How does a business make money?
The No.1 secret is.
I call it a secret, because so many business owners don’t know or understand the number one secret to making money in a business. The number one secret is tuning your business so as you make a healthy gross profit (GP) percentage.
Why is a healthy GP percentage the number one secret to profits?
I call the generator of your GP percentage the engine room of your business. If the engine room is not fit, healthy and powerful, no matter what you do in the rest of your business, you will never overcome a weak, under-performing engine.
Imagine having a car weighing 1500kg (say an SUV) and a four cylinder engine of 1.5 litres.
No matter how hard that engine works, your vehicle will make slow and uneconomical progress because the engine room cannot produce enough power and torque to move the vehicle swiftly along the road.
What numbers go into creating your GP percentage?
It’s simple. It is your sales minus your cost of sales (or S minus COS). Identifying exactly what your cost of sales are (sometimes also called cost of goods sold or COGS) is vital to knowing what “friction” is inside your business engine room.
Different businesses have different components to their COGS. If you are a plumber for example, your COGS is the trade/wholesale cost of parts, plus consumables (say adhesive) and the direct labour cost (wages) for doing the actual plumbing work.
As an example let’s say you sell $1000 of plumbing services. The parts are $200, you use $20 of adhesive and use 10 hours of labour for which you paid your employee $30 per hour. Total cost of sale is therefore $520 ($200 + $20 + $300). This gives you a Gross Profit of $480 or 48 percent on the total job ($480 is 48 percent of $1000).
Key question: how do
you know what a healthy GP percentage should be for your industry, business or trade?
E3 Business Accountants (and so should your accountant) has access to two national databases that benchmarks just about every industry type in New Zealand. Using the plumber as an example, our database contains actual figures for the top 25 percent, the middle 50 percent and the bottom 25 percent performers.
You need to ask yourself, why do some plumbers perform more profitably than others? And even more importantly, where does my business rank?
In the survey a plumber’s healthy engine room GP percentage is 65 percent. A weak engine room would yield just 45 percent. The difference between 45 percent and 65 percent is the difference between profit and purgatory.
In the example above, 48 percent GP is near the bottom of the survey results. This has occurred because of any one or a combination of the following:
➜ The job was under-priced and should have been sold for $1,100. This would have yielded a 58 percent GP
➜ The job was completed inefficiently and should have taken seven hours, not 10. Doing the job in seven hours would have yielded 57 percent.
➜ The cost of the parts and/or consumables was not correctly priced and cost more than expected.
Now, look at the GP percentage if the job was sold for $1100 and took seven hours with no change to the price of the parts or consumables. If this was the scenario then the GP percentage would have been right up there with the top performers yielding 67 percent.
In summary: The business secret number one to making a sustainable and deserved profit is making sure your GP percentage is enough to run your business.
Jamie Tulloch is the
managing director of
E3 Business Accountants
and can be contacted by calling 0800 11 33 99,Source: www.magazinestoday.co.nz