A common issue in business occurs when business owners don’t fully understand how profit their business is generating.
The Importance of understanding profitability:
- Financing – Understanding business profitability is important as profits influence financing decisions such as obtaining loans from banks.
- Dividends– Profitability is also important when extracting dividends out of a business as these are restricted to the profitability of the business.
- Tax– Profitability is important as it helps understand and plan for future tax bills.
Understanding profitability
A common misconception of profit is where business owners believe profit is simply sales proceeds less direct expenses such as material costs. However, this fails to incorporate other direct costs such as travelling for that job and even more commonly fixed costs that the business incurs but fails to recharge to their customers. Examples of these include rent, rates, and insurance, which can amount to substantial amounts; but businesses often fail to factor these into quotations. These problems lead to businesses believing they are making a greater profit than they actually are and can lead to a rejection in financing and disappointment in dividend declarations.
How to better understand profitability
Utilising an accounting software, such as Xero, by regular book-keeping can be useful to give an accurate position of profitability within your business.
Having an up-to-date position of your current costs and expected costs can help with forecasting future profit. This can help to establish break-even points and determine whether you can hit your goals.
A solution to better understand profitability on specific jobs and projects involves tracking costs incurred. Software such as Xero and Dext enable you to assign costs to a job. This can enable businesses to evaluate the profitability on different jobs, which can also help influence marketing activities.
Robson Laidler can provide further support to help identify how profitable your jobs are and can help you improve profitability on jobs. Contact us for further support on understanding how profitable your business is and tips for improvement.