Learning How To Calculate Profit Margins | Virtual CFO
It is extremely important that entrepreneurs learn early on in their business how to calculate the profit margin in their business says virtual CFO. The reason why many entrepreneurs do not understand this already is because many entrepreneurs get into their business because they are good at providing the product or service that they sell, not because they are experienced in running a business. Because of this, many entrepreneurs struggle with understanding basic business financial literacy. Into it, the makers of accounting software QuickBooks did a survey of small business owners and entrepreneurs in order to gauge how financially literate they were about business finances. The respondents of the quiz were asked questions about what an accrual is, what the role of a balance sheet is, and how to increase cash flow in their business. An overwhelming majority of respondents, 82% scored less than 70% on the survey, indicating that many entrepreneurs struggle with understanding their business finances.
One of the most important things that an entrepreneur can understand in their business, is their income statements. Virtual CFO says that this is a document that can help entrepreneurs make informed financial decisions, as long as they are reviewing it before they make any financial decisions in their business. Large decisions like making an asset purchase, hiring or laying off staff can be made more easily and looking at the income statement, but also smaller financial decisions like running payroll and paying bills are also vital financial decisions, and an entrepreneur should into the habit of reviewing their income statement before doing any of those things. The way that an entrepreneur can ensure that their income statement is easy-to-read, so that not only will they review it on a regular basis, but so that they can more easily understand it, is ensuring that it is kept to a single page.
How entrepreneurs can ensure that there keeping their income statement to a single page, is by ensuring that they have three or fewer revenue accounts in their business. Many entrepreneurs believe that by having more than three means that there being communicative and how their revenue is getting into their business, that it actually ends up creating a lot of work and increases the potential for the revenue accounts to be misclassified. Also, having more than three revenue accounts means that the income statement may not fit on a single page, may become very difficult to read and make good financial decisions on virtual CFO says that businesses should ask their accountant how many accounts they should have, and which accounts they should be if they are confused. A great example would be a restaurant should only have one account for food. Many restaurants believe that they should have one for drinks, one for dessert, one for food, one for take-out. But by simplifying this all into one category of food will make it much more easy for that restaurant owner to make financial decisions.
By understanding how to keep their income statement to a single page can help entrepreneurs review that information says virtual CFO. By having an easy-to-read document, entrepreneurs can ensure that they have the best information available to make informed financial decisions in their business that can help them avoid financial issues in their business.
Way More To The Process Than Virtual CFO!
Industry Canada says that there is a high failure rate of businesses in Canada, 15% failing in their first year, 30% failing by year two, and 50% failing by year five, virtual CFO says that these statistics can be significantly altered by helping entrepreneurs gain an understanding of their business finances. Especially since 29% of all failed entrepreneurs say the reason why they failed was that they have run out of money in their business. One of the ways that entrepreneurs can avoid this, is by understanding the expenses in their business so that they can calculate the margins in their business more easily. When entrepreneurs understand what their margin is, they can price their products and services in such a way that have them covering their direct and general expenses, and avoid running out of money.
The first thing that entrepreneurs need to do is learn how to separate their direct costs from their general has. Virtual CFO says that this is very important to do in order to help an entrepreneur understand what the margin is of their business. The direct costs are the expenses that exist only when an entrepreneur makes a sale, and is directly related to selling their product or service. It includes raw materials and labour. The overhead expenses or general expenses are all of the costs that exist in the business whether or not an entrepreneur makes a sale. These costs include the rent of their space, utility bills, phone and Internet bills, things like office supplies.
These costs need to be kept separately so that an entrepreneur can ensure that they are pricing their product to cover all of the cost of goods sold. However, virtual CFO says that entrepreneurs also need to ensure that they are pricing their products and services in such a way that they are covering their direct costs, and also making additional money so that they can pay for their overhead expenses. Then they need to calculate how many products or services they need to sell in order to cover their overhead expenses. That is their breakeven point and their margin. By understanding what their margin is, as well as keeping an eye on their expenses to ensure that they are not increasing over and above that margin, can help entrepreneurs avoid running out of money in their business. It is important to note however that if the direct costs go up by the same percentage that the sales go up, this is not indicative of costs going out of control, but costs going up simply because sales are going up. The more sales an entrepreneur makes, the more they are going to have to pay in labor and materials to make those products or services.
When entrepreneurs are more comfortable with understanding their expenses, they can calculate their margins or adequately. When they are able to do this, the be able to understand what their breakeven point is, and ensure that their pricing their products in a way to turn a profit, and they know how many products they have to sell in order to cover all of their expenses in their business. By understanding this, entrepreneurs can avoid running out of money in their business which is the second most common reason why entrepreneurs fail.