Measure Your Business and Manage your Continued Profitability

Yo, if you wanna know if your biz is killing it, getting better, or falling off, you gotta check out Variance Analysis, specifically Year on Year analysis. We’ve talked about Variance Analysis in another blog, so hit up the link at the bottom for the deets.

To get the real scoop, focus on some key formulas that’ll shed light on how to measure your business. And remember: do NOT include VAT in these calculations.

Key Formulas to Know to Measure your Business

Before you dive into calculating your GP Ratio, make sure you’ve got these formulas down:

Gross Profit = Total Sales minus ‘Cost of Sales’

Where:

Total Sales = Turnover before deducting costs for materials, overheads, labor, or drawings.

and

Cost of Sales = ‘Opening stock’ plus ‘direct purchases/materials’ and ‘direct labor’ minus ‘closing stock’

Direct purchases/material costs are the expenses you can directly link to making specific goods or services.

** Pro Tip: If you’ve got returns or discounts, make sure to knock those off your turnover or Total Sales to get your Net Sales. Use that number instead of Total Sales.

Gross Profit Ratio

The main formula to check how profitable you’re being is the Gross Profit Ratio (expressed as a %). Here’s how you break it down:

(Gross Profit / Total Sales) x 100

So, what’s a good GP ratio? It really depends on what kind of biz you’re running. But generally, if you’re sitting between 50% and 70%, you’re in a pretty solid spot if you’re a retailer, restaurant, manufacturer, or any other goods producer.

Keep an eye on those margins. Set a benchmark for your profitability ratios after your first business period and compare it to your budget if you made one. Then, check each period against the last to make sure you’re not slipping. In the UK, HMRC uses the GP ratio and NP ratio to audit your sales figures (we’ll dive into the NP Ratio in another post). Changes in these ratios can point to all kinds of issues, including undeclared income. They also compare your ratios to similar businesses, so keep it tight.

What Causes Changes in Gross Profit?

So, what’s shaking up your gross profit? Here are some things to look out for:

1. Sales prices have changed - Did you bump up or lower your prices? Are they still competitive with the other players around?

2. The unit volume of items sold has changed - Has foot traffic dipped? Are you capturing all those sales?

3. The product mix sold has changed - Different products have different GP margins. Was that a smart move or just a trend?

4. The purchase price of direct materials has changed - Found a new supplier? Did you adjust your selling price to match costs?

5. The required amount of direct materials has changed - Are you dealing with scrap, spoilage, or design changes? Have you trained your crew or lost some key gear?

6. The amount of direct labor has changed - Are you using labor when you don’t really need to?

7. The cost of direct labor has changed, possibly due to:

   1. Altered overtime levels - Are you paying higher rates for extra hours, or do you need to hire more folks?

   2. Changes in the employee mix with different pay rates - Are you bringing in more expensive workers?

   3. Changes in equipment used - Did you invest in some new, efficient gear or lose something crucial?

8. Double-counted inventory during stocktaking - Check your stocktaking process and make sure you’re doing it the same way every time.

9. Incorrect units of measure during stocktaking - Are you using metric or imperial?

10. Theft of stock or takings - Keep your eyes peeled.

It’s super important for business owners to keep a close watch on the GP Ratio. It should stay steady, even if sales volumes are all over the place. If it flips, you gotta dig into why.

Make sure your business plan includes a budgeted GP Ratio so you can use that as a benchmark and compare it period by period (annually or quarterly). Stay sharp!

Further reading Variance Analysis