Strategy Session

How to Stop Losing Money in Your Business (And Four Financial Elements You Need to Understand)

breakeven point direct cost expenses financial performance financial responsibility fixed expense gross profit gross profit margin operating income profitability May 13, 2022

Are you unhappy with how much money you're making in your business? Maybe it's time to dig deeper into what's causing the problems.

Most business owners know when their companies aren't doing well financially. Perhaps their accountants inform them, or they feel it in their bank accounts.

The problem is, they don't know what to do about it.

Their operational performance might seem ok, and perhaps they're even making sales. But the money left at the end of the month tells a different story.

The unfortunate reality is that many businesses operate at a loss, or they're barely breaking even. You also have those that work extra hard, but their profit percentages are in the single digits.

That might be fine if we're talking about tens or hundreds of millions in sales. But that's not the case here.

So, here's where the issue lies:

Business owners and entrepreneurs don't know their numbers. 

They also don't understand them, which leads them to ask the wrong questions about how to boost their financial performance.

Now, let's look at the four financial aspects you need to know and how they impact your organization.

The 4 Essential Metrics to Track

Metric #1. Your Gross Profit Margin

Say you're selling a computer for $2,000 with a gross profit margin of 20%.

If the costs incurred to deliver that computer amount to $1,600, you'd make a profit of $400.

But what if your profit margin was higher?

Imagine selling a $2,000 computer with direct costs incurred through the delivery being only $1,400. 

Now, you'd make $600 gross profit.

You can look at this in two ways. 

On the one hand, you're looking at a 10% extra profit margin. However, if you take 20 and add 50% to it, you get 30.

In other words, your profit margin would go up by 50%.

This example is for a single item sold. But once you're talking about selling multiple products or services, increasing your margins will have a massive impact on your gross profit.

Picture selling 50 units for $100,000 at a 20% profit margin. With a delivery cost of $80,000, you'd make a gross profit of $20,000.

If you could lower the delivery cost, thereby increasing your margins, your expenses would amount to $70,000. All of a sudden, you're making a gross profit of $30,000 on $100,000 in sales.

That's 50% more money from just a 10% increase in margins.

One thing is clear: visualising and understanding your gross profit margin is key to running a successful, profitable business.

Aspect #2. Calculating Your Margins

Figuring out your gross profit margin involves some calculations. 

But they're not as difficult as you think. The trickiest part is finding all the variables.

How do you do it?

First, you want to list all your revenue sources.

Second, you want to outline your managing costs.

In doing so, you’ll get a summary of your finances that will show the fixed and variable costs associated with every product or service that you sell.

These are the numbers you need to know like the back of your hand. It’s because they tell you exactly what's happening inside your business in the present.

Once you know what's going on, you’ll have good information to act on and you’ll be able to make positive changes towards improving your financial results.

Aspect #3. Fixing Losses Inside Your Business

To explain how losses can occur and what you can do to prevent them, let's stick with the computer scenario.

Say you're selling a computer for $1,000 apiece. And it costs you $600 to deliver it to your customers. But you also have fixed expenses of $700.

That means selling a single unit would give you a $400 profit. However, you'd actually be at a $300 loss due to your fixed expenses.

Things look different when you sell two units. 

In this scenario, you'd make $800 gross profit, which also covers the $700 in expenses. This would put you in the green with an operating income of $100.

Granted, this isn't much, but that's not the point.

The idea is that two things often contribute to a poor financial situation – high gross profit margins and not enough sales.

You can try to fix this by either increasing your margins, as I've already explained above, or increasing your sales.

Since fixed expenses don't add up for each product or service sold, any sale you make after a certain threshold would no longer have to pay for fixed expenses. Thus, your gross profit will increase.

These are the two big questions you have to ask yourself when you're in a financial hotspot:

  1. How can I lower my fixed expenses?
  2. How can we sell more at a higher profit margin?

Aspect #4. Operating Income

The term ‘operating income’ is a simplified version of EBITA, which stands for “earnings before interest, taxes, and amortisation.”

But operating income just sounds cleaner and should be easier to understand.

So, what is this number?

This is the amount you get after covering all your fixed expenses from your gross profit.

Your operating income will give you a good idea about your organization's financial performance. After reviewing your monthly and quarterly figures, you can use that number to see if you're moving forward.

But there's another reason why it's important to know these numbers.

Imagine looking to get an exit - you're interested in selling your business. This number is a huge factor in your valuation.

Why?

Most buyers evaluate a business at four to six times the earnings multiple - that means four to six times your operating income. So, you need to ensure that number keeps going up if you want your company to be valuable.

Take More Financial Responsibility

Here's the thing about being a good business owner:

You don't have to get a finance degree or become an accountant to run a profitable company. And you can have someone else do the math, track every financial metric, etc. 

That said, you need to know and understand the numbers that can make or break your business.

That knowledge will give you valuable information. And using that information, you'll get to make better decisions inside your business and develop strategies to increase your operational and financial performance.

Knowing your numbers is necessary if you want to stop losing money and drive more value into your business.

 

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