*Snap* and we’re already in November.
How has 2020 been for you?
Because this has been a really, really difficult year for plenty of businesses. Whether you’re from a large Multinational Company (MNC) or just a small-medium enterprise (SME) business owner, there are only two ways to describe the arrows on your financial statements.
Either it’s green, massive financial growth with the declaration of increasing profits, or red surging expenses plunging your company into debt or negative cash flow. Every business owner is trying their level best to keep their business afloat, and hopefully be on track to profit in the next few months, or years.
But really, how would us business owners know if our company is on the right track in terms of financials? How do we avoid the mistake of actually reporting a gross profit when our operations or expenses is in the negative? As the legendary stocks investor Warren Buffett believes, bad things aren’t obvious when times are good. It’s easier to be measuring success when you pay extra attention to data.
So whether you’re a budding entrepreneur that loves picture and HATES numbers (and do not have a CFO), or you squint at the annual financial statements each time they pop up, we will spare you precious time and effort. Here are the 3 financial numbers you, as a business owner, should be informed in 2020.
Every business has expenditures. Whether it is cost directly incurred, to purchase or to produce the item that is sold (Cost of Goods Sold, COGS) and for overhead, marketing or operations, these are impossible expenses that the owners of every business must bear. The breakeven point tells the amount of sales your company needs, to break even or start making profits. To keep it short and sweet, it’s the point at which:
Breakeven Point = Overheads / Gross Profit Margin
Company AAA sells its product at RM 100 each. Each of these item cost AAA RM 40 to purchase or produce. AAA has a monthly overheads of RM 20,000.
Gross Profit Margin = Gross Profit / Revenue
= (RM 100 – RM 40) / RM 100
= RM 60 / RM 100
Breakeven Point = Overheads / GP Margin
= RM 20,000 / 60%
= RM 33,333 per month
Hence, if you are running a small niche-targeted business, its always better to have a smaller break-even point. As an SME owner, if you know your BEP by heart (usually measured in decimals or percentage), you know how much money is spent for the company. This will guide you to spend smarter money on your cost of goods sold (COGS) wisely by looking at the Gross Profit Margin.
Other expenses like Marketing and Advertising campaign would need to take good care while keeping your staff expenses low and your operations lean. The audience in your business is more specific. You can focus your initiatives towards your targeted audience and ensure that every single cent of your expenses is effectively and efficiently spent to boost profits for your business.
On the other hand, if you are running a huge enterprise, there is even more urgency for you to calculate your BEP. Any huge business, from manufacturers to mass producers has high breakeven points and often have to spend a huge chunk of expenses cost on a variety of initiatives.
By knowing this metric in your business, you can monitor expenses that are either less efficient or determine alternative methods to lower cost, avoid losses and improve sales and profit. The breakeven point is the first metric to grasp before Performance Marketing can improve the state of the business.
This metric is tightly correlated to the success of your business. Cash Conversion Cycle indicates how efficient your company can convert its investments in inventory and other resources into cash flows from sales. No business can survive if no sales are made. Conversely, any business with high sales volume translates to high revenue and if managed well, high profits.
Cash conversion cycle is a useful metric because it shows just how long it takes for your cash to first be converted into item (stuck as inventory) and accounts payable (AP). Then through the sales you closed and accounts receivables (AR), and back to cash.
In much simpler terms: How long it takes for your cash to be invested into inventory, sold, and received in the form of cash again. Often times, the lower the number, demonstrates better management, and more efficient businesses. Does your company have a low CCC?
The formula to calculate CCC is as straight-forward as follows:
CCC = Inventory Days* + AR Days** – AP Days***
*Inventory Days = Average Inventory ÷ COGS x 365 days
**AR Days = Average Receivables ÷ Revenue x 365 days
***AP Days = Average Payables ÷ COGS x 365 days
One of the biggest mistakes plenty of companies make is not gauging their cash conversion cycle. This simple mistake has seen new business owners falling into debt because their expenses exceed their income. These expenses are hidden within factories and warehouses, where the cost of storing the items in huge leased properties take up so much of their costs, and they are unable to close enough sales in time.
At best, they break even and make no earnings. Worst case scenario, they have negative cash flow and have to find other ways of cutting expenses (which usually results in mass layoffs). Understand that your cash conversion cycle will allow you to model, and track your financial projections and effectively manage your cash flow.
Last but not least, the crucial figure: Cash Buffer Days.
Many people in the startup world refer to this as a ‘Startup runway’ because of its striking resemblance to how an actual runway allows aeroplanes to take off and land. A runway or Cash Buffer Days is a metric that determines how long your company is able to survive if every source of cash inflow stops.
How many days can the company owner and his business survive, with no money in and only money out? Throughout the pandemic, COVID-19 has led to the bankruptcy of various industries, namely the Tourism sector because the average daily cash outflows exceed the average daily cash balance.
As we are closing in on 7 months of the outbreak and lockdown, many F&B and retail chains are also forced to stop operating because they do not have enough cash reserves to fund their overhead expenses like payroll, financial commitments, costs, and debts, effectively losing money every business day, on zero income.
Cash Buffer Days = Cash Balance ÷ Monthly Outgoings x 30 days
Thus, if your company would strive to remain in business during these trying times, it is vital for you to know how much buffer days you can afford to sustain should the policy for control orders continue to be tightened day by day.
Understand that these financial numbers is key to predicting the future, and the success of your business. Making business decisions with these ratios in your head is critical in both the short, and long term period. Don’t be surprised that the bank would question you on your assets, liabilities, equity, capital, tax and statement-related figures before you apply for a loan in these trying times.
Aside from that, every business owner has to know their margin, revenue, the profit you make per sale after subtracting the price of your goods sold, and its financial projection across a financial year, and in some industries, monthly and quarterly period.
Every good CEO or Founder must be able to plan ahead in the future while keeping an eye on the current health and accounting numbers of the company to reduce the probability of incurring loss for shareholders or stakeholders.
Here is some bad news for you if you dislike numbers and refuse to learn after these hard times. Whether you’re a creative, or an artistic person running a business. Individuals in companies that typically ignore the variable portion of tracked data as a guide to your result will eventually, or finally find yourself in a serious situation with cashflow issues.
More often than not, this will translate to failure in the business or more severely having the person legally declare bankrupt.
The most robust and mature businesses achieve unparalleled success as they tend to be built on a system where the process is carefully monitored. The success of these companies is owed, not to the location, vast network or even to the levels of their position, but instead through communication that exists on topics and questions about dollars and data.
As mentioned earlier, it is crucial for every business owner to be understanding the fundamentals of these numbers and metrics, how much they are spending and selling their product (or products) in order to increase their revenues.
CALTRiX is a Cloud Accounting Implementation Partner (specialized in Xero) in Malaysia that seeks to provide an ease of mind service and experience to clients and vendors that are willing to learn and grow their business with us, on the basis of getting to read and simply access your essential accounting activities – paid or unpaid invoices, payments, utilities bill, depreciation and more. Our clients are accessible to basic financial reports as well via online (Profit & Loss Account and Balance Sheet template) together with their accountant.
Some of our clients including successful e-commerce entrepreneurs, chain restaurant business owners, corporate finance consultant companies, solar energy and recycling heroes and many other industry. Our customers refers to us, and view us as relevant authorities to help their company save precious hours with digitalizing accounting processes and automation through integrations of cloud accounting software as you focus on achieving profitability.
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