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Knowing Exactly How Much Profit You Are Making

When times are tough the need for accurate information on profitability, margins & cash flow is vital. Owners/managers need to know how the overall business and each section is performing, which products are making money and need to identify any inefficiencies and poorly performing activities/products/services.

Traditional accounting measures are insufficient to track how a company is moving towards its strategic objectives and towards survival in these extremely turbulent times. This is so, for two reasons:

a) Annual audited accounts which give a picture of a past period do not link physical measures and profit, fail to identify relationships between profitability drivers and don’t differentiate between cause & effect measures.

b) Financial accounts serve the purpose of stewardship accounting but owners & managers need to be able to measure the effects on their profit and loss account of various actions and changes in activities.

Your management accounts should give you clear unequivocal answers to questions such as:

  1. Which factors contribute most to profit and cash flow?
  2. Why are profits falling/rising and what actions should be considered as a result?
  3. What is the gross margin from each product/sector?
  4. What would be the effect on net profit of price or volume changes?
  5. What amount of sales & gross profit is required to break even?

 

Gross margins

Gross margin analysis is vital but is this available to you? Many businesses know the exact cost of some small overhead costs but have no proper analysis of their gross margins. In some of these cases there is a lot of focus on some overhead items (phone costs etc) and not enough on gross margin inefficiencies which are often a multiple of these ‘focussed’ overheads. Whilst there are standard formats for financial accounts there are no generally accepted formats for management accounts. The attached model format might be considered to show gross margin and net profit analysis, Balance Sheet & cash flow positions against budget.

With this information the process of making changes to improve business performance can be done in a manner to optimise results and avoid making decisions which could be detrimental to the business. Getting the right information is the starting point. Having the personnel to determine and implement the appropriate strategy and change is the point at which many businesses will succeed or fail.

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