Most small business people would agree that their Profit and Loss account (now more correctly called a Statement of Financial Performance) is among the easier – if not the easiest – financial document to understand. It’s typically presented in two parts.

The top half of the statement reveals the various sources of income the business has received for the period covered, such as a quarter, half year or full financial year. After subtracting the cost of producing your goods or services, it shows your gross profit figure.

The bottom half of the account lists all the relatively fixed running costs (business overheads) such as rent, power and communication costs you need to pay each month regardless of sales levels. When these costs are subtracted from the gross profit the result is a net profit figure (before tax).

So far, so simple, but you can learn more.

How well is the business performing?

These two results enable you to work out two key performance indicators (KPIs) that offer important insights into how your business is performing.

The first, your gross profit margin, is the gross profit expressed as a percentage of sales.

To work this out (if your accounting software doesn’t do this automatically), you divide the gross profit figure by the sales total and multiply by 100 to get the percentage.

Here’s an example:

Gross profit: $80,000

Sales: $400,000

GP %: 80,000 divided by 400,000 = 0.2 x 100 = 20%

Multiplying by 100 allows you to study the gross profit margin as a percentage, so you can easily compare this result with previous margins, irrespective of fluctuating costs or sales levels. Has the margin improved? If not, it’s time to investigate the causes. For instance, has there been an increase in the cost of materials or production labour?

You can now compare your gross margin to similar businesses, because turning the result into a percentage overcomes any differences in size. Regardless of whether they are smaller or much larger businesses, it’s the gross profit percentage (GP %) that tells the performance story.

Depending on which sector you operate in, we can help find the average GP percentage for your industry. Your aim should then be to at least equal the industry average, and preferably do even better. You can also aim to improve on your previous gross margin results.

How profitable is your business?

The net profit margin reveals how profitable your business is when your overhead costs are deducted from the gross profit. It’s worked out using a similar formula. For example:

Net profit: $50,000

Sales: 300,000

NP %: 50,000 divided by 300,000 = 0.166 x 100 = 17%

This KPI empowers you to spot trends before they become disasters. If your net profit margin has fallen, you need to dig for the causes. For example, you may find your marketing costs have blown out with no increase in sales. The lesson here would be to measure your marketing and advertising to see what is actually working, so you can drop any unproductive tactics.

Three tips

1. Use your gross profit and net profit margins as benchmarks to set improvement goals. Try to improve both on internal benchmarks (your current performance against previous results) and external benchmarks (the average for your industry type).
2. Don’t rely on just an annual profit and loss account. You can’t effectively drive your business forward using a rear view mirror that reflects dated data – you need more up-to-date figures. Use your accounting software to generate more frequent profit and loss accounts, such as monthly or quarterly statements. These enable you to take prompt action to fix any negative trends before they do serious damage to the business.
3. Remember to you can always get in touch with us to interpret trends in your results so you can take the right corrective action.

Small businesses can grow in boom times as well as periods of difficulty by working smarter and taking advantage of opportunities. Put these following effective tips into practise to help grow your business.

1.  Utilise new technology

Modern technology can save you time, improve productivity and reduce your operational costs. Make use of Facebook, Twitter, Google+ and other social media tools to market your business.

Dropbox is a cloud-based service that can be used for document creation and sharing, while Skype is commonly used for calling or video conferencing.

2.  Communicate better

Always take a friendly but professional approach to any form of customer interaction including written invoices, quotes and emails. Create guidelines for dealing with customers in writing and over the phone. Reply to messages as soon as possible. If you take too long to return a call or email, you may lose a potential customer to a competitor.

Try writing a blog or column about your chosen industry. Think about sponsoring an event or gifting your products or services to a local sports team, community group or school.

3.  Become more innovative

Even if your products and services are selling well, always look out for new ways to refine your business. Organise regular brainstorming sessions and invite staff to share their ideas on ways to improve products or services.

4.  Tighten up your credit policies

For any orders, make sure your customer completes a credit application and that they understand your terms of trade. Encourage your customers to clear payments quickly by emailing or posting invoices and giving clients a clear time frame to pay. Revisit your terms of trade and make any necessary changes if need be.

5.  Improve your record keeping

If you’re selling products, keep a record of every product sold and ensure you’re aware of how much stock you have. There are free or low-cost point-of-sale (POS) computer programs that can manage stock inventories and provide a record of each product sold. Create a database for future follow-ups by recording clients’ names.

6.  Join business associations and organisations

Business associations and organisations give you access to industry leaders about current innovations and developments within your chosen market for an annual membership fee. They hold regular events, seminars, short courses and networking evenings which can be incredibly valuable for meeting business owners, identifying investors, and learning more about your industry.

7.  Develop a website

If you’re a well-established business, potential customers will be searching for you on the Internet – often before they pick up the phone or walk through your door. An effective website needs to be functional, communicating what you offer and your point of difference.

8.  Manage your time more effectively

Take note of where your time is going each day. Some tasks could be consolidated, or completed at a dedicated time each week. There are free or low-cost time management tools such as Toggl and Google Drive that monitor your daily workload and can generate weekly reports.

9.  Buy good quality business cards and use them

Take any opportunity to hand out your business card when you meet new people – even outside of work.

10. Generate referrals

There are many ways to create referrals and grow your business. For example, you could pay for them per lead, write a blog, attend trade shows, or simply advertise through various media.

Your small business will need to harness a variety of methods for it can grow sustainably, so take the time to plan ahead and try some new approaches.

Good luck and let me know how you get on.