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2011

Profit-loss-blues-in-article.pngHow small businesses can watch their bottom line more closely

 

by Christopher Freeburn

 

Small business owners quickly learn about the necessity, particularly in this economy, of having a well thought-out business plan, doing the right amount of market research, and keeping excellent records. Good bookkeeping and adherence to proper account forms and standards often distinguish small businesses that succeed from those that fail.

 

Part of the importance of maintaining good financial records is that it permits the business owner to see exactly where his or her business stands at any given point, to observe in detail its strengths and weaknesses, and to make sound judgments about the business’s likely future results. This allows the business owner to quickly address problems in the business and plan accordingly for changing market conditions.

 

Among the most important financial metrics that a small business owner should pay strict attention to is the business’s profit/loss, or P/L, statement. Simply defined, the P/L statement compiles the business’s cash inflow and outflow over a specified period of time, deducting the latter from the former to tabulate the business’s net profit or loss for the period. P/L statements provide a far better indicator of a business’s overall health than other financial statements—like cash flow, for instance—because P/L statements show, directly, the business’s overall viability.

PuttinProfit-loss-Pull-Quote.pngg together a P/L statement

P/L statements have a specific and simple format. Since the underlying formula for determining profit or loss is straightforward—revenue minus expenses—the P/L statement just adds up those items that bring revenue into the business, and then those that take money out of the business, and performs a little subtraction.

The proper components of a P/L statement are as follows:

  • Sales revenue. In this section of a P/L statement, the business should identify any source of revenue for the firm. Revenue can be stated in aggregate, but it is often more useful to breakdown various sources of revenue if the business includes more than one geographic area, industry, or income stream. (A business might lease out equipment or space, for example, in addition to selling goods or services.) On the P/L statement, the various categories of revenue are listed and then added together to create a subtotal.

  • Cost of sales. In this section, all costs involved in producing the goods or services by the business are stated. This includes the cost of materials, supplies, labor (for those working directly on the products or services), and money spent on equipment or leases.

  • Gross profit/loss. This figure is determined by simply subtracting the cost of sales from the sales revenue. If the difference is positive, the business is making money and records a gross profit; if the result is negative, then the business is losing money. A gross profit/loss percentage may then be obtained by dividing the gross profit/loss by the total sales revenue.
  • Expenses. Into this section go all the overhead costs of running the business that are not specifically related to producing the goods or services that the business sells. These include the salaries of employees not directly working to produce the business’s products, rent, utilities, insurance, distribution, marketing, office supplies, accounting and legal expenses, maintenance, and any taxes paid by the company.

However, it’s important to note that many businesses exclude a few items from their expenses to calculate another net income metric known by the acronym EBITDA. This term, which stands for earnings before interest, taxes, depreciation, and amortization, is often used to compare the profitability of various companies without having to account for differences in accounting methods or financial investments.

Net profit/loss. This figure is determined by subtracting the expenses noted above from the Gross Profit/Loss subtotal. It is entirely possible for a business to have a gross profit, but a net loss, meaning that the sales revenue is sufficient to cover the creation of the products sold by the business, but insufficient to cover the administrative costs of running the business. Depending on the situation, this can suggest that administrative costs have been allowed to run too high.

The value of P/L statements

P/L statements are important for small businesses because they cast a clear light on the enterprise’s actual financial functioning. It is possible for some small business owners to become too devoted to measuring cash flow, sales numbers, or other financial indices of the business, while forgetting the most important data of all—whether or not the business is actually making money. Keeping a close eye on the P/L statement will bring that into sharp focus.

Many small businesses actually lose money during their initial years of operations. Building sales revenue is not an instantaneous process for many firms and prudent entrepreneurs often anticipate several years of net losses before the business starts making a profit. Nonetheless, P/L statements allow entrepreneurs to examine the underlying engine of their business in a structured and efficient manner. For a business to succeed in the long run, it must produce profits eventually and the only way to know if your company is profitable is to be watching your P/L statement.

P/L statement resource box:

For more on why a company may or may not want to monitor EBITDA as well as their P/L statement, you can visit this resource.

Payment Options - White-in article.pngSmall businesses have gone through quite an evolution when it comes to payment methods they accept. Gone is the cash-only small business. Even sandwich trucks and garment district clothing outlets have embraced the electronic age. Point-of-sale retail locations are increasingly moving toward the latest technologies that allow credit card readers to be plugged into smart phones. And, if you’re doing business on the Internet, online payments and shopping cart services have become de rigeur.

 

Cash

While there are still a few companies focused on the immediacy and low risk of cash payments, this way of doing business no longer fits with how customers function in the world. Most people have become comfortable with credit and don’t carry enough cash to cover a major purchase. From the small business’s perspective, running a cash-only operation is the surest way to be audited by the IRS, and the IRS requires the filing of Form 8300 for purchases of more than $10,000 from any single buyer.[i]

 

Checks

Since electronic check verification companies and check guarantee technology have greatly lowered the risk of fraud or insufficient funds, small businesses would be well advised to continue to accept checks. However, if you do so, you should know that there are guidelines for creating a customer check payment policy. For example, checks should be drawn on a local or at least a same-state bank; companies should not accept checks for more than the amount of a purchase, i.e. in exchange for cash back or to cover a tip; starter or non-personalized checks should not be accepted; and all check writers should provide a valid drivers license or alternative ID card as identification.[ii]

 

Credit Cards

The convenience and delayed payment inherent in using a credit card can lead customers to exceed their budgets or make impulse purchases. While this may be something individual consumers want to curtail, for a small business this way of thinking can lead to great increases in the average sale and in the ultimate bottom line.

 

On the other hand, there are some risks associated with accepting credit of which small businesses should be aware: There are laws that require you to protect your customers’ privacy and keep their personal information secure and failing to comply may result in significant fines and penalties. Additionally, processing credit card transactions can add to your bookkeeping burden.

 

And, most important, there are fees associated with credit card processing that warrant careful attention. While credit card merchant account salespeople may offer unbelievably low credit card processing rates, many small businesses don’t know how to evaluate these offers because they are unfamiliar with the concept of “interchange.” Interchange is the wholesale price structure charged to processors, who then mark up and resell these services to small businesses. The problem is that interchange comprises more than 125 separate rate categories and many of them have high surcharges attached to them that dramatically increase the fees merchants pay for credit card transactions.[iii] These higher rate categories include non-swiped sales, and the use of reward cards, corporate credit cards, cards from foreign countries, and government purchasing cards.

 

Debit Cards

Although more than 74 percent of U.S. families have one or more credit cards, according to a 2006 U.S. Federal Reserve study, debit cards are becoming even more popular. Debit card use has grown by 20 percent a year since 1996 and has surpassed credit cards as the most common form of payment.[iv] Payment Options Pull Quote.png

 

Smart Phone Card Readers

Small business merchants who are mobile can use their smart phones as payment kiosks through the use of matchbook-size credit card readers that allow customers to swipe their card, use the touch screen to sign, and then get a receipt via e-mail or text. The card readers are free from companies like Intuit, Square and Verifone, and come with a per transaction fee of approximately 15 cents per swipe and 2.75% of the transaction. While this technology didn’t exist a few years ago, payments via smartphone credit card readers are expected to total $11 billion this year and $55 billion by 2015.[v]

 

Online Payment Services

If your small business does all or even some of its business over the Internet, online payment services are imperative. Less expensive and easier to implement than traditional merchant accounts, online payment services allow you to accept payment from any customer with an email account and a bank account. These services are available through many banks, as well as services like PayPal and Bill Me Later – all of which enhance the security of customers’ financial information through two-factor authentication.[vi] Finally, online payment services require the use of a virtual shopping cart that calculates the total, tax and shipping costs of an order. These are sometimes offered by online payment services, or can be purchased through a third-party shopping cart service.

 

In addition to the above payment options, there are some additional innovative technologies currently being introduced or under development. For example, most electronic payment processors already translate payments into U.S. currency no matter where in the world your customers reside. Customers will soon be able to reduce transaction time by waving their credit card at the register and having a Near Field Communications (NFC) technology read it wirelessly. Additionally, online payment services like Paypal are developing smart phones apps that will allow person-to-person fund transfers by bumping two i-Phones together.[vii]

 

While all of these payment options have their value, the best approach for most small businesses is to offer a variety of options to customers. Demonstrating flexibility will enhance your professionalism, facilitate increased sales, and enhance customer loyalty by meeting a wider variety of payment preferences.

 

 

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