You’re ready to put your passion to work and turn your idea into a profitable company. But, do you have the tools you need to run a business? If you’re bad at crunching numbers, you could be in trouble when you launch a startup.
The importance of small business financial numbers
Your business is more than what you see on the surface. The numbers in your accounting books reveal a true picture of your company.
Financial records are a reflection of your successes, disappointments, and lessons. They show which decisions helped you grow and which set you back. How well you collect and analyze data plays a huge role in your company’s momentum.
Your business’s numbers help you identify problems in your operating processes. For example, you can compare your prices to costs to see if your prices are set too low. You might be losing money because you don’t know how to price a product competitively enough.
Numbers also help you track your performance. You can look at your business’s net income over time to check if you are growing or sinking. A clear picture of your finances helps you approach lenders, plan large purchases, and celebrate achievements.
The numbers you need
Do you know which financial numbers you should be keeping your eye on? The following figures will help you run your business successfully.
Net profit shows your business’s profitability during a certain period. Find net profit by subtracting all allowable business expenses from your gross profit.
Keep in mind:
- Gross profit is the total money earned minus the cost of goods sold, or COGS (expenses that go directly into items).
- Expenses include operating costs (e.g., shipping expenses) and overhead (e.g., utilities).
With net profit, you can figure out how much to pay yourself. You also need to report net profit on government forms and legal documents. You must show net profit to lenders to gain capital like small business loans and startup business credit cards.
Profit margin is another way to measure profitability, but it shows the percentage of profits that you take home after paying expenses.
Here are three steps for how to determine profit margin:
- Calculate the net profit
- Divide the net profit by the total amount earned (your revenue)
- Multiply the result by 100
For example, you own a pizza shop. You sell a large pizza for $15. The total cost to make the pizza is $10. To find the profit margin, calculate the net profit, divide the net profit by the amount earned, and multiply that number by 100. The profit margin is 33%, meaning you keep 33% of the money you earn.
$5 / $15 = 0.33
0.33 X 100 = 33% (Profit Margin)
Your profit margin can show you if you are pricing your services or products too low. You might have more sales than you can keep up with, but you could be losing money if your profit margin is too small.
The break-even point happens when your income is equal to your expenses. You do not turn a profit or lose money. You use the break-even point to figure out how many items you need to sell to make a profit.
To find the break-even point, divide fixed costs by the selling price minus variable costs.
Keep in mind:
- Fixed costs don’t change when the number of your sales change (e.g., rent).
- Variable costs do change when the number of your sales change (e.g., cost of materials).
Let’s say you want to find the break-even point for your new bike shop. You sell each bike for $100. Each bike costs you $50 in variable expenses. Over the year, you have $20,000 in fixed expenses. Your break-even point is 400, meaning you need to sell 400 bikes to make a profit.
$20,000 / ($100 – $50) = 400 Bikes
Small businesses can use the break-even point to find how low to set a price without losing money. The break-even point is critical if your sales items don’t have fixed prices and you negotiate with customers.
Days sales outstanding
Days sales outstanding (DSO) is the average number of days you take to secure money after a sale. The lower your days sales outstanding, the less time it takes you to collect. Days sales outstanding is measured over a specific period.
To find DSO, divide your accounts receivable by your credit sales. Then, multiply that number by the number of days in the period.
Keep in mind:
- Accounts receivable is the money owed to your business through invoices.
- Credit sales occur when you give a customer your product or service before they pay the total amount due. Note that credit sales include invoices but not transactions made with a credit card.
For example, you own a web design company and want to know the average time it takes you to collect invoice payments. You look at the whole year. You have an accounts receivable balance of $10,000. And, you have $115,000 in credit sales. Your DSO is 31 days, meaning it takes you about 31 days to collect payments.
$10,000 / $115,000 X 365 days = 31 DSO
Knowing your DSO helps you check your invoicing process. If you have a large days sales outstanding, you might need to change your invoice payment terms. For example, you could shorten the number of days customers have to pay you.
What if you’re not good with numbers?
If you’re not good with numbers, there are things you can do to help you with all your business’s financial figures. You can automate bookkeeping processes with accounting software. And, you can hire an accountant and meet periodically to review your books and get advice.
Do you need an easy way to keep all your financial numbers in order? Patriot’s online accounting software uses a simple cash-in, cash-out system. We offer free, U.S.-based support. Try it for free today.