Running a business is both an incredibly exciting experience and a nerve-racking one! The main hurdles which catch out small businesses are consistently balancing the books and managing cash flow. To avoid becoming a failed-business statistic, all business owners need to get their heads around some accounting basics, such as determining if your business is profitable. Here’s how…
The two major systems of accounting are accrual-based accounting and cash-based accounting. Let’s take a closer look…
Under this system, you match your revenues to your expenses. This means that you will record a transaction when it occurs, as opposed to when you receive cash. For example, if a customer pays off an item over a twelve-month period, the transaction is recorded as a complete once-off payment. This is a better way of getting an accurate idea of your businesses finances, but accrual-based accounting is more difficult and costly to implement initially.
Note: At RBK Business Accountants, we support the accrual method.
Cash-based accounting tends to be an easier way to record the amount of money you are earning each month. While this won’t give you a very detailed idea of your business finances, for most small businesses it’s an effective solution until they expand. With cash-based accounting, you enter the payment amount into your accounting spreadsheet or software only after receiving payment.
Whether you choose the accrual accounting system or the cash-basis accounting system is up to you – you need to select a system with which you feel comfortable, and capable of instituting, as this will be the basis from which you will conduct further bookkeeping.
This refers to outgoing monies – your overheads, production and transport costs, purchases, employee pay and benefits, etc. These expenses need to be listed in the same timeframe you use to record your income. This should be done on a consistent timescale for the sake of keeping your books ordered and accurate. If you add your income weekly, then you should add all your expenses weekly, too.
Working out profitability this way will show whether your business is profitable or not, but it won’t give you specifics as to why your business has a good margin or not. To calculate your net profit margin, you will subtract your expenses from your revenue (income). Remember, this will give you a bird’s eye view of your profitability! To find out if your business has the potential to grow and maintain profitability in the long-term, you need to evaluate these figures over an extended period.
“Annual income twenty pounds, annual expenditure nineteen [pounds] nineteen [shillings] and six [pence], result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery” – Charles Dickinson, David Copperfield.
In the most simplistic sense, you need to carry out this process over the course of a at least a few months to a year to assess whether your business is making a loss or profit. Being profitable some months and not others may be untenable, especially if overall your expenses are higher than your income. If you see a pattern like this emerging, you need to take a deeper look at why this is the case and what you need to change. To discover what is damaging your business profitability you will have to take stock of all the individual elements of your business, such as what you are charging for your product or service, employee productivity, and how you structure your payment plans among many other things.
Don’t struggle with your bookkeeping! Get professional accounting and bookkeeping solutions so your business can thrive. Speak to RBK Accountants today to get your business on track…