Red Zebra Business Centre -Management Memos
April 2010. Making Measurably More For Your Business Since 1985!


MaxProfile
Sometimes the KISS principal can make life really hard! 


Max Williams, Principal Consultant


In recent times, we have come across a wide range of enterprises where the business owner is not really able to manage the business from a financial point of view. Sure, the owner can control expenditure, and within limits, they can control their selling prices. But that is just a small part of the story.

The real issue is that simple accounting systems, and the traditional practices of running the accounts through the accountant in time to lodge the tax return, mean that it's not until long after the end of the financial year that you know what the business is really making.

We had a client comment some little while ago now, that they had had a great month, and had  made a very substantial profit.

That would be good in the normal course of events - if only it were true!

It wasn't true because there had been only a small amount of stock purchases that month. Because purchases were small, it appeared that the cost of doing business was small, and the good sales meant a great profit. In reality, the trader had simply cashed out his investment in his stock. Whether there was any profit in it or not, was a matter of conjecture.

That story has been repeated many, many times over the years.

Many years ago I was talking to a client's accountant - with a view to changing the way the accounts were being kept. "Is it really worth it for such a small business?" asked the accountant. His client, and mine, was in a very competitive business, and he was going backwards at a very fast rate!

What we were seeing here was a nice, simple, easily managed, accounting system that was driving the client broke! He certainly needed any additional complexity like a hole in the head. But the simple system was not providing the information he heeded to get the business right.

In the years since then, there has been a constant chorus of resistance from clients and their accountants and book keepers, who want to keep the system simple. No doubt we all applaud simplicity. In this case, the simplicity is based on some simplistic assumptions about the market and the supply sources these client work with.

As markets get more competitive, and more and more mass merchants drive down selling prices, we need more, not less information.

This month's topic has ?dull and boring' written all over it.  Yet it can be the most important learning experience of the whole year.

We certainly hope it is for you!





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Simple Sum!


M

ost times, we judge a business on its performance on its sales performance. "What's its sales" is the usual question. But this question makes lots of assumptions. This month we question some of those assumptions.






It makes sense to judge a business by its income. After all, the bigger the income, the bigger the enterprise it can sustain.

When we see a business of a certain size, we reckon we can judge its performance by its sales income. But is it right to do that?

More particularly, is the sales level a real measure of the actual income of the business you're looking at? Now that's a subject worth a little look!

At first this might seem a bit high-falutin? and bookish. But hang in there! It is important! And is not usually so clear!

English is known for its subtle shades of meaning carried by almost identical words, and the two words 'income' and 'revenue' seem almost identical at first look. Accurately, and in every day English, 'revenue' means 'income received', and 'income' means 'money received'. Certainly that's very confusing!!

But look a bit further. In the business lexicon, the idea of revenue is more fully developed. Here, 'revenue' is described as 'The money received from the sale of output'. So, your sales revenue is the money you get for having made the sale. Right?

So then, whatever is the income? Mostly, we think of sales as the income for the business, but what we can see now is that the sales value is not the income at all. Actually 'sales' is the revenue.

In fact, it's the gross profit that's the real income.

This system has been in use since Italian traders first introduced it in the 13th century. It's this underlying practice that's become the basis of our accounting standards, and our taxation system.

In earlier years, it was common to report a 'Trading Account' showing the results of the trading part of the business - that is, the buying and selling - generally resulting in a profit, That's the profit we call the 'gross profit'.

Traditional accounts following this format also then show a 'Profit & Loss Account' following the Trading Account. Here the Gross Profit is shown as the income, and all the operating expenses are deducted from this income.

In more recent years, it has become a practice to roll together both the 'trading account' and 'profit & loss account', and many of the popular accounting systems in use today operate this way. In more traditional accounting circles, however, these two items are still shown separately.

Where those traditional formats are in use, the trading account shows both the 'Sales' and 'Cost of Goods Sold' value - with the difference being the gross profit.

It is the gross profit that goes over the page into the profit and Loss account as 'the income'. That is, the real income!

There is a pretty good justification for this system.

As a business person, you can control everything about the business except the Cost of Goods Sold. Whatever your trading environment, you can influence the quantity and control the price of what gets sold, but, for any given product, the Cost of the Goods You Sell (the Cost of Goods Sold) is effectively within the control of the supplier.

You can negotiate to your heart's content, but ultimately it's the supplier who determines the price at which he is prepared to supply. So, there is not a lot you can control in the trading account - it's the competition and the suppliers who hold all the cards!

It is for this reason, that until the Cost of Goods Sold is known accurately, there is no accurate measure of the income of the business. In that case, there is no prospect that the income and expenditure sides can be managed effectively in relation to each other.

Look below the gross profit line, and it all changes. Everything is within your control -the space occupied; the extent of the telephone account; the number and size of motor vehicles; the volume of stock; the number of lights that are kept burning through the day; and so on. All these, along with all the other costs of running the business, are directly within your control.

In short, proper management of your business means you need to know the Gross Profit at any time, and not only after the end of the financial year. Traditional bookkeeping and accounting methods actually ensure that you as manager are not able to manage that income except on a long term basis, and not until after the formal accounts have already been prepared. Usually, that's about fifteen months after the opening of the trading year!

Proper management can only be achieved through the implementation of solid stock and purchasing management software. This will mean extra work with your book keeper and accountant for a while until you get a proper system installed, and running properly over a complete annual cycle.

But is it all worth it!

Yes Siree Bob! When you see such a system work, you as manager, can make a real difference to the profitability of your business! And isn't that what you really want?

You may need more help with setting up your commercial management systems and techniques. But what a worthwhile investment that will be!





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