How Small Business Owners Should Use a Profit and Loss Report - Gross Margins

Often you hear that one of the key ways that small business owners keep 'score' of their success is to observe how much cash reserve is generated. To a certain degree, I believe this to be true, but there's a pre-step though. How does one go about creating this cash reserve from business operations. Do we just close our eyes and hope that with each sale made we are able to earn a little profit to cover other operating expenses? If you like living on the edge and dancing around the fire, then by all means, please continue to operate your small business this way. However, if you're operating a small business in order to build a valuable asset, then you must become more calculated and focused in building and growing a cash reserve from business operations. How do you go about doing this, you ask? Glad you asked because that's the topic of today's post. Let's dig in.

I'm Making Sales, But I'm Not Making Any Money???

I've seen this scene far too many times while consulting small business owners. Sales are moderate to robust, but there's hardly no money in the bank in terms of a cash reserve. Why and how did this happen? We've been talking about the importance of learning how to use the profit and loss report to actively manage your small business to become more profitable and sustainable. The section we're talking about today is understanding and putting to use the information from the gross margin section of the profit and loss report. Let's get this idea of looking at this section of the report from a 'backwards perspective' out of our thinking. Here's what I mean. Don't make the mistake of waiting to receive this report a week or month too late because by then it's far too late to do anything about it. Instead, use projections rooted and derived from previous periods to develop a forecast of this section of the profit and loss report because the very existence of your small business depends on it.

Let's Hit the Bull's Eye!!!

Gross margins quite simply let you know if you're making money over and above the cost of sales for the products and / or services that your small business markets and sales. Of course, this assumes that you've done a decent job in understanding the cost of sales for your small business. What is it that makes the gross margin section so important, though? This section of the profit and loss report earns its weight in gold when you apply a minimum standard for achievement based on industry or market norms. Here's what I mean. You don't want to shoot in the dark for setting a minimum standard for gross margins because there's no significant basis to it other than your 'wishful thinking' For example, if you're operating a restaurant, you should know on average that overall gross margins should fall no lower than 50% to 60%. From here, you can continue to get specific with various product and service offerings to really discover the gross margins for each and every offering that your small business provides. Now here come's the magic. Once you've experienced a period of operations and have a pretty good set of data to generate projections (no less than a month factoring in seasonality, if it pertains to your industry) in combination to the minimum standards based on industry or market norms, you can gain a pretty solid picture of the cash reserves you'll be able to generate for up to a month or two. Here's the other key observation of conducting this type of gross margin analysis: you'll understand that you're in control (aside from the macro market factors that you or anybody can't control) of DRIVING THE ACTIVITIES that will manifest the increase in cash reserves by MONITORING GROSS MARGINS. Don't you see it now? By taking an active approach to managing and monitoring the gross margin section of the profit and loss report, you are able to drive both the sales and cost of sales sections with a eagle's eye approach. Remember, the devil is always in the details my friend.

I hope that this series on using a profit and loss report to help your small business become more profitable and sustainable has been more than helpful because we're pushing on to the next section, putting to use the information found in the operating expenses of the profit and loss report. Till then, stay tuned... 

How Small Business Owners Should Use a Profit and Loss Report - Cost of Sales

We Made A Sale... That's A Good Thing, Right? 

Yes... and no. In continuing our conversation on how small business owners should use the profit and loss report as a key tool for operating their business, we're talking about the cost of sales section today. Sometimes, this section of the report is called the Cost of Goods Sold. Not to get too technical with the accounting terms here, but there are several ways to value the cost of what a business sells. Here's the important take away for this section of the profit and loss report: are you making a profitable (and hopefully sustainable) margin on the products and / or services you are selling? How do you know if you are or not? Remember, business's live or die on margin. 

What's All This Talk About Margin? 

By now you ought to know it doesn't mean a whole lot just to make a sale. Don't get me wrong; selling is a vital foundation of building and growing a great business, but it doesn't mean a whole lot when you're selling at a loss. In order for the sale to mean something, it has to come at a profit meaning that it has to cover its own cost in addition to leaving a cushion or margin for covering other expenses, growing a reserve for reinvestment, or at least a modest return on the invested capital of the owner(s) and / or investors. For example, when consulting restaurants, I've noticed that food costs (which are the primary costs in operating a restaurant) are typically marked up by a certain amount depending on the section of the menu the food item is found. Here's the key difference between a restaurant that thrives and the one that dies: thriving restaurants know their margins intimately incorporating this knowledge into their advertising and marketing plans while dying ones only guess at it. This key in understanding and knowing margins applies to every business no matter the industry. If you don't know your margins, you're doomed to fail BIG!!!

So, How Do You I Use the Cost of Sales Section to Operate My Business More Efficiently 

Similar to the Sales section of the profit and loss report, you have to ask several questions when observing the detail of the cost of sales section. First, let's start with the total amount reported. It's not enough to know the total amount sold for the period whether it's a day, week, month, quarter, or year. You need to know specifically what products and / or services sold and from whom or where these products and / or services were purchased? Were they made internally or externally? At what degree were they made internally or externally? Were purchase discounts given or earned and if so, why and how? Maybe not available on this section of the profit and loss report, but you could investigate a little deeper and be aware of the methods or processes of how the business goes about purchasing the products and / or services it sells. Ultimately, whenever you're analyzing the cost of sales section of the profit and loss report, you are conducting a cost analysis to ensure the business isn't losing any unnecessary money from having loose controls and a lack of monitoring just because hey, we're making sales, right? 

For our next post, we'll talk about gross margins and why when used in comparison to previous periods and even budget plans, can become a great indicator of your small business's future profitability and sustainability. Stay tuned... 

How Small Business Owners Should Use a Profit and Loss Report

Work Smarter... Not Harder

During my time in consulting with small businesses, I've observed that many very rarely use the information available to them by way of a profit and loss report. Often, these owners are too busy looking after employees or contractors; taking care of clients or customers; or taking time to produce products and / or services for delivery. Often, they are working just to survive. It's the American Way, right? An honest day's work for an honest day's pay. I still believe there's some merit to this blue collar working philosophy, but it largely fails to help the small business owner progress in achieving the ultimate goal of sustainable profits and growing cash reserves that are unrestricted. What's the one management tool needed to help these small business owners achieve these profits that lead to robust cash reserves? It's putting to use the information available in the profit and loss report to operate the business in the most efficient and focused manner possible But, how does one go about doing this?

Nothing Happens Until a Sale is Made

In learning to put to use the profit and loss report, the most important piece of information available are the sales numbers. When looking at a profit and loss report, the sales numbers are listed first at the top of the report. The sales section of the report shows how much product and / or services has been sold over a certain period of time such as a day, week, month, quarter, or year in a dollar amount. Although this dollar figure is important, it doesn't help you unless you understand the activities that are driving this amount. The more detailed the sales section of the report, the better use to the small business owner it is. For example, for a weekly profit and loss report, it's not enough to just notice that I've sold $10,000 worth of products or services. I need to know how this happened such as what product and / or service sold and how much of what specific product or service sold? At what price point did these sales occur? When did these sales occur? How was payment received for these sales such as cash or credit? Were there discounts and other allowances made in order to motivate these sales? Were there any refunds given or returns made? 

As you can see, by having the proper level of detail from the sales section on the profit and loss report, you are able to see without seeing the activity that's driving sales in the business which is quite important because without sales there's no business. Also, by asking these questions about the sales section, you are able to concentrate your efforts on areas that need your attention such as investing time and resources in product and / or service development, restructuring pricing and offers based on customer's perceived value, increasing time and resources in marketing and advertising, hiring outside or inside sales help, looking for patterns or oddities especially when comparing to budgeted amounts, etc. Now, we're getting into the use of the profit and loss report as a real life management tool for operating the business and not just a do nothing report that's given to a banker or investor when money is needed or the tax authorities when you're audited or assessed a tax. 

Next post, we'll talk about the cost of sales section of the profit and loss report. Stay tuned... 

Why Profit and Loss Reports Are A Small Business Owners Best Tool In Running A Business

A little over six months ago, I attempted to record a webinar series called, 'Small Business Financial Literacy 101' and it was an epic fail. Don't get me wrong, I was rather encouraged that I had the wherewithal to discipline myself to screen record 3 videos and upload them to my LinkedIn page. Damn proud because I had been thinking about doing it for AT LEAST 2 YEARS. Yep... procrastination is a mother for sure. The reason I considered it an epic fail is that the response I expected did not happen.... and what response was that you ask? I wasn't looking to gain numerous likes or even shares; my aim was to connect to those small business owners that struggle to understand the operations of their business from a numbers perspective.

Seeing the Unseen

When I began working with small businesses in the early 2000's, I was trained in dealing with them from an accounting and financing book perspective. I hadn't operated a small business let alone help manage one. I only saw and understood small business from financial statements and annual reports. It wasn't until I got fired from my job at the bank in 2008 and began working for and consulting small businesses that I made the connection between numbers and real life activity. That's when I truly knew how valuable a small business financial reports are. Even if you're operating a small business with minimum staff (i.e. one or two people) and making less than $125,000 in sales per year, listen to me, you still need to utilize a profit and loss report, a balance sheet, and a cash flow statement. Getting by on just relying on bank statements especially when you're still using a personal checking account to run your business transactions through is a huge mistake from a planning, tax, and operations perspective. 

Do You Know Where You're Going and Do You Know Where You've Been?

This is the essence of having and using a profit and loss report to help in operating your small business. It helps you to make sense of where you've been and also provides guidance on how to get where you want to go. How, you ask? Profit and loss reports capture the important activities of your business in three buckets: Sales, Costs of Sales, and Operating Costs. In each one of these buckets, small business owners are given information that captures the essence of the business's activity over the last day, week, month, quarter, or year depending on the accounting system used. It's not just enough to be able to provide a profit and loss report to your bank or even the IRS when required, You need to learn to use the profit and loss report to help in managing and operating your small business to minimize the risk of failure and increase the chance of survival and profitability. 

The Question Every Small Business Owner Need to Ask About the PPP Relief Funds

It's Deja Vu...

It's gotten to the point now where I don't even want to open up my Google Business News feed anymore. Usually, I like to catch up first thing in the morning on all the latest business news stories both nationally and internationally before I really get into the day. Well, it's been pretty much the same story for the past month or so. I guess I know what it feels like to be Bill Murray in the movie Groundhog Day...

Not in anyway attempting to be insensitive or callous to the plight of small business owners far and wide during this Covid 19 pandemic. True, I get it. We're in unprecedented times for sure. Things are happening that no one has every seen or experienced before unless you're a time traveler of course. Ok, I digress. Seriously, though, if I had a dollar for every article on my feed that states how small business owners were screwed over the first tranche of the PPP SBA relief funds, I'd be a pretty wealthy guy. Where am I going with this, you ask? Well, I'm glad you asked. Small business owners need to ask themselves this one question about their frustrations in not getting in on the first round of the PPP funds:

Were You Receiving Help From Your Bank Before the Covid 19 Outbreak? 

Relationship First...

Let's think about this question for a minute? First, let's set the context? Around mid March 2020, the U.S. shut down literally due to the projections and conversations about the coronavirus and it's pending impact and devastation. Again, I'm not making light of any of this. What happened next was something quite unthinkable. The U.S. government along with state and local governments began shutting down 'non essential' businesses which included a large portion of small businesses that employ a vast number of the U.S. population. What's the engine that keeps small business operational and in accounting verbiage a 'going concern'? It's money... and where does money come from? Here's a hint? It doesn't grow on trees. No, money comes from people (consumers) and other small businesses that spend money in order to make money. Plain and simple, right? Let's go back to our question for a moment and let me come from another angle. I wonder how many of the small businesses that are frustrated about the first round of the PPP SBA relief funds either had an existing credit relationship with their bank let alone had the wherewithal to entertain having a credit relationship. Not trying to be ugly here in any shape, form, or fashion. Logical and objective in a compassionate and empathetic approach. 

Here's the reality: even with the pending second round of PPP SBA relief funds coming, I don't foresee many small businesses being able to obtain these funds and there's a good reason for this. The banks are lending their own money with a guarantee from the SBA in the event of default. In other words, the banks are in this to make money (i.e. earn interest even if it's fixed at 1% although they are earning fees for lending out these funds as well), not lose it. Unless you have an existing credit relationship with a bank that's satisfactory, don't get your hopes up. Not being a downer here; naturally, I'm a pretty optimistic person, but I perceive what's about to go down and it's not going to be good. 

Are You Looking For Another Small Business Lending Option? 

Despite this reality, there are still available small business funding sources in the market that small business owners aren't aware of. For the PPP funds, I didn't even begin to talk about the restrictions and guidelines that you have to abide by in order to ensure there's no recapture of the funds or even worse penalties assessed for improper use of the funds. One specific source of small business funding available is from Innovative Capital Strategies through their Capital Ready Package program. Through this program, small businesses are guaranteed a minimum of $100,000 with no minimum personal credit score or minimum time in business. Prior to doing my homework on this firm, I thought it was just another fly by night hoax, but I was wrong. Again, as a realistic and viable alternative to waiting around to see if you and your small business will get in on the second round of the PPP SBA relief funds, hedge your bets and look into obtaining funds for your small business to help you to not only weather the current storm we're in, but to also position yourself for max market growth. If your small business is in need of funding, you need to check out the Innovative Capital Strategies website. 

Small Business Financial Literacy 101 - Sales

Why are Business Financial Models Important for Small Business Owners

Why Are Business Financial Models Important?

Significant Pain Points of Not Having and Comprehending the Business Financial Model

• Lack of Direction
• Sales and Marketing Efforts are Not Fully Maximized
• Business Owners / Principals Have No Focus on Building or Extracting Wealth for Retirement or Family Estate

Benefits of Having A Business Financial Model

• Yields a Logical Thought Process for the Business
• Provides a Comprehensive Model for Planning and Executing the Operational and Financial Components of the Business
• Gives Investors and Bankers a Way to Quickly Evaluate and Assess the Value of the Business

What is A Business Model? Laying the Ground Work...

Business Model Definition - "A business model (also called a business design) is the instrument by which a business intends to generate revenue and profits. It is a summary of how a company means to serve it employees and customers, and involves both strategy (what a business intends to do) as well as implementation (how the business will carry out its plans)" Source: Wikipedia


Business Financial Model Definition - "Financial models are not about absolute values; they are about relationships. A good financial model demonstrates the relationships and the business tradeoffs that compose the profitability potential of the business idea. If you understand the relationships, the drivers of revenue, drivers of cost, and the critical success factors, you understand the core of the business." Source: Pro Excel Financial Modeling by Tom Y. Sawyer


Major Components of a Business Financial Model

• The Staffing Model
• Sales and Revenue Model
• Cost of Goods Sold and Inventory Model
• Cost of Sales and Marketing Model
• Operating and Capital Expenditures Model
• Statements of Profit and Loss and Cash Flow

Who Needs A Business Financial Model? 

Start up and early stage entrepreneurs and business owners (1 to 5 years of operations) use Business Financial Models as a tool to create a dynamic business; it is a building block that leads him or her to a strong, profitable business.