To get a quick gauge on how well your business is doing and where problems may be arising, you can use a profit model. A profit model is essentially a stripped down version of the profit and loss report prepared by your accountant each year that you can use to get a quick summary of how your business is doing in terms of profit.
There are five key elements to a profit model:
Net sales revenue: This is the total number of all the goods and services your business has sold and multiplied by their net sales prices, that is the price of the product minus any discounts, and also minus costs that can be directly linked to the sale of the goods or services. Examples of these costs may include swipe fees charged by banks for processing credit card or bank card purchases, sales commissions paid to employees, etc. The net sales revenue gives a more realistic view of how much revenue you made, as it takes into account the aforementioned costs. By examining this figure, you may be able to identify costs that you can shed to boost revenues.
Product costs: The product costs represent the cost of your products and also includes losses that occurred from write-downs and shrinkage from inventory.
Variable operating costs are costs that depend on the amount of business you’re doing, such as packaging and shipping costs. (When examining product costs and variable operating costs you’ll come up with a figure known as margin. Your margin is your revenue minus product and variable operating costs prior to adjustment for fixed costs.)
Fixed operating costs are locked in costs that occur regularly for your business and do not vary based on business volume. An example of fixed costs would be rent, insurance, employee compensation, accounting fees, etc. Taxes and licenses for vehicles are also fixed costs.
Interest expenses are essentially how much interest you pay each year on the outstanding debt of your business.
Once you have a good grip on your profit model, you can begin considering ways to boost your profits. If you feel your fixed operating costs are too high, you may consider finding a less expensive place of business to rent or right-sizing your workforce or contracting some duties out. If costs are beginning to take a large bite out of your revenues, it may be time to more aggressively push to broaden your customer base or it may be a better idea to raise prices to reflect your increased costs of doing business. If variable operating costs are rising at an uncomfortable rate, you may want to address the increased cost of doing increased business by finding new delivery and packaging options.
The profit model provides a valuable snapshot of your business that you can use to gauge your costs and revenues to determine methods of protecting and increasing your profits. Analyzing and applying the knowledge learned from profit models takes experience, and new business owners may want to find a mentor to help guide them through the process of learning how to read profit models and apply what they’ve learned.