Expert Eye: Understand business costs to help plan for the future
There probably isn’t a day that goes by without us reading about the cost of living crisis and record high inflation. But what does this mean for local businesses, asks Simon Shaw of Duncan & Toplis.
There is no doubt that we are continuing to see higher prices of goods, including the very sharp rises in motor fuel. For the cost of electricity and gas, unlike for consumers, there is no energy cap protection offered to businesses and therefore these costs will be driven by the market.
Many of the pressures on prices are coming from factors outside of the control of business owners and therefore it is difficult for some to adapt and absorb these increases.
We are also living in a time where there is a shortfall of workers in certain sectors. This is forcing employers to offer higher pay to get the right staff as well as increase the wages of existing workers as they are impacted by their own increased cost of living.
Although no business enjoys increasing prices, all these factors have inevitably led to businesses looking very carefully at their own costs and in many cases having no choice but to pass on some of these increases to their customers.
The Bank of England is predicting the rate of inflation will continue to increase, reaching 13% later this year, before slowing down. Some other commentators are forecasting inflation to peak at as much as 18%.
It’s therefore particularly important that businesses understand the costs they are incurring and how these are reflected in the prices they charge now and in the coming months.
One important measure for businesses is the gross profit percentage.
Although the costs that make up this will be different for every business, in basic terms it is the difference between the costs of buying and/or manufacturing the goods or services sold and the price paid by the customer. For example, if the costs are £50 and the sales price is £75 the gross profit percentage is 33%.
When calculating this, VAT should be excluded from both the costs and sales price.
It is important that businesses can calculate this percentage on a regular basis, so they ensure the sales price is correctly set and they concentrate on the goods and services which give the best return.
Don’t forget that where there is a people cost in manufacturing goods or providing services, it is vital that these costs, including employers’ national insurance and pensions, are included in this calculation.
This gross profit will contribute to the fixed overheads of the business and provide profit for business owners, as well as generating funds to be re-invested.
All businesses will also have an element of fixed costs, including rent, electricity, staff, and other overheads. Having a clear understanding of these costs, both now and what they might be in the future, is important so the level of gross profit which needs to be achieved is known.
Understanding the gross profit, overheads and predicted sales will enable the business owner to have a profit forecast, which is usually drawn up on a monthly basis and looks forward for at least the next 12 months.
Keeping this up to date as costs change is important so any sales price adjustments can be made quickly to react to increases in costs and/or changes in sales.
Although profit is important, cash continues to be king. Once the projected profit forecast is available this can be turned into a cash flow forecast which will incorporate the difference in timing between purchases/sales and payment/receipts, as well as factoring in outgoings such as repayment of loans.
With any forecast I would recommend having a number of different versions of the same forecast which ask the question what if? These would include taking account of such things as increases in costs, changes in sales levels and receipt of cash from sales.
Understanding the costs of your business and having these robust profit and cash forecasts will enable you to react quickly to changes and plan for the future at a time when change is the only certainty.
