How Often Do You Analyse Margin & Expense Changes on Business Net Profit?
No matter the size of your business I would recommend testing and analysing the effects that changes in gross profit margins and expenses can have on your business’ net profit. This is not a difficult task and is a great exercise to see how changes, even minor, in cost of goods and expenses can affect your profit.
All you need to complete this analysis is a simple spreadsheet and a summary of your key financial data. One point to add here is that it is always a good idea to group and summarise your sales, cost of sales and expenses. What I mean here is to flatten down the view of a detailed profit and loss report that lists all your business’ chart of accounts. So rather than try and test high level changes across a multitude of accounts, you do this across a summary of all of them. For example, you could group your expenses as follows:
- Sales
- Cost of Sales / Goods
- General & Admin
- Rent & Outgoings
- Marketing
- Employment
- Motor Vehicles
- Interest & Depreciation
The grouping and summarising of your accounts will depend on the type of business and industry you operate in. If you are in an industry that has a high reliance on vehicles and equipment, these items would have significant costs that are relevant to your profitability and as such you would want to have these appropriately separated and grouped. For a retail business that has little reliance on vehicles and equipment to generate revenue, these costs would be minimal and fall into general and admin costs. So, remember to group you accounts that best summarises the items that have an impact on your net profit.
Once you know how you want to group and summarise your accounts, have your accounting system reflect these groupings. This can usually be done in report layouts or the naming and grouping of the actual chart of accounts. This will depend on the systems that you use. If you are unable to use your accounting system to summarise this data, then it would need to be done in an Excel spreadsheet.
Now that you have your financial data summarised appropriately, let us look at a simple example of how you can analyse and test changes in key items and their effects on profit. To keep this example visually simple we will use $1,000,000 for sales.
| Total | % of Sales | |
| Sales | $1,000,000 | 100% |
| COGS | ($450,000) | 45% |
| Gross Profit | $550,000 | 55% |
| Margin | 55% | |
| General & Admin | ($20,000) | 2% |
| Rent & Outgoings | ($65,000) | 7% |
| Marketing | ($40,000) | 4% |
| Employment | ($250,000) | 25% |
| Motor Vehicles | ($20,000) | 2% |
| Interest & Depreciation | ($70,000) | 7% |
| Total Expenses | ($465,000) | 47% |
| Net Profit | $85,000 | 9% |
| Margin | 9% |
In the above example a business turning over $1M has a decent gross profit margin of 55%, total expenses of 47% of sales and a profit of $85k which is 9% of sales. Overall, this business seems healthy. But how much does this business’ profit change with a few improvements in margins and expenses?
What if this business was able to negotiate better pricing with suppliers, or increase its prices by 2%? Overall, the effect will be an improved gross profit margin flowing directly to net profit, in this example that is an additional $20k in profit. For the price increase we are assuming sales remain the same but the overall gross profit margin increases. That is, the business achieves the same sales with less work. This is assumed to keep the example simple.
| Current | % of Sales | Updated | Change | ||
| Sales | $1,000,000 | 100% | $1,000,000 | 100% | $0 |
| COGS | ($450,000) | 45% | ($430,000) | 43% | $20,000 |
| Gross Profit | $550,000 | 55% | $570,000 | 57% | $20,000 |
| Margin | 55% | 57% | |||
| General & Admin | ($20,000) | 2% | ($20,000) | 2% | $0 |
| Rent & Outgoings | ($65,000) | 7% | ($65,000) | 7% | $0 |
| Marketing | ($40,000) | 4% | ($40,000) | 4% | $0 |
| Employment | ($250,000) | 25% | ($250,000) | 25% | $0 |
| Motor Vehicles | ($20,000) | 2% | ($20,000) | 2% | $0 |
| Interest & Depreciation | ($70,000) | 7% | ($70,000) | 7% | $0 |
| Total Expenses | ($465,000) | 47% | ($465,000) | 47% | $0 |
| Net Profit | $85,000 | 9% | $105,000 | 11% | $20,000 |
| Margin | 9% | 11% |
Now let us assume that this business is not only able to reduce prices with its suppliers but looks at improved rostering efficiencies for its few casual staff leading to a reduction in wages down to 22% of sales. What do these two improvements have on overall net profit?
|
Current |
% of Sales | Updated | Change | ||
| Sales | $1,000,000 | 100% | $1,000,000 | 100% | $0 |
| COGS | ($450,000) | 45% | ($430,000) | 43% | $20,000 |
| Gross Profit | $550,000 | 55% | $570,000 | 57% | $20,000 |
| Margin | 55% | 57% | |||
| General & Admin | ($20,000) | 2% | ($20,000) | 2% | $0 |
| Rent & Outgoings | ($65,000) | 7% | ($65,000) | 7% | $0 |
| Marketing | ($40,000) | 4% | ($40,000) | 4% | $0 |
| Employment | ($250,000) | 25% | ($220,000) | 22% | $30,000 |
| Motor Vehicles | ($20,000) | 2% | ($20,000) | 2% | $0 |
| Interest & Depreciation | ($70,000) | 7% | ($70,000) | 7% | $0 |
| Total Expenses | ($465,000) | 47% | ($435,000) | 44% | $30,000 |
| Net Profit | $85,000 | 9% | $135,000 | 14% | $50,000 |
| Margin | 9% | 14% |
In this example the improvement would be $50,000 as margins have increased 2% points and wages reduced 3% points. This total of 5% points equates to $50,000. As this business’ turnover is $1M, any 1% point improvement in margins or reduction in expenses will lead to an additional $10,000 of profit.
The above example has been simplified to highlight the importance of analysing costs and their affects on profit. But it does highlight that if you are able to make a small improvement here and there it will start to add up and the end result can be significant.
Contact met if you would like more detailed analysis done on your business’ financials.
