Many business owners think that subtracting expenses from income is enough to determine whether or not they are making a profit. And while it might be as simple as this in some cases, it’s often a common mistake made by small business owners before they realize that they are actually losing money. As a small business owner, how you handle your accounting and budgeting will determine how easily you are able to spot financial issues that are likely to take you from making a profit to making a loss.
Create Separate Budgets
It’s important to avoid relying on a single master budget created at the beginning of the year for projected income and expenses. Even if this budget is regularly updated, it’s easier than you think to miss financial issues that could end up damaging your business. You should also create a cash flow budget that demonstrates the income and expenses throughout the year. It’s easy to think that you are doing well based on your current income and expenses, but a long-term cash flow budget could show an entirely different story.
Consider Bad Debt
It’s dangerous to assume that everybody who owes your business money is going to pay you. If you operate by sending invoices with payments expected on their receipt after carrying out work for a client, there is not always a guarantee that your client is going to pay their invoice when expected. Anything can happen, from clients simply ignoring the request to pay to clients and customers disputing bills or going bankrupt. Factoring in around 5-10% of bad debt can help you create a more realistic profit and loss projection.
Hire an Accountant
Bookkeeping involves simply recording business finances, while accounting involves more analytical methods for handling your business’s cash. Keeping records of any invoices issued and payments received comes under bookkeeping, while more analytical accounting methods might include projecting bad debt, calculating future interest payments, and aging receivables. It’s definitely worth hiring a qualified accountant to help you spot hidden costs that have the potential to take you from profit to loss. This will help you better understand your company’s profit vs profitability. Read Profit vs Profitability: What You Could Be Missing for more information.
Remember to Include Interest
If you use credit cards or loans to make business-related purchases or buy on credit, you’ll need to add interest and any other financing-related expenses to your budget to get a more realistic look at your profit margins. Failing to include these in your financial planning could lead to a mistaken belief that your business is making money when it is not. If you know what your current interest payments are, it can be useful to calculate how much interest expense will be decreased if you are able to use cash reserves to pay the business debt down.
In many cases, simply subtracting expenses from income isn’t enough to work out if your business is turning over a profit. Keep these other factors in mind to get a clearer view of whether or not your business is making money and if it’s likely to continue.