Successful business owners make it a habit to review their profit & loss at least every month. This allows them to keep a finger on the pulse of their business by reviewing their revenue alongside their expenses.
If your bookkeeping processing isn’t up to date and/or you don’t have a P&L statement to review, we can help!
Utilize your P&L to inform your pricing strategy decisions
Once you have developed good habits surrounding the review of your P&L statement, you can use it to make data driven decisions around your pricing strategy.
This starts with the calculation of your gross profit which is your sales minus direct expenses. Direct expenses are any staff members and materials that go into delivering the product or service that you are selling.
When preparing quotes or working out their pricing most businesses utilize one or both of the following pricing methods: Bottom up pricing and Top Down quoting.
Bottom Up Pricing
Here are the steps to a bottom-up pricing method.
1) Start with material cost, for this example we will say $400.00
2) Add the labor cost, we will say this project will take 4 Hours @ $40.00 per hour. Total labor cost is $160.00
3) The cost so far is now $560.00 (material + labor)
4) Now calculate and add a markup, which can be a set amount, a percentage or even a random number. For this example we will do a markup of 20%. Which is equal to $112.00
5) Total price is now $672.00
Top Down Pricing
Here are the steps to utilizing a top-down method.
1) Determine what the total price will be, based on competitor pricing, or how much you think that the customer will pay, etc. Let’s use $799.00 for this example.
2) Next you will subtract a margin, we will stay with 20% which is $159.80
3) The remaining $639.20 is what you can use for the cost of your product or service.
4) You need to source a material supplier that can be competitive on material price
5) You will need to deduct the cost of the labor
6) Add steps 4 & 5 and it needs to be lower than your amount from step #3. If not, you need to find cheaper material or labor.
7) If your amount Is lower than your amount from step #3, You now have a price to quote to the customer.
Top Warning Signs Within Your P&L Statement
#1 Declining Profit
As your business continues to grow, it becomes increasingly difficult for business owners to keep a close eye on each individual quote, price or job.
If you review your P&L at the end of each month and see that your gross profit is going down, this is a huge warning sign. Following this, you will usually see your revenue increasing, but your bank balance showing a decline. This happens when your costs are increasing faster than the sales. This needs to be addressed by:
1. Examine and lower your expenses
a. Are your materials costing more than they used to?
b. Is your productivity or throughput declining?
c. Are you paying your employees more?
2. Increase your prices.
Yes, there is a huge risk that customers may not buy from you – But would you want someone to buy from you if you lost money each time?
#2 Decline in sales and marketing spend
In order to grow a business, you must invest in sales and marketing. A rule of thumb is to spend at least 10% of your sales revenue on sales and marketing.
If you are spending less than that, you could wind up seeing your business stagnate or decline.
#3 Founders salary
If you want to build a sustainable business you need to pay yourself a small, reasonable salary. As a business owner, this may feel difficult for a number of reasons, but remember that this will pay off in the long run. Additionally, the business profit CANNOT be your pay! You should be paid for the work you do within the business just as if you were an employee. You should also get a return on the business asset that you own, just like any other investment.
This will help you avoid building yourself a stressful job instead of a business because it forces you to build in enough profit margin to pay someone else to do the work.
It’s also a critical concept if you ever want to sell your business because you’ll get a much higher sale price if the new owner can pay someone else to run the business, or if they can consider the profit as an extra-high wage for themselves.
#4 Increase in Wage Costs As Percentage of Revenue
If your business is growing, then you should expect to hire more employees. So, an increase in wages by itself shouldn’t be a worry. However, if there isn’t a corresponding increase in revenue, then this could indicate a decrease in profitability and cash flow.
#5 An increase in your AR (Accounts Receivable)
While this is technically on your balance sheet and not your P&L, this is another warning sign to look out for.
On one hand, this could mean that you are selling more. (PERFECT!!)
However, it could also mean that your customers are paying you more slowly. This can lead to all kinds of problems like:
• Decrease in cash flow
• Problems meeting payroll obligations
• Increasing interest on your credit cards as they are being paid late or loans aren’t being repaid in a timely manner
• Missed bank covenants
However, the most important thing is to make sure your bookkeeping is up to date and accurate; otherwise you won’t be able to see the warning signs. Or even worse, you’ll see the wrong warning signs
Developing efficient and consistent behaviors with your P&L statements will help you better understand your business’s success at a glance. This allows for more opportunity gain future investment as it assesses business profitability. While skills in maintaining proper P&L statements vary from business to business, the absence -or lack of it entirely -will obstruct specific issues when they arise. It may feel daunting to incorporate up to date P&L within your organization, but with our concise and straightforward methods, any business can experience the benefits to having it in place. Our team of experts at MCDA CCG, INC. have extensive experience analyzing business finances and strategically implementing adequate book keeping solutions specific to you. Contact us today for a hassle free consultation, where we can evaluate your current situation and help build your unique P&L statements while educating you on how to review them.