trader or a partnership, its what’s due to you and what you pay tax on – but it’s a bit misleading as its before what you as proprietors might expect to earn as a wage for managing the business. So best get real and mentally deduct a living wage for each proprietor before you count real profit.
It’s the reward for your effort, and also all of the risks you take in running a business – and a return on your investment in the business – after all, you could cash in and put the money in the bank although, at today’s interest rates, you wouldn’t make a lot.
So what’s the difference – Turnover and Profit?
The basic difference is you can’t spend what you take in Turnover, you have to pay out VAT, suppliers of goods, staff, rent and all business expenses. Whereas, after setting aside money to finance increased working capital financing (stock and debtors) and new equipment, profit is yours to spend – and be taxed on. So its profit that matters – and within profit, how much cash you can actually spend – the more working capital you need, the less profit will be turned into “free cash flow” – or simply, what you can spend on you.
So – you need to focus on making profit. How? Well, usually it will mean making sure that turnover growth remains profitable – in other words, don’t chase business that doesn’t leave you better off after everything is paid for.
So you may need to increase Turnover but think about whether you could cut out some of your Turnover – think in terms of clients and products and services – and actually end up making more money (profit). And freeing up working capital so releasing more cash you can spend. Turnover for the sake of it? A big NO! Remember, Vanity versus Sanity.
So how can I increase my turnover?
Accountants do like to use formulas! Lets say Turnover is the number of people you serve or sell to X the number of times you sell to them or serve them in a year X the value they spend with you.
And the value they spend with you is the number of products they buy or services they take from you X the average price per product or service.
So, to state the obvious, you can increase turnover by doing one or more of the following, whilst not reducing any other element:
Increase
Number of customers
Number of times they buy
Amount they spend with you
How to increase the amount they spend?
Sell additional products and services
Increase prices
There are a whole variety of ways in which you can try and stimulate customers to buy more often – to spend more each time they buy – which are beyond the scope of this article. But what you might want to do is ….
Make it easy for customers to do what you want! Even financially rewarding – buy more often and spend more when they do buy.
As to how to get more customers – if only I were a marketing consultant and had the space here …..
How to increase profit?
That’s more difficult! The key issue is that Profit needs to be looked at as
Turnover
Less – costs that vary directly – materials, variable wages- called Cost of Sales
Whats left is Gross profit
Gross profit as a percentage of Turnover is called GP% or margin
Take off of this all other costs:
Fixed wages
Rent
Other overheads
Total of these is Overheads
What’s left is profit.
So you can increase profit by some or all of the following
- Maintain Gross profit in # but cut Overhead
- Increase Turnover but ensure the increase in Gross profit is more than the increase in Overheads you spend to increase or service the increase in Turnover.
- Increase # of Gross profit by reducing Cost of Sales – for example, reducing costs of materials and goods you buy in to sell, at least by more than you reduce the price you sell them for; or reducing direct wages – for example, cutting overtime or maybe making it more profitable by charging a higher price to customers requiring your staff to work additional hours.
This may all be common sense but busy running a business – who has time for it? Too many variables! This is where a simple financial model of your business – or a budget – enables you (or your Accountant) to “play” with the numbers and judge and select the best outcomes you expect.
But be careful – do make sure you measure the impact on cash at every stage – the best laid plans ….
We at Forbes faced this challenge by developing a cut down spreadsheet to enable clients to model their business easily – if only more of them would take the time to do this ….
For more information on how this all works and a free simplified break even calculator, do please check our website at http://www.forbesca.co.uk/common/calculators/break_even.html, and register for free to access all of the information available, get weekly newswires and further urgent updates from time to time.