Are You Making a Profit?
Profit measures success. The following includes questions and comments that can help you analyze them and determine if you have the kind of record-keeping system you need. They’re meant to point to areas where further study might be profitable.
Analysis of revenues and expenses
1. Have you chosen an appropriate period for profit determination? This is generally a 12-month period. But not always January to December (depending on if the business is seasonal).
2. Have you determined your total revenues for the accounting period? What’s your gross revenue? How much of your product or service is returned or credited? What are the discounts you give to your customers and employees? What are your net sales (gross sales minus returns and rejects plus discounts)? What’s your income from other sources, such as interest on bank deposits, dividends from securities and rent on property leased to others (non-operating income)? What’s your total revenue (net sales plus non-operating income)?
3. What are your total expenses? Common ones are: Cost of goods sold (beginning inventory plus purchases minus ending inventory); wages and salaries (include what you’d pay someone else to do your job); rent; utilities (electricity, gas, telephone, water); delivery expenses; insurance; advertising and promotion; maintenance; depreciation; taxes and licenses; interest; bad debts and professional assistance (accountant, attorney and so forth).
There are many other types of expenses, and each must be recorded and deducted from your revenues before you know your profit.
A financial ratio is an expression of the relationship between two items selected from the income statement or balance sheet. Ratio analysis helps you evaluate the weak and strong points in your financial and managerial performance.
4. What’s your current financial ratio? Your current assets divided by current debts tells if you have enough cash to pay creditors. The higher the ratio, the better. Cash, receivables, marketable securities and inventory are assets. Be realistic in valuing receivables and inventory. Current liabilities are those that must be paid in one year.
5. What’s your quick ratio? Also known as the acid-test ratio, it’s found by dividing quick assets (current assets minus inventory) by current liabilities. This test doesn’t include inventory. It tells if the business could meet its current obligations with quickly convertible assets should sales revenue suddenly cease.
6. What’s your total debt to net worth ratio? Total debt, divided by net worth, then multiplied by 100 is a measure of how a company can meet its total obligation from equity. The lower the ratio, the better the credit rating.
7. What’s your average collection period? You find this by dividing accounts receivable by daily credit sales (annual credit sales divided by 360). This shows how long it takes to get cash after making a credit sale.
8. What’s your ratio of net sales to total assets? Net sales divided by total assets measures the efficiency with which you’re using your assets.
9. What’s your operating profit to net sales ratio? Divide operating profit by net sales and multiply by 100. Don’t include interest income and interest expense.
10. What’s your net profit to total assets ratio? This ratio (divide net profit by total assets and multiply by 100) is often called return on investment (ROI). It focuses on your overall profitability. ROI is the most important measure of a firm’s financial position.
11. Do you know your net profit to net worth ratio? Divide net profit by net worth and multiply by 100. This ratio provides information on your operations resources productivity.
Sufficiency of profit
The following questions are designed to help you measure profit. Several organizations publish financial ratios, including Dun & Bradstreet, the Accounting Corporation of America, Bank of America and some trade associations. Published ratios are only averages; you want to be better than average.
12. Have you compared your profit with your profit goals?
13. Are your goals too high or too low?
14. Have you compared your profits (absolute and ratios) with those made in the last one to three years?
15. Have you compared your profits (absolute and ratios) with those of your competitors?
Trend of profit
16. Have you analyzed the direction of your profits? To do a trend analysis, performance indicators (absolute amounts or ratios) should be computed for several time periods (yearly for several years, for example) and the results considered side-by-side. You can then evaluate your performance, see the direction it’s taking and make forecasts.
17. Does your firm sell more than one major product line or provide several distinct services? If so, a separate profit and ratio analysis of each could show which items are most and least profitable, and which are slow- or fast-moving.
18. Do you have a general journal and/or special journals, such as one for cash receipts and disbursements?
19. Do you prepare a sales report or analysis? Do you have sales goals by product, department and accounting period (month, quarter, year)? Are your goals reasonable and being met? If not, list the likely reasons. The list might include general business climate, competition, pricing, advertising, sales promotion, credit policies and the like. Once you’ve identified the apparent causes, you can take steps to increase sales (and profits).
Buying and inventory system
20. Do you have a buying and inventory system?
21. Do you keep records on the quality, service, price and promptness of delivery?
22. Have you analyzed the advantages and disadvantages of buying from several—or a minimum number of—suppliers?
23. Have you analyzed the advantages and disadvantages of buying through cooperatives or other systems?
24. Do you know how long it usually takes to receive each order? How much cushion do you need to maintain normal sales while you wait for orders to arrive?
25. Has your business ever suffered because you were out of stock?
26. Do you know the optimum order quantity for each item?
27. Do you (or can you) take advantage of quantity discounts for large-size single purchases?
28. Do you know your costs of ordering and carrying inventory? The more frequently you buy, the higher your average ordering costs (clerical costs, postage, telephone), and the lower the average carrying costs (storage, loss through pilferage, obsolescence). The larger the quantity per order, the lower the average ordering cost and the higher the carrying costs. A balance is needed to reach the minimum cost overall.
29. Do you keep records of inventory for each item? They should be kept current as items are added to or removed.
Other financial records
30. Do you have an accounts payable ledger? This ledger will show what, whom and why you owe, and will help you make your payments on schedule.
31. Do you have an accounts receivables ledger? This ledger will show who owes you money, why, how much, and how long it’s been outstanding.
32. Do you have a cash receipts journal?
33. Do you have a cash payments journal?
34. Do you prepare an income (profit and loss or P&L) statement and a balance sheet?These are statements about the condition of your firm at a specific time and show the income, expenses, assets and liabilities of the firm. They’re absolutely essential.
35. Do you prepare a budget? This “record in advance” projects future inflows and outflows. It’s usually prepared for a single year, generally to correspond with the accounting year, then broken down into quarterly and monthly projections.
Once reasonable projections are made for every important product line or department, you can set targets for employees to meet for sales and expenses. You must plan to assure a profit. And you must prepare a budget to plan.
Source: BizMove.com; Small Business Knowledge Base
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