Want to Be Profitable? 3 Metrics to Watch

You don’t have to possess a high degree of financial expertise to manage a small business. But there are three critical areas you need to monitor:

Input Efficiency

The first aspect of business operations to examine is input efficiency. This is commonly measured by knowing how much cost you incur for everything you sell. It goes beyond calculating overall gross profit by deducting from sales revenue the direct costs to manufacture or acquire goods. The truly useful figures are gross profit for each product. Studying cost fluctuations for every one of your products permits you to know the cost to produce more of anything and recognize when to adjust your prices.

For a wholesale or retail business, the costs are more than just the outlays for each item. You have to allocate expenditures for warehousing, packaging and shipping as well as personnel costs for selling, receiving and customer relations. Facility operating costs are not necessarily equally proportioned among all products. Some items require more overhead.

This same input analysis applies to service businesses, where owners can measure the costs for each type of service offered. There are always subtle variances. The nature of some projects requires more selling time. A month of emails and phone calls to land big deals is more costly than just three days to procure simpler contracts. After adding travel expenses and some contract labor, sometimes the larger projects don’t provide any more profit than the smaller ones.

Output Efficiency

The second area to assess is output efficiency. For companies providing services, the recommended measurement is revenue per employee. A growing business naturally tends to add staff. Eventually, extra support personnel are supposed to help the frontline employees produce more revenue. Constant examination of revenue per employee is a simple way to make sure this is happening.

For product-oriented companies, management of inventory is crucial. Efficient businesses move inventory quickly. There’s nothing worse for a retail or wholesale business than having to mark down old inventory to get rid of it. Plus, holding inventory uses up capital that could be deployed for other purposes. Measuring inventory turnover requires accurate financial statements. Your accountant can help you maintain that accuracy and show you how to measure inventory turnover. A trend of slowing inventory turnover is generally a sign of trouble.

Cash-Flow Management

The final area to evaluate is cash-flow management. This involves calculation of the average number of days required to collect accounts receivable and the days that accounts payable are held. These measurements also require accurately rendered financial statements immediately after the end of each month.

Net income and bank balances are not reliable predictors of future cash. Aging trends for accounts receivable and accounts payable are proven indicators of financial health. A sound business doesn’t continue stretching delays for paying bills. Your accountant can help you with these cash-flow calculations that allow you to avoid a cash crisis.

Why Do-It-Yourself Payroll Software Might Be a Mistake

The biggest headache confronting most small-business owners is payroll. An incorporated enterprise must prepare paychecks even if the owner is the only worker. That also applies to an S corporation or LLC that’s federally taxed as a corporation.

Payroll calculations are complex and tedious. Computing payroll taxes, determining employee deductions, writing checks and remitting tax payments are time-consuming tasks. Consequently, business owners are inclined to hire payroll services. But an increasing number of businesses are embracing one of the many do-it-yourself computer applications for payroll.

These platforms allow businesses to save the cost of outsourcing payroll. However, payroll software is not a once-in-a-lifetime expense. These programs require constant updates to the embedded payroll tax tables because the Internal Revenue Service frequently revises them. Subscription to an online update is needed. This is not free.

More important, payroll software isn’t a completely automated process. It’s easy to use only if you have bookkeeping experience.

Manual data input is required for every new employee and each pay date. Someone must generate quarterly payroll reports and annual forms such as W-2s.

A payroll system that integrates with the general accounting program is best.

Stand-alone applications sometimes promise to interface with popular accounting programs. But interfaces are cumbersome to operate and often unreliable.

Money-Saving Strategies for Your Business

Although a business owner spends a lot of time determining how to earn money, the bottom line is equally affected by limiting how much money is spent.

Fortunately, saving money is easier than earning it. The best way to start is by examining money-saving strategies in three areas where wise spending improves business.

Make the Right Employee Assignments

For many businesses, the largest expense is payroll. You can’t make much of an impact on your bottom line by pinching pennies on office supplies and telephone expenses. The first step in confronting payroll costs is to simply get a person with the right skills for each job. For example, place individuals with “people skills” in capacities where they maintain contact with customers or suppliers. Workers who can’t write a properly structured email must have assignments away from the public.

You have a problem if your business has grown to the point of requiring more employees in customer-contact capacities but lacks enough staff with people skills. An unfortunate fact of business is that sometimes the individuals who got you here today are not the same folks who can carry you to the next level. Don’t be afraid to make changes. Chances are that employees are well aware of their unsuitability for new tasks you’ve assigned to them.

Paying for productivity you’re not receiving runs counter to the long-term interests of both employer and worker. It causes poor business results that lead to everyone becoming part of a failure. In fact, most employees who are in over their heads will depart for more satisfying positions. If you continue hiring the wrong person for a job, the cycle repeats itself.

Employee turnover is costly. Interviews, orientation and training consume precious time. Find the right person for every job with a well-crafted ad that describes the position in clear bullet points. Address every point with the individual you hire for or assign to the job. If there’s any mismatch between skills and duties, find a different person.

Involve Employees in Their Benefits

Next on the expense hit list is employee benefits. The purpose of benefits is to attract and retain better employees. To achieve this purpose, inform employees how much is spent for their benefits.

This is particularly relevant for health insurance. By informing employees about the cost, they can provide input about coverage that’s important to them. You can then tailor a policy to meet their objectives and reduce cost by eliminating benefits that aren’t important to them.

You also want to capture a tax credit currently available for providing health insurance. Remember to discuss with your accountant the details needed to calculate this tax credit.

Don’t Waste Marketing Dollars

There’s seemingly no end to the number of ways a business can waste money on marketing. Small businesses need to have value from their marketing expenditures.
Target your expenditures to those areas that get noticed by the most people.

Wasteful marketing costs limit your ability to budget for effective measures. Most marketing firms advise small businesses to steer away from spending on sponsorships, onetime mailings and holiday cards.

Tips to Avoid an Audit by the IRS

The Internal Revenue Service (IRS) audited 1.11% of all tax returns filed in the last government fiscal year. However, business returns with gross receipts of $25,000 or more were audited twice as frequently as the overall rate.

An IRS audit requires a time-consuming and frustrating process of collecting detailed business records. There’s no perfect method for avoiding an audit, but you can execute measures to limit the possibility.

One important way is to exercise care in choosing your tax-return preparer. The IRS has new tax-return preparer regulations. This permits easy identification of preparers who frequently compile returns that fail IRS audits. That increases the audit potential for every return of such preparers.

Carefully gather complete tax information. The IRS compares figures on your tax return to W-2s, 1099s and other reporting by payers of income to you. Make sure your tax return matches these information reports.

Don’t estimate any figures. Don’t use rounded-off amounts. Take the deductions you are entitled to report, but be prepared to justify them with accurate records. The IRS uses a discriminant function system score to select returns for audit. This compares amounts you claim for specific deductions to the statistical averages for your income level. Any large deduction relative to your income might require response to an IRS audit with proof of the amount.

Last, make sure your state income tax return is accurate. If you’re audited by a state and owe additional tax, an IRS audit is likely to follow. The IRS maintains information-sharing agreements with every state.