The gross profit on a product is computed as:
Sales – Cost of Goods Sold = Gross Profit
To understand gross profit, it is important to know the distinction between variable and fixed costs.
Variable costs are those things that change based on the amount of product being made and are incurred as a direct result of producing the product.
Variable costs include:
- Materials used
- Direct labour
- Plant supervisor salaries
- Utilities for a plant or a warehouse
- Depreciation expense on production equipment
Fixed costs generally are more static in nature. They include:
- Office expenses such as supplies, utilities, a telephone for the office, etc.
- Salaries and wages of office staff, salespeople, officers and owners
- Payroll taxes and employee benefits
- Advertising, promotional and other sales expenses
- Auto expenses for salespeople
- Professional fees
Variable expenses are recorded as cost of goods sold. Fixed expenses are counted as operating expenses (sometimes called selling and general administrative expenses.
While the gross profit is a rand amount, the gross profit margin is expressed as a percentage. It’s equally important to track since it allows you to keep an eye on profitability trends.
This is critical, because many businesses have gotten into financial trouble with an increasing gross profit that coincides with a declining gross profit margin.
Related: Common Budgeting Mistakes to Avoid
The gross profit margin is computed as follows:
Gross Profit / Sales = Gross Profit Margin
There are two key ways for you to improve your gross margin. First, you can increase your prices. Second, you can decrease the costs to produce your goods. Of course, both are easier said than done.
An increase in prices can cause sales to drop. If sales drop too far, you may not generate enough gross profit rands to cover operating expenses. Price increases require a very careful reading of inflationary rates, competitive factors, and basic supply and demand for the product you are producing.
The second method of increasing gross profit margin is to lower the variable costs to produce your product. This can be accomplished by decreasing material costs or making the product more efficiently.
Volume discounts are a good way to reduce material costs. The more material you buy from a supplier, the more likely they are to offer you discounts.
Another way to reduce material costs is to find a less costly supplier. However, you might sacrifice quality if the goods purchased are not made as well.
Whether you are starting a manufacturing, wholesaling, retailing or service business, you should always be on the lookout for ways to deliver your product or service more efficiently.
However, you also must balance efficiency and quality issues to ensure that they do not get out of balance.
Let’s look at the gross profit of ABC Clothing Inc. as an example of the computation of gross profit margin. In Year 1, the sales were R1 million and the gross profit was R250 000, resulting in a gross profit margin of 25% (R250 000/R1 million). In Year 2, sales were R1.5 million and the gross profit was R450 000, resulting in a gross profit margin of 30% (R450,000/R1.5 million).
It is apparent that ABC Clothing earned not only more gross profit rands in Year 2, but also a higher gross profit margin. The company either raised prices, lowered variable material costs from suppliers or found a way to produce its clothing more efficiently (which usually means fewer labour hours per product produced).
ABC Clothing did a better job in Year 2 of managing its mark-up on the clothing products that they manufactured.
Many business owners often get confused when relating mark-up to gross profit margin. They are first cousins in that both computations deal with the same variables. The difference is that gross profit margin is figured as a percentage of the selling price, while mark-up is figured as a percentage of the seller’s cost.
Related: Should You Ditch Your Annual Budget?
Mark-up is computed as follows:
(Selling Price – Cost to Produce) / Cost to Produce = Mark-up Percentage
Let’s compute the mark-up for ABC Clothing for Year 1:
- (R1 million – R750,000) / R750,000 = 33.3%
Now, let’s compute mark-up for ABC Clothing for Year 2:
- (R1.5 million – R1.05 million) / R1.05 million = 42.9%
While computing mark-up for an entire year for a business is very simple, using this valuable mark-up tool daily to work up price quotes is more complicated. However, it is even more vital.
Computing mark-up on last year’s numbers helps you understand where you’ve been and gives you a benchmark for success. But computing the mark-up on individual jobs will affect your business going forward and can often make the difference in running a profitable operation.
4 Ways To Improve Your Budgeting Skills
Increasing revenue isn’t solely dependent on how much money your business is making but also relies heavily on how well you manage it.
Traditional budgeting methods have undergone a digital makeover in recent years, and now offer businesses an abundance of streamlined services, tools and access to experts that will help improve your budgeting skills. From regulating current expenses to applying for funding, a well-crafted budget is an essential part of developing a healthy financial forecast for any business.
1. Take advantage of budgeting software
Creating an effective business budget will require a bit more than just utilizing a personal financing software. Luckily, there are plenty of tools available that focus on helping you get your professional finances in order. Centage, which came out in 2001, is a powerful portal that gives companies the chance to streamline their budgeting, while also providing forecasting and consolidation features to help you create more strategic budgeting plans. Investing in a budgeting software is a great way to stay organized at any stage of your professional development.
2. You can’t predict the future, but you can prepare for it
In addition to making the most of the available budgeting tools on the market today, it also pays to do your research. Understanding market fluctuations, as well as competitor activity, will help you create a clear budget plan based on these variables. Keeping up to date on the changes that tend to happen frequently within your industry will also grant your business a bit of extra confidence when it comes to making future decisions. Budgets can provide a strong financial forecast help businesses adapt quickly to changes that might have set them back in the past. For example, if your product is largely dependent on seasonal trends, these projections will give you a greater sense of which months you will be seeing more revenue, allowing you to allocate these funds accordingly throughout the year.
3. Ask an expert
Creating an effective budget for your business goes way beyond simply organizing your finances. Reaching out to an expert to help you construct a budget that fits both your personal and industry needs can better schematize your current plan, and potentially make your business model more profitable.
The rapid growth of the freelance economy has resulted in the creation of platforms that give businesses, big and small, access to a wealth of skilled finance professionals. Whether you’re in the market for a quick consulting session, or on the lookout for a long-term advisor, speaking with someone who specializes in creating budgets for business is a great way to gain valuable insight on the best ways to handle your finances.
4. Don’t forget about funding
Access to funding is an important resource for any business, especially those that are in the early growth stages. Whether you are starting out small with a modest self-investment, asking friends and family for a bit of help, or preparing to pitch a big name investor, having a financial forecast in place is a must.
For those that are hoping to get their hands on VC funding, presenting current activity and future financial projections is an essential part of the process. Of course, investors understand that budgets are subject to change, but without a financial plan in place, investors may question whether or not your business is a worthwhile investment. A clearly constructed budget can help illustrate the value of your company, in addition to showing what will be done with supplementary funding to increase growth.
For small and big businesses alike, an agile and well-crafted budget is key when it comes to maintaining and improving your company finances. From managing the day to day expenses to preparing for unexpected changes in the market, getting into the habit of good budgeting is the best way to ensure steady growth for your company.
It’s Vital To Your Business Success: How To Manage Your Budget Better
Should I take budgeting seriously, and what can it do for me?
A budget is or should be a part of your business plan. It is one of the major control methods to make sure your plan is implemented rather than ignored.
I agree that there are some very successful businesses that operate on a seat-of-the-pants basis, but there are a lot more trying to do so but instead floundering around in the dark.
Unless you are gifted with unerring judgement and great insight you are likely to achieve more success by working to a plan and budget.
Budgets are often prepared by financial managers and tend to focus on operating and capital expenditure rather than sales, purchases, inventory and debtors targets. A better approach is to start by agreeing what performance your company would like to achieve for all key areas.
The sales budget could be a separate section of the main budget to manage expected sales by whatever breakdown suits your business: Type of product, by division, branch or sales channel, or type of customer. In each category budget for margins, discounts and commissions.
Correctly managing your expenses
Key expense items like payroll, overtime, marketing promotions, travel, vehicle expenses and IT costs should be planned for and monitored via the budget but I suggest you don’t clutter the expense budget with too many items which you have little power to manage.
Rather lump these together, you can always drill down if the costs get out of hand. If you have a seasonal business with variations in sales and expenses depending on the time of the year, make individual budgets per month.
Do not forget balance sheet lines, especially capital expenses for new buildings, machinery or vehicles, and also borrowings and other liabilities.
Debtors, creditors and inventory should all be planned and monitored and it is a good idea to monitor measures like average days outstanding for debtors and creditors, days inventory held, bad debts and obsolete or lost stock.
The last items can be target ratios which may not form part of the budget, but should be reported on regularly so that you do not get nasty surprises at the year end. Prepare the budget with everyone concerned to get buy-in. The budget becomes an agreed plan of operations to which everyone is committed.
Continuously review your budget
Monitoring performance against budget should be done at least quarterly, but I prefer once per month in a management meeting. If you are the only manager, set aside time each month for a vital review your performance against budget.
The actual results must be up to date and available. Use a simple spreadsheet showing budget, actual and variance or a dashboard which shows key metrics as graphics or tables.
Examine those items where the variance to budget is significant and probe for reasons. The dangerous ones are the start of a trend — for example sales in one area consistently below budget or mushrooming overtime costs.
For any bad variances that are not just a short-term hiccup you should plan to correct the problem, or if the problem is insurmountable, replan to get around it.
Course correct your budget as you grow
The budget can be changed because circumstances are different to those envisaged when the budget was prepared, but a better option is to add another column for a revised budget, so the amount of the change remains obvious.
Managing the budget should not be limited to complaining about excessive entertainment or travel costs, but a vital tool to give stark visibility to key areas of the business that are not performing as expected.
It should involve all the key players in decision-making to catch and fix problems early, but also to seize opportunities presented by better-than-expected performance at the earliest time.
Treat budgeting as a management tool and it is likely to treat you to more profit and less nasty surprises.
An excellent way to increase profits is to treat budgeting as a management tool. Never be scared of your budget — use it instead.
#Budget2017: 5 Areas Where Businesses Are Seeking Clarity From The 2017 Budget Speech
Here are a few other points I hope Minister Gordhan will clear up in his Budget Speech this year.
Yolandi Esterhuizen, Compliance Manager at Sage, on a few points that she hopes Minister Gordhan will clear up in his Budget Speech this year.
We’ll all be watching Finance Minister, Pravin Gordhan, closely on 22 February when he will present his Budget for the 2017/8 tax year.
With a revenue shortfall of around R28 billion to plug and slow economic growth, he is expected to announce some tough tax measures to ensure government has enough money in its coffers to meet its objectives.
Compulsory annuitisation of provident funds
Members of retirement funds and payroll administrators alike would like to see clarity around this long outstanding issue. At the moment, provident fund members may take all of their retirement savings as a lump sum upon retirement.
Government wishes to align provident funds with pension funds and retirement annuities – with these classes of retirement funding, members must reinvest their retirement pay-out into a vehicle that will pay them annuities each month.
Related: Budgeting Basics
In January last year, Government announced that compulsory annuitisation of provident funds would take effect from 2018. However, provident fund members started to enjoy a tax deduction on their contributions from March 2016.
Government said last year that it would review the tax benefit for provident fund members to achieve fairness between all retirement funds if an agreement is not reached within two years. Removing the deduction would cause a decrease in the net pay of many individuals who pay into provident funds.
The #feesmustfall movement has yet to lose momentum and funding for tertiary education remains high on the agenda. We may hear more about how government will incentivise businesses to help employees pay for their children’s university education through loans or bursaries going forward, given the pressure to help youngsters pay for their education.
The Taxation Laws Amendment Act, 2016 promulgated on 19 January 2017 provides for an increase in the amounts which are exempt in terms of bursaries provided to employees’ relatives.
If an employee earns more than R400 000 a year, the full bursary is taxable. R400 000 or less, a portion of the bursary is exempt.
Related: Budgeting Mistakes
National minimum wage
The National Minimum Wage Panel Report last year recommended that government sets a minimum wage of R3,500 per month for full-time workers, or R800 per week, or R20 per hour.
This follows extensive consultation between government, business and labour, with the aim of setting a wage that reduces poverty and inequality. It seems that the National Minimum Wage may be implemented sooner than many of us expected.
The devil will be in the detail. Will there be any regional or sectorial exclusions? How long will business have to phase in the new minimum wage?
Government knows that there is a balance between setting the minimum wage that will have positive impact on inequality without affecting job creation, undermining the sustainability of the country’s enterprises or triggering high inflation.
National health insurance
The White Paper on National Health Insurance (NHI) was published for comment on 11 December 2015. Though pilots are underway for the NHI, there isn’t much clarity about how it will be funded. A payroll tax is one option government has put on the table, but a VAT increase is also an option.
NHI is being implemented in phases over a 14-year period that started in 2012, but most stakeholders are anxious to get clarity about the funding model. Hopefully, Minister Gordhan will provide some insight in his Speech.
It is yet to be seen whether the Minister will opt for new taxes in the vein of carbon and sugar taxes announced in recent years, hike personal or company taxes, or increase the VAT rate.
We have long speculated that government may add an additional income tax bracket for high income earners, or look at wealth taxes in its search for new revenue and its quest to reduce inequality.
Millions of entrepreneurs in the world’s Small & Medium Businesses trust Sage as they power the global economy. We will be waiting to see how the Budget will affect payrolls and accounting so that our customers will be ready for any new rules and regulations the government introduces.
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