How to Assess If Your Small Business Is Making Money: If you think that subtracting your expenses from your income is enough to determine
whether or not you’re making a profit, you might be making the same mistakes many small-business owners make before they realize they are losing money. How you handle your budget and accounting determines whether or not you can spot financial problems that take you from profit to loss.
How to Assess If Your Small Business Is Making Money
- Bookkeeping vs. Accounting
Bookkeeping is often considered a simple recording of financial numbers, while accounting is a more analytical way of handling your finances. For example, recording invoices billed and payments received is an example of basic accounting. Projecting bad debt, aging receivables and calculating future interest payments are examples of accounting techniques. If you aren’t a qualified accountant, hire one to help you spot hidden costs that might not occur or come due for payment until late in the year, taking you from profitability to a loss.
- Create Separate Budgets
Don’t rely on a single master budget you create at the beginning of the year that consists of projected income and expenses. Even if you regularly update your budget, you might miss financial issues that can damage your business.
In addition, create a cash flow budget that shows when your income and expenses will occur during the year. You might think you are doing well, based on your current income and expenses, but a long-term cash flow budget will show if you have more debts than you have income to service them. If you have a large number of payments to make in one or two months and don’t have cash to pay them, you might have to take out a loan to create a bridge to make it until you collect more receivables, adding unexpected interest and fees to your bottom line. If you are short on cash, you might need to delay payments to vendors; if they cut you off, your sales will decrease.
- Consider Interest
If you buy on credit, use a credit card or loan to run your business or need to take on debt later in the year, add interest and other financing expenses to your budget. Not including those in your financial planning won’t let you know if you’re making money or not. If you know your current interest payments, calculate what will happen if you use cash reserves to pay down debt; this might decrease enough interest expense to move you from a loss to profit.
- Factor in Bad Debt
Don’t assume that everyone who owes you money will pay you. If just one client or customer goes bankrupt, disputes a bill or refuses to pay you, it could wipe out your profits. Not only will you not realize your profit on your sale to them, but you’ll also have to pay for the labor, expenses and overhead costs you accrued selling to them. Look at previous years’ bad debt percentages and decrease your projected receivables by that percentage each year. If you run a new business, create budgets that factor in several percentages of bad debt, often between 5 to 10 percent, to give you a more realistic profit-and-loss projection.
- Calculate Opportunity Costs
Running your business precludes you from taking another job or using your capital to invest or pay down personal debt. Calculate how much money you could earn working another job and how much interest you would save each year if you used the money you are putting into your current business to pay down debt. While your business might be making money, it could be costing you considerable personal cash.
These are tips on How to Assess If Your Small Business Is Making Money.