Understanding the Math Behind Running a Business By Tom Donato

It’s almost that time of the year when we get to know the truth about how well our businesses performed throughout the financial year. Unfortunately for some businesses the hard truth hits home and that there was actually little to no profit and in too many instances was actually a loss.

The last couple of years have been a roller coaster of emotions and financial tug of war with so many lockdowns and restrictions. For most there was financial assistance from governments, which saved many small businesses from going under and for some there was turmoil and uncertainty.

It’s time to put the pandemic behind us now and concentrate on the future.

First things first! The business finances!

When you run a business the most important aspect is understanding the basic equation that all business owners need to know.

That is that all money coming into the business is the Turnover. All money paid out in order for the business to run I like to call the Handover (expenses) and any money that’s left I like to call the Leftover (profit).

So, the turnover minus the handover equals the leftover.

That’s a very simple way to remember that in order to have profit a business needs to turnover more than it hands over. owners lose track or are not aware of some of the costs associated with running a business. They may be somewhat aware, but they fail to constantly keep their finger on the pulse.

Often, they find themselves not having enough funds to pay the GST or the Superannuation or the PAYG tax or the insurance bill they forgot about in April.

The key is to budget.

I often speak to businesspeople that are very good at budgeting their turnover but sometimes don’t take the time to budget their expenses.

It is critical that time to compile an expenditure budget is allocated at the beginning of a financial year in order to track and ensure that there are profits left over in the business.

The most common question is how will I know how much I am going to spend next year?

The answer is usually easier than most people think.

It’s easy to look at the previous year’s expenditure and just add a percentage increase to all the categories. For example, most leases stipulate what the rent will be for each term, you can expect wage rises within the year, insurance will usually go up as will the cost of goods a business needs to service their clients.

If a business owner understands a profit and loss statement then an expenditure budget is just that, with an increase.

An expenditure budget should look exactly like your P/L only it hasn’t happened yet.

It should also include the expected turnover and the expected profit.

Why is this so important?

The answer is it will help businesses budget for their turnover and help you assess and adjust pricing to make sure that what’s coming into the business is greater than what’s going out.

It will also help you understand that if the turnover declines, then there are certain costs that can be cut such as a nonperforming team member, or look at product wastage or can you afford that photo shoot?

Having a benchmark of cost vs percentage of turnover also makes it easy to calculate what you can afford in your expenditure budget.

For example, if you expect your turnover to be $1m and you budget for a 40% wage cost then you know that you can only spend $400K in wages. If you budget for 12% product cost, then you only have $120k to spend on product.

Obviously, this is an example only as every business has different turnover capacity from a one-man show turning over $100 -$200k p.a to thirty or forty employees turning over $2-3 million.

The most important percentage of all is the Leftover percentage.

I always say that the owner’s wage has to be separate to the profit.

No matter what, the owner must draw a wage. The higher the wage of course the smaller the profit margin.

This is really important for those that are ever thinking of selling their business. A business is valued according to the Leftover.

It’s always going to be your money but think about the value of your business when presenting a P/L statement to a prospective buyer.

One of the most frequently asked questions is ‘What should my profit percentage be?’.

That’s the one-million-dollar question!

I always say to begin with the end in mind.

Then you work backwards.

Always determine how much money you want to make first and then add in what you can afford to spend on everything else based on the turnover you think you can achieve. There are so many varying factors.

Does the owner work on the floor? If so, the wage should be included in the wage expenditure.

Looking at your P/L every month as ‘a per month’ and ‘year to date report’, will help you evaluate how you are travelling to reach your desired financial outcome.

The trick is to act swiftly when the numbers don’t add up.

What I have always found is that the expenditure is always spot on but sometimes the turnover can vary for a number of reasons. Pandemics, staff leaving and taking clients, council doing work in front of your premises for months and so on. The power of checking P/L every month is invaluable for controlling your profit margin.

When you continuously look at your finances inevitably what happens is the opposite. Your turnover actually increases. Where you budgeted for a 6-8 % growth you may find a 1011 % growth.

Keep in mind that in order to do a higher turnover you may have had to employ more staff and inevitably used more stock, unless of course you simply increased your prices. Now there’s an idea!

Increasing Prices

The single biggest block that some business owners have is knowing their own worth and when to increase prices. should be at the forefront. Wages are now at record highs and getting higher. Product companies will be looking to recover some of their losses from the last few years of pandemic, freight costs are going through the roof. Even petty cash items will be increasing exponentially. Whilst there is always that fear of clients going elsewhere because we put prices up, years of experience has proven otherwise. Just because one client says “oh I have never paid that much before “ ninety-nine won’t even blink. The “hey day” of hair salons was early to mideighties when profit margins were incredibly high. Owning a well-run salon was like printing money from the mint.

Profit margins were as high as 40%. As time went on expenditure increased, new costs crept in - EFTPOS charges, Superannuation, using quality products at the back wash basins, offering café quality coffee to the clients, having to pay for apprentices TAFE fees and the list goes on. We absorbed those costs without increasing our prices enough to accommodate and maintain our profit margins.

It is critical that businesses look at their expenditure and adjust pricing to ensure your return on investment.

Now is the time to do it.

Clients expect it. Most of your clients or their partners might be small business owners themselves and know the struggles that all other small businesses are enduring. They have put up their prices and are expecting you to put yours up as well.