Business Success: An Accountants Perspective
It is a cold, wet January day in London, England in the midst of the COVID-19 pandemic lockdown. Harsh times for a lot of people, let alone small businesses and start ups.
Despite these dreary surroundings I am full of positivity.
I have just finished a day of monthly business reviews with a number of my clients. During these reviews we appraise the financial performance of their business versus a forecast, and quantify any risks and opportunities that may arise in the short to medium term as well as discussing any forthcoming decision.
My positivity is stemming from the success of the businesses that I am working with, despite the challenging economic situation that they are facing. This has inspired me to share the core subjects that we focus on — hopefully the below advice may help small businesses with their path to improved profitability.
The below is a brief summary of the key areas that we focus on. These areas are not exhaustive, as running a business can be incredibly complex, however are all very important considerations. This is an ideal read for most small businesses and hopefully the principles can be applied to larger organisations as well.
- Unit Economics
I am not sure whether this is the textbook definition of Unit Economics, however this is where we look at the gross profit (or margin made) of selling one unit whether this be a service or a product.
Let’s imagine an E-commerce business that sells trainers. The business would purchase stock from a wholesaler or manufacturer and then re-sell these to consumers through their website or online store.
Simply, sales price less the cost of the trainers less any variable costs would be the Gross Profit/Margin.
e.g.
Sales price: £100
Purchase price: £70
Payment processing costs: £1
Postage costs: £4
£100-£70-£1-£4=£25
There are various things to consider here…
Firstly, the selling price — is this too high or low? Are we undercutting the competition by 25%, or is the competition selling cheaper than us? In the latter scenario, if we drop prices below the competition will we increase sales volumes? It is always advisable to conduct some kind of competitor analysis to understand your price point in the market. If your prices are higher, then you may be able to sustain this by fast shipping times, unique products, customer service or another unique selling point.
Purchase prices and variable costs are also an interesting area to consider. Can your business change supplier or buy directly from the manufacturer to reduce your prices? Can you reduce your cost per unit by buying a larger volume? However, you also need to consider whether the business may be left with stock that takes a long time to shift, tying up your cash (please see section 5). Are there alternative payment portals or postage companies that can reduce your price?
After the business has considered the above, and taken action to maximise revenue (that will still generate sales volumes), and minimise costs then the business is in a great starting position and it is time to start looking at sales volumes…
2. Sales Volumes
I know this is stating the obvious, but maximising sales volumes is key. If you are looking at external investment for example, investors may focus more on sales volume growth rather than just solely profitability.
How should you maximise sales volumes? There are various marketing strategies that I have seen my clients use such as social media advertising, social media influencer affiliations, Google pay per click ads, leaflet drops, attending trade fairs. The list can be endless!
From my days at British Gas one thing that will always stick with me is that it is always easier (and cheaper) to sell to an existing customer. Therefore, making a customer ‘stick’ is invaluable. For example, in the energy world a lot of consumers switch suppliers through price comparison websites, who charge a hefty fee for this. Quite often this fee may take over a year to re-coup from the margin generated by a customer. However, if you have a customer that has electricity with you and you want to supply their gas, you simply pick up the phone, send an email, write a letter or so forth — all inexpensive ways to acquire customers and often an easier sell due to the existing relationship.
Therefore, I always advise my clients to focus on turning existing and historic customers into repeat customers, whether this be through email drops, discounts for returning customers or a similar strategy.
Marketing to new clients as well as retaining existing customers is a recipe for growth. Growth will increase profits, and demonstrate to external stakeholders that you have a sustainable business.
We will talk more about the finance side of marketing in the next section, however lets look at some simple maths in relation to sales volumes.
In the example of the footwear retailer from section 1, let’s imagine that they sell 10 units at a margin of £25 in a month. This equates to £250 margin.
Lets now assume that the business overheads are £300. The business is making a loss as the margin generated does not cover the costs, let alone providing any return for the business owner. Alarm bells are ringing and drastic action would need to be taken to increase sales volumes.
Lets think of a different, more complex scenario now. Lets assume that that 20 units are sold generating a £500 margin. Now the business has made £200 of profit. If the business owner is treating this as a ‘side hustle’ and is only spending 5 hours a month on this, then this could be viewed at as a success, however if they have quit their £36k a year job to set up this business then this profit does not compare to the £3k a month they would have made whilst staying as an employee.
I hope I have demonstrated the point that understanding sales volumes are vital. Make a plan for the next year’s sales volumes! Look at where you want the business to be in a year. If you want to double your volumes, how will you do that and be cognisant of the volume you need to sell to generate a profit that is better than your income prior to starting the business.
3. Business Overheads
‘Overheads refer to the ongoing business expenses not directly attributed to creating a product or service’
I remember watching the Dragons Den once and a travel company was pitching for investment. They were receiving the usual grilling from Peter Jones, who was actually very complementary on the profits made from the business. Peter asked ‘How did you generate such great profits’. The business owner simply replied ‘We keep our costs variable where possible’ (i.e. costs are only incurred when an activity takes place, such as a sale or a unit manufactured). This stuck with me- as a rule, try to keep your costs as variable as possible.
Business overheads are usually fixed (or stepped) in nature i.e. they stay the same for a duration e.g. business insurance is a fixed premium, rent is fixed therefore go against this notion of ensuring that costs are variable.
Therefore (where possible) try to keep your overheads down to a minimum. For example, if you can run your business from home rather than renting out expensive offices or any other tactic that saves your business from committing themselves to ongoing expensive costs. Regularly review your contracts and shop around — try not to commit to yearly contracts. Use contractors and freelancers rather than taking on permanent staff. Until the business is consistently delivering sustainable sales volumes then watch your overheads like a hawk and implement whatever strategy you need to to minimise them.
Let’s go back to our friend — marketing costs. These are vital to grow your sales volumes. These costs are strange in nature — they can be variable or fixed, and marketing pushes can be successful or not. Again, try to keep these costs variable, whereby costs are only incurred when a sale is made. For example, one of my clients sells beauty products and uses social media influencers. At first my client would pay a fixed amount to an influencer for posts on their pages. By looking an alternative scheme whereby the influencer was paid each time they directed a sale to my client, there was an increase in sales volume. My client was happy because the influencer actively promoted the business rather than a post here and there. Also, the influencer was happy as they started to earn more money than with the fixed fee. Win Win!
In summary:
- Maximise your margin per unit by pricing appropriately and minimising your variable costs
- Have an awareness of the sales volumes required to 1) cover your overheads and 2) provide owners/investors a sufficient return
- Keep your overheads to an absolute minimum!
4. Taxes
Don’t forget the tax man!
The tax man wants a piece of everything you make. By keeping abreast of all of the mechanisms to minimise your taxes and ensuring that provisions are made for forthcoming tax bills can save your business.
- Always make sure you are aware of your tax liability at any point. Understand what taxes you will be liable for and how much these will be and when they need to be paid.
- The tax man can help support your business. For example, in the UK the HMRC there are R&D (Research and Development) tax credits available that will minimise your bill. If you are self employed there are marriage allowances that can be transferred between one another. Losses in one year can reduce the tax bill for the following year. There are loads of weird and wonderful schemes that the HMRC do to help stimulate the economy.
- Employ an expert! Tax is incredibly complex — get someone who is qualified in this field to manage this for you. Quite often they will pay for themselves by saving your business tax.
5. Cash Flow Management
Cash flow management is a fine art and my area of expertise. For small businesses, cash is the lifeblood of your business and a careful eye needs to be paid to this area.
As a general rule:
‘Try to receive income as soon as possible, and delay your outgoing payments as long as possible (without breaking any contractual agreements)’
One of the first things that I do with my clients is to create a financial forecast. We look at how the business is performing and where we want it to get to and use this forecast as a way to discuss strategies that will deliver the desired performance. A key part to this is the Cash Flow forecast.
The Cash Flow forecast is vitally important, as it highlights times at which a company may have cash surpluses or deficits. The latter is an issue and needs to be addressed, so having knowledge of this is key so that funds can be borrowed or payments deferred for example.
A good way to structure your cash flow forecast is as follows:
CASH FROM OPERATIONS:
- Cash from sales — do customers pay at the point of sale, or in arrears? Are customers on a monthly subscription?
- Cost of sales — what is the cost of delivering these sales and when will they need to be paid? The example used in section 1 is that a trainer manufacturer may buy in bulk. The business may have to invest in a lot of stock up front which is an outgoing of cash, however the subsequent income may be received over a period of time once items are sold. Where possible, try to keep your sales income and expenditure as close to one another as possible.
- Overheads- these are usually very easy to forecast as they are usually the same each month
- Taxes- understand how much is due and when. These are usually payable in arrears which is great news for cash, however don’t forget about them. It is very easy to forget a tax bill that is due in 6 months time!
CASH FROM INVESTING:
- Do you have any big purchases coming up — a new van, a refurb of a shop, new equipment etc? These can often catch businesses out but not factoring in when these need to be paid.
CASH FROM FINANCING:
- Do you have any loan payments that are due? When are these due? Can you look at cheaper alternatives e.g. a loan versus a business credit card
- Are you going to take out any loans in the future — when will this be, how much for and when are the repayments due?
- Do you plan to bring on investors. Your business may be doing well, however could be doing a lot better if you bought new machinery or invested in a huge marketing push for example which can only be financed by bringing on an investor. Investment takes time to obtain (which will be covered off in another article), however is always something to consider for growing businesses. Always think about when will the investors want their money back, and how much?
Get your spreadsheet open, use the categories advised above and structure the spreadsheet by month — the below is an example, however my way is superior 🤣
I am hoping that some of my knowledge may be of use to a business owner out there. As mentioned earlier on, this is just a snippet of how to financially manage a business however should be of some use.
I provide Accounting and Financial Management services to small to medium sized businesses, and also from time to time host webinars and training sessions.
If you would like to get in touch please message or email me on info@mcquade-consulting.co.uk
