Topics: Profit margin, Generally Accepted Accounting Principles, Balance sheet Pages: 5 (1326 words) Published: November 8, 2014
Accounting systems can provide enormous amounts of information, including full profit statements, balance sheets and details of outstanding debtors, creditors and stock-holding levels. Sometimes they produce so much information that owner-managers cannot cope and prefer to ignore them. In fact, most small firms can be controlled by monitoring, on a timely basis, just six pieces of information that tell the owner-manager different, but vital, information on the performance of the business. These are called financial drivers. They are like the instruments on a car dashboard. They tell you different things about the engine of the business and different pieces of information are important at different times and in different circumstances. On a road with a speed restriction you watch your speedometer. When changing gear at speed you watch your rev-meter. When low on petrol your eye never strays from the petrol gauge. The financial drivers tell you all you need to know about driving the business. The six financial drivers are: 1 Cash

As we have already seen, it is vital to monitor cash. Without cash the bills cannot be paid. For a start-up or when it is in short supply cash may have to be monitored on a daily basis, but most small firms need to keep an eye on it at least on a weekly basis. Actual balances need to be compared to forecasts. 2 Sales

This tells the firm about the volume of activity it is experiencing. This should also be compared to forecasts. If sales are running ahead of forecasts, does the firm have the resources to meet these demands? Current sales may be a good indicator of future sales, but if not, then order books may also have to be monitored. It is sales that always drive cash flow and profitability. It should be monitored on a daily or weekly basis for most start-ups and at least monthly even for an established business. 3 Profit margins

In the process of setting prices in line with projected costs, the owner-manager will also be setting profit targets. These can only be achieved if the sales volume targets are met, at the appropriate prices, and costs are controlled. Profit margins give the owner manager this information. They should be compared to original forecasts and kept as high as possible. Margins probably need only be monitored on a monthly basis. It might be that it is sufficient simply to monitor contribution margin. This would be the case if fixed overheads are unlikely to change dramatically or quickly. In the example of Jean Young, there are no variable costs and in this case it is therefore more appropriate to monitor net profit margins. The net profit margin is net profit expressed as a percentage of total sales. In the previous example of Jean Young this is: Net profit × 100 Sales :11985 × 10017200 = 70%

4 Margin of safety or break-even
Break-even is an important reference point and we shall be looking at this important concept in more detail in the next section. However, as a business grows the break-even point is likely to increase. That is a fact of business. In order to grow most businesses must, at some point, take on more fixed overheads. This increases the break-even point. What is important is not so much the absolute level, but rather how much above it the firm is operating. The margin of safety is a measure of how far sales are above break-even, expressed as a percentage of total sales. In the example of Jean Young, because she has no variable costs, this happens to be the same as the net profit margin and is: Total sales − Break − even sales × 100

Total sales = 17200 − 5215 × 10017200 = 70%

The higher the margin of safety the better, because that makes the firm safer in terms of maintaining its profitability should sales suddenly decline. Margin of safety is therefore a measure of operating risk. However, it reflects a number of factors: level of sales, ability to maintain contribution margins and ability to control fixed overheads. It is therefore a powerful piece of...
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