Tax & Accounting

Differences Between Gross and Net Profit (and Why Neither Matter Unless You Get Paid!)

Differences Between Gross and Net Profit (and Why Neither Matter Unless You Get Paid!) 1000 668 emily
Wondering if you’re doing everything you can to boost revenue and cut costs? Or if your business is actually more profitable this year than it was last? The best way to answer these questions is with a thorough assessment of profitability. That’s where gross and net profit calculations come in. These are two of the most important metrics for measuring your capacity to generate earnings relative to costs and expenses. Let’s take a look at the differences between gross and net profit, and what they can reveal about the financial health of your business.   Gross profit: a general overview of profitability You can calculate your company’s gross profit by subtracting the cost of the goods or services you sell from your total revenue, over a specific period of time. The equation looks like this: Sales – cost of goods sold = gross profit When determining the cost of goods sold (otherwise known as COGS), businesses take into account all of the processes involved in their production and delivery to customers, including:
  • raw materials
  • manufacturing
  • packaging
  • shipping and fuel.
Once you know your gross profit, you can divide it by your total revenue to calculate your gross profit margin – a percentage that shows exactly how much money is left over after you’ve covered your COGS. This calculation will show you how efficiently you’re managing your resources – and where optimization is needed – so you can work toward a healthier bottom line.   Net profit: drilling down to profits after all expenses The net profit calculation goes a step further by determining how much revenue remains after subtracting all expenses, including COGS.  Net profit reveals your precise profit per dollar of sales after deducting operating expenses, taxes, interest paid on debt, etc. In order to keep abreast of your financial status, it’s wise to calculate net profit every month. Determining your net profit is crucial for a number of reasons, including:
  • knowing how much you can safely pay yourself each month, or divide among your business partners;
  • applying for a business loan, where net profit is an important part of the lender’s free cash flow analysis
  • measuring performance  against the industry benchmark and your main competitors.
  Protect your profits by ensuring you get paid It goes without saying that calculating gross and net profits won’t be very useful if you’re having trouble collecting payment from your customers. Staying on top of accounts receivable is crucial for maintaining positive cash flow, turning a healthy profit, and growing your business. Here are a few tips for ensuring timely payment:
  • require payment up front, and only offer 30 day terms to clients who have proven their trustworthiness
  • track invoices weekly, contact clients immediately after the payment deadline has been missed, and work together to set a new deadline
  • suggest an installment program for clients who are encountering financial difficulties.
Tighter invoice collection combined with clear insights into profitability will pave the way to smarter, more efficient management – your key to long-term sustainable business growth. Quantum Advisory is a business accounting and advisory firm that empowers family businesses to step up, scale up and sell up. Visit www.qagroup.com.au or call 1300 700 711 and start the journey.

The ‘Illawarra Factor’ – Our secret unfair advantage

The ‘Illawarra Factor’ – Our secret unfair advantage 1022 682 emily
To those of us who live and work in the Illawarra region, it’s home. A place built on a rich history of steel and mining. A place where we all know the peaks and troughs of Australian industry and the resilience it takes to run a business. A place built buy hard working men and women who spend their day to day labouring somewhere between the mountains and the sea. Of course, as an eclectic group of realists, it’s easy to be consumed by the negatives. The down sizing of BlueScope, the knock-on effect this has had on dependent companies, infrastructure that needs upgrading and THAT Rabbitohs field goal back in September. Sure, we have our challenges but let’s take a look at a report recently released by global advisory firm Deloitte. Their report analyses our city and makes many interesting observations about our location, resources, investment, proximity, infrastructure and access to skilled talent through the initiative of the University Of Wollongong. Their report provides some very interesting numbers. According to Deloitte:
  • The costs of commercial rent in the Illawarra is up to 50% less than Sydney
  • The cost of Labour is approximately 85% of the cost of labour in Sydney.
  • Retention of employees is high with a comparatively low employee churn rate of 5% compared to Sydney’s 25%.
This all sounds impressive but what does it mean? Being nerdy numbers people, we decided to look at how this would impact a real-life business operating right now. We took the Profit and Loss Statement of one of our clients with a manufacturing business in Western Sydney. We removed names, rounded amounts to the nearest thousand for simplicity, and it looked like this: As we can see, this is a well-run business, achieving sound margins and a healthy profit. Next, we began adjusting the numbers to take into account the ‘Illawarra factor’. First, we reduced labour by 15% then we reduced rent. We could have reduced rent by anything up to 50% but we took a conservative estimate for the comparison and reduced rent by 30%. To be completely fair we then looked at additional expenses that may increase due to this particular business being based in the Illawarra and not in Western Sydney. We raised Freight by 40%, Motor Vehicle Expenses by 50% and Travel costs by 100%. The latter assumed that the personnel within the business would have to travel to further to service a comparative market size. That said, this business has less than 10% of it’s market in Sydney and is servicing customers all over the country so maybe we were getting a little paranoid. As can be seen by the revised Profit & Loss Statement below, the result is VERY different. In summary, the Gross Profit margin increases by 4%, the Net Profit Margin increases by 5%, and the tangible Net Profit increases from $778K to $1,147K (47%)! Now let’s be realistic, this Sydney Manufacturer probably can’t and won’t relocate to Wollongong any time soon. However, I would like to challenge every business owner in the Illawarra, are you capitalising on this opportunity? The advantages don’t stop with the profit margins.
  • We have a large pool of skilled talent constantly graduating from the University of Wollongong. Let’s reduce the 20,000 plus people commuting their talent out of town every day.
  • A lot of our talent relocates to Sydney or interstate to larger cities. Even if salaries in Wollongong are 10% – 15% lower than Sydney, the cost of real estate is typically 35-40% lower in the Illawarra. The great Australian dream gets closer.
  • We have a great public transport system and logistics networks to get our people, services and products to the rest of Australia.
  • Residents of the Illawarra enjoy a great coastal lifestyle, world class healthcare and modern shopping, hospitality and entertainment facilities.
How are you using the unfair advantage we have being right here in the Illawarra? Maybe it’s time to check our doorstep for growth opportunities? With over 40 years’ experience working with Wollongong businesses, we’re ready to help you step up and build another great local legacy. Credit: Advantage Wollongong & Deloitte

Strengthening your balance sheet

Strengthening your balance sheet 1000 670 emily
Your balance sheet (now more correctly called a Statement of Financial Position) reveals a great deal about your business, including the total value of your assets – the things you own; how much you owe to others – your liabilities; and the level of your solvency. These three aspects will be studied carefully by lenders and investors − and by buyers if you intend to sell your business. But they should also be important to you, because it’s important to be solvent at all times. In other words, you need to have more assets than liabilities available to pay your debts. If you can’t pay bills when they fall due, your business may be technically insolvent. Fortunately two simple tests can quickly reveal your solvency.
  1. The Current Ratio test
This test simply involves dividing your assets by your liabilities (you should find both figures on the balance sheet). For example, if a business has assets of $435,000 and liabilities of $180,000, the current ratio is 435,000 divided by 180,000 = 2.42. In other words, the business has $2.42 in assets for every $1 of debt. On the face of it, the business is solvent, as the minimum ratio most banks would regard as acceptable is $2 for every $1 of debt. But wait a minute. Your assets include stock (your inventory). What’s your stock really worth? If you had to sell it all tomorrow to pay off your debts, could you really get out the full amount shown on the balance sheet?
  1. The Quick Ratio test
Let’s try a tougher test – this time leaving out your stock. The aim here is to find out if your business has enough quick money (ready cash) to pay your bills if your creditors demanded repayment tomorrow. Let’s say the business has $325,000 in stock. Subtract this from the assets figure of $435,000 and the assets reduce to $110,000. Now for the Quick Ratio: $110,000 divided by $180,000 = 0.61. Hmm − the picture is no longer so rosy. The business has only 61 cents in ready cash for every dollar of debt, meaning it could not immediately pay its debts. Your aim should be to have at least $1 in assets available in quick cash for every $1 of debt, a ratio of 1:1. You’ll sleep better, and so will your bank manager. Strengthening your balance sheet A positive step to strengthen your balance sheet is to take a closer look at the quality of your inventory. If you had to sell all your stock in the next week or month to pay your debts, would you get the full amount shown on the balance sheet? In many businesses, the answer would be no. If you know you have obsolete or slow-moving inventory sitting on your shelves, talk to us about ways to get rid of it. We can discuss ways to reduce or get rid of obsolete stock, such as:
  • Holding a sale.
  • Bundling unwanted stock with more popular items as a ‘special offer’.
  • Choosing the most advantageous time of year to write it off if necessary.
We can also show you how to measure the stock turn rate in your business to improve stock management and profitability. In broad terms, the faster you turn over your stock, the more efficient your business. A fast turnover rate can also reflect more efficient inventory management. Closing tips
  1. Many business people find a balance sheet more difficult to read than a profit and loss account. If this applies to you, we can help you understand it better so you can gain more from the figures.
  2. Getting a balance sheet just once a year is certainly not enough! A balance sheet offers important insights into your business. With the right accounting software you can generate a balance sheet whenever you need one.
Quantum Advisory is a business accounting and advisory firm that empowers family businesses to step up, scale up and sell up. Visit www.qagroup.com.au or call 1300 700 711 and start the journey.

10 tips to reduce debtor days for small business owners

10 tips to reduce debtor days for small business owners 1000 667 emily
Steady, reliable cash flow is crucial for the survival of any small business – so taking steps to ensure your customers pay promptly should be a key priority. read more