Calculating The Businesses Profit Margin | Virtual CFO
One of the most important things that an entrepreneur can do according to virtual CFO, is calculate the profit margin of their business. The reason why, is if an entrepreneur can understand their profit margin, they can ensure that they are making enough money on the sale of their products or services to cover all of their expenses. The reason why this is extremely important, is because the company behind accounting software QuickBooks, did a survey of small business owners in order to gauge how financially literate they were in their business finances, and asked the respondents of the survey questions about balance sheets, accruals and cash flow. An overwhelming majority of the business owners who responded, 82% scored less than 70% on the test. This means that many entrepreneurs while entrepreneurs understand the services and products that their business produces, they are less knowledgeable about running their business.
One of the most important things that an entrepreneur can do in order to help understand their margins, is to learn how to read to their income statement. Virtual CFO says that this is an important document that can help entrepreneurs make great financial decisions, but they should understand how to ensure that it remains a easy to readís documents. One of the first things that they should do is ensure that there is only three or fewer revenue accounts in the business. While many entrepreneurs believe that their business is unique and they need to have more than three revenue accounts, or they believe it is very helpful in creating several, this actually creates a lot of work, increases the potential for miss classifications, and ultimately makes the income statement much harder to read.
Some examples of different businesses and how many revenue accounts they should have included a contractor should have two accounts, one for projects and one for service calls. The reason why these should be separate is that there is very different amounts of labour, management, raw materials and way that the business was acquired. A restaurant, on the other hand, would typically have one because their business is just selling food. I dentist might have three accounts one for the doctors income, one for the Associates’ income, and one for the dental hygienist.
By understanding how to keep their revenue accounts down, business owners are ensuring that there keeping their income statement to a single page so that they can make informed financial decisions in their business. Since it is important for a business owner to be reviewing their income statement before making any financial decisions in their business, including making bill payments and running payroll, being able to very easily read this information is very important. The longer the income statement is, the harder it is to read, and entrepreneurs may decide to not read it and make their decisions without looking at the information at hand.
When entrepreneurs understand what their income statement is, and how to keep it short, they will be more apt to read it on a regular basis says virtual CFO, which will allow them to make better financial decisions, that will help their business financially.
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while many entrepreneurs get into the business that they own because they love the product or service that they sell says virtual CFO, many entrepreneurs struggle with understanding their business finances, which can create huge problems. Half of all entrepreneurs that open businesses in Canada will fail within five years, and industry Canada says that 29% of all failed entrepreneurs say that their business failed because they ran out of money. If entrepreneurs are better able to understand their expenses, both direct expenses and general expenses, they will be better able to understand the profit margin in their business, and price their products or services in such a way to help them avoid running out of money.
Many entrepreneurs understand that they have to price their products in such a way that they recoup all of the cost of goods sold. That is, all of the costs that have gone into producing their product or service. This includes raw materials as well as labour. However, virtual CFO says that entrepreneurs often do not understand that they also have to price their products in such a way that they are paying for their overhead expenses as well. While the cost of goods sold, also called direct costs exist in the business only when an entrepreneur makes a sale, the overhead expenses are all of the costs that an entrepreneur will incur simply by being in business. This includes rent, office supplies, utility bills and administrative staff. Not only do entrepreneurs need to price their products to recoup their direct costs, but a portion of every sale needs to go towards their overhead expenses. By calculating how many products they need to sell to cover their overhead expenses in addition to their direct costs is the entrepreneur’s profit margin.
When they understand what their profit margin is, and how many products they need to sell in order to cover their direct costs and their general costs, can help entrepreneurs ensure that they are setting the price of their products and services in such a way that there avoiding running out of money in their business. It is very important that an entrepreneur keeps an eye on both of their direct costs and general costs at all times, to ensure that prices do not creep up, higher than their prices are. If so, they either need to find ways to cut costs, or increase their prices. One of the most important things however, is when an entrepreneur understands that as long as direct costs are going up at the same rate as sales, that is not an indication of costs going out of control, it just indicates that the more sales of entrepreneur has, the more they are going to have to buy raw materials and pay for labour.
By helping entrepreneurs understand how to calculate the margin in their business, can help them price their products appropriately says virtual CFO, so that they can ensure that they are turning a profit in their business. By understanding, this can help entrepreneurs avoid running out of money in their business.