If you think your homebased business is too small for you to take the time to create financial statements, think again. If you're serious about what you're doing, you should have these reports for your own information. Even if you never plan to ask a banker for a business loan, your financial statements will provide a fascinating picture of how your business is doing and enable you to monitor cost-of-goods and inventory figures, overhead costs, and net profits each year. Sometimes when you're not sure if you're just treading water or actually making gains, financial statements can offer surprising and comforting evidence that you're on the right track.
Here's the book that can help you maximize your business profits through better management of all your business expenses—the strategies Barbara has used throughout the life of her homebased business.
Copyright © 2000-2013
Analyzing Sales and Profits
How to Use Financial Reports to Study the Overall Profitability of Your Business and Every Product or Service You Sell
by Barbara Brabec
Statistics from the U.S. Small Business Administration tell us that between 45 and 48 percent of all businesses fail within the first five years, and about 95 percent of these failures are attributable to poor management. Although you have to be a smart marketer to bring in the bucks, managing your business efficiently is even more important than mastering the principles of marketing. You might be a whiz at advertising, getting publicity, networking and running a Web site, but if you don't know how to run an efficient office, finance growth, manage time and handle a heavy work load or an unexpected surge of business, you could find yourself in hot water.
In the early days of a business, business owners are often so busy scrambling for clients or customers that they donít take time to plan, let alone create financial reports or try to analyze where their income is coming from. But since profit is so closely tied to both sales and costs, you must consider both of them whenever you are looking for ways to increase business profits. Selling more goods or services won't mean much if your costs also increase to any degree. On the other hand, if you can lower your costs, your profits will increase even when you don't make additional sales.
An accountant once told me it was a lot easier to increase profits by decreasing costs than by increasing sales because of the high cost of marketing and obtaining each new customer. I saw the wisdom of that remark the first time I did a serious study of my own business records. I worked at my publishing and mail order business for almost two years before I found the time to get serious about my record books and the information in them. What I finally learned came as a real surprise.
At that time, I was writing articles and trade books, publishing a couple of my own books, reports and a newsletter, speaking, and doing some consulting. Each of those activities took a certain amount of my time, a factor that was fairly easy to estimate on an annual basis. Although I had always kept track of the income each of my business activities was generating each month and year, it was not until my third year in business that I decided to break down all the business expenses and overhead costs relating to each of those income categories. Suddenly I could see what really was happening with the business. Then I knew the direction I had to take to realize greater profits in the years ahead.
At the same time, I began to analyze the income and expenses related to each item in my product line. Then I could see that some products that seemed to be making money (based on gross sales) really were not profitable at all in terms of their material and handling costs. As a result, I dropped some of them.
Study of a Fictional Business
A thorough analysis of your books after a year or so will no doubt surprise you, too, particularly if you make and sell a variety of products, or if you are involved in a diversified business involving both products and services. Perhaps the fictionalized account below of a business that involves the sale of both products and services will give you a better idea of what I'm talking about. Let's assume that this business grosses $120,000 one year—100,000 of which is from the sale of products, the balance from some service, let's say teaching. Here's how the figures might look on the Schedule C tax report:
There are many costs related to a product business, but the costs related to the service portion of this fictional business are nominal (a few materials and overhead expenses) because all direct expenses are paid in addition to the teacher's fee. That means the profit margin is going to be very high on the service side of this business, as the following illustration shows:
Product Portion of Business
Service Portion of Business
In total, this fictional business has $65,000 in expenses. Although the bottom line is still the same—$55,000—the service portion of the business is clearly the most profitable in terms of labor, materials, and other expenses. But, to really understand what's happening here, one would need to continue the analysis by separating all the income and cost figures for each individual product or service. Although there might be ten or twelve products in a line, such an exercise might show that one of them was generating 50 percent of the income, and one or more were, in truth, costing more to inventory and ship than they were worth.
Whether this business owner decides to expand the service area or the product area would have much to do with the particular business and the market for the products or services it offers. If it is a one-person manufacturing company, and no plans are being made to hire employees to increase productivity, then perhaps it would pay to drop part or all of the product line and concentrate on providing additional services. Choosing the right direction for this business may not be a simple matter, but with figures to work with, at least the owner will not be making plans in the dark.
At least annually, do an income-versus-cost analysis for each product and service you offer. The answers you get will help you evaluate the correctness of all your prices and give you the comfortable feeling that you know where you're going and why, even when the profit picture is not as rosy as you would like it to be.