Management consultancy & finance
Numbers: Do you know how to count and keep score?
Numbers are the truth when it comes to your business. They strip the business bare, showing it out if it is going down and showing it off if it is on the up and up. Every entrepreneur should be able to know the numbers of their business and what they mean. This even becomes an important task for an entrepreneur who is running a small business. They need to know their costs inside out and know how they affect their revenues.
“Men lie, women lie. Numbers don’t.”- Shawn ‘Jay Z’ Carter
First things first, know how to record numbers, have a financial journal and keep records. However, most of the small businesses that seek funding don’t have financial records to show how they performed in the recent year(s). Most can only give guesstimates and it is often hard for them to know their margins or their overheads. This lack of understanding about the business is a red flag for every investor, because knowing your business is knowing your numbers. It makes an investor question if your business is really sound and viable to invest in.
Now what are the numbers that you have to pay attention to?
It is not enough for the business to just produce, it has to sell. Most Malawian firms are production companies so the revenue shows how much you are making from the product you are selling. This is NOT the cash that flows into your bank account.
To give an example of the difference between your cash flow and revenue, think of your company selling products with a payment term of 30 days. As soon as the products are sold to your customer it is called revenue. However you receive the money after 30 days. If you make the sale on the 29th of November, you’ve got revenue in November, while you receive the cash in December.
Make sure you know the units that are being sold at what rate and where they are being sold from and if the revenue is growing. The revenue determines the size of the company, but doesn’t say anything about the strength and sustainability of the company. Scaling-up, as described in our previous blog, is mainly to increase the revenue.
Cost of Goods Sold
These are direct costs that are incurred in producing the goods sold by a company. This includes the cost of the materials and labour directly used to create the good. It excludes indirect expenses, such as marketing costs and other overhead costs. This figure can be used for businesses that sell physical products and have inventories. For those that run a service business, they can calculate the cost of revenue per unit of good or service. The Cost of Goods Sold will help one to determine the cost price for every unit they sold. Costs for raw materials, packaging or other products that are not sold yet, are NOT taken into account here. They are placed under “inventories”, with the main reason to separate and keep track of all the materials that you bought in bulk for actual usage.
The gross margin is related to the cost of goods sold (or cost of revenue). It determines how much money is actually left over after you’ve subtracted the cost of your product or services. If you are in a competitive market, your margin will be quite low; however, if you have proprietary goods or high quality, in-demand services, your margin will be high. The Gross Margin is one of the key figures of the business, as it determines the profitability of the main activities and indicates the possibilities of scaling-up.
Also known as net profit or net earnings, your net income is quite related to your cash flow. This is a good indicator of how your business is doing, whether there needs to be an adjustment, or if you are on the right path. Knowing this number helps you determine the financial position of your business. This is the difference between your overall income and expenses (including taxes).
Profit and Loss
Your profit and loss statement (also stated as P&L) is crucial, as it gives you a snapshot of the financial status of your business. You can create your P&L statement on a weekly, monthly, quarterly, or yearly basis, although most often it is done monthly, quarterly, semi-annually or annually. The P&L statement is an overview of the difference between your company’s revenue and your company’s expenses.
If it’s positive, your company has made a profit, and the opposite is a loss.
Operating cash flow is the lifeblood of a business. It often does not matter what your revenue is if you don’t have the positive cash flow. That is mainly because you will not be able to pay your expenses, and soon might have to close down your business. This is why you should pay extra attention to it. Cash flow is the difference between cash inflow (money from goods and services) and cash outflow (bills, loan payments, taxes, etc.).
This is an extra number to note. For most Malawian business which deal with physical goods, it’s crucial that you measure how much inventory you have on a weekly basis. When you know how much inventory you have at the beginning of the week and at the end of the week, you can also get to be in control of your sales and production. You can use the following equation to keep control of your sales and production:
Starting inventory + production – sales = Ending inventory
If this equation doesn’t add up to the counted inventory at the end of the month, you lose inventory.
If your inventory is increasing, this is usually an indicator of sales problems unless you want to build up your inventory on purpose. You will need to adjust your orders or productions in order to balance out the decreased sales.
Connected to your inventory, remember, are storage costs, waste, and of course reduced profits, so it’s very important that you monitor your inventory number.