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Best Practices: Understanding Revenue and Profit

Are you looking at the right numbers when it comes to assessing your business goals?

Your sales may be higher, but your expenses may be growing as well (rent, employees, equipment, etc.), so where do you stand when it comes to revenue and profit?

Shabir Ladha, CPA, CA, and partner at KBH Chartered Accountants, based in Edmonton, Alberta, joined us for a Facebook Live on financial best practices to break down revenue, pricing, profit, and more essential financial definitions. KBH Chartered Accountants works with clients from the single consultant with $50,000 a year in revenue, all the way to large-scale manufacturers with $200 million in revenue—so Shabir shared many real-life examples with us.

The following are excerpts from our interview with him, and you can watch the full Facebook Live interview on our Facebook page.

Shabir takes us through the following concepts:

1. The difference between revenue and profit
2. Strategies to control your profit
3. Smart ways to gauge business health

1. The difference between revenue and profit

Revenue or sales is really that number that you invoiced. How much did you sell?

If it’s a product based business, how much product did you sell? If it’s a service based business, think of lawn care or a furnace repair service or something like that, a plumber, it would be services that were sold or completed in a period of time. That’s the revenue. That’s that top number on an income statement or a profit and loss statement.

The profit number is after all expenses. I’ve taken my sales number, I’ve deducted off all of my costs which could be wages, it could be fuel for driving around in my truck, it could be equipment, if I’m a plumber it could be parts and materials that I need. It’s all of those costs that are required to run my business during that month, and then what’s left over is my profit.

Ideally those costs include paying the business owner and then we still have profit at the end. But the profit is really how much I made, the revenue is how much I sold.”

2. Strategies to control your profit

Ensure you have a full picture of your labor costs

“Pricing labor is an interesting one because when you look at the cost of labor, business owners often just look at the cost itself. If I’ve got an employee and I’m paying them minimum wage in Alberta at $15 an hour, I think $15 an hour. But I have to add into that the employer cost of CPP [Canada Pension Plan] and EI [Employment Insurance]. For our American friends, that’s social security and unemployment insurance and all of those related payroll costs.

If I happen to be an employer that offers benefits, I have to layer on benefits as a cost, as well. If I’m paying for some training, there are those costs. There are a lot of costs related to labor that don’t always get factored in. If I think, ‘Well I’m paying my guy, my employee $15 an hour, I need to charge them out, price my service to my customer at $30 an hour. So I’m making 15 to cover all my other costs.’ No, there’s at least a few percentage points above that 15 that disappears in other costs than what I’m thinking about.

You really need to know what your labor costs look like before you start to say, ‘Well I’m going to add 10%, 20%, 50%, 100% based on an industry to get my pricing for my labor.’ Labor cost is a big one.”

Quote

You really need to know what your labor costs look like before you start to say, 'Well I'm going to add 10%, 20%, 50%, 100% based on an industry to get my pricing for my labor.'

Shabir Ladha, Partner, KBH Chartered Accountants Quote

Factor in your up-front costs

“Quite often in the construction industry there are a lot of up front costs. I need a lot of materials and supplies in order to do a job, whether that’s framing a house, or an interior plumbing job, or I’m installing a new furnace. I’ve got to pay for some of those up front. Most businesses will add a mark-up of some kind to those materials. Again it varies as to what that mark-up will be—5%, 10%, 20%—but there should be a mark up in there for a number of reasons which you don’t think about or owners don’t always think about.

These are things like the amount of time it takes for them to say run to the local hardware store to pick up those materials. There’s a fuel cost involved, there’s a wear and tear on a vehicle that’s involved there, there’s time—and I might be paying an employee to be doing some of that work as well.

And then there’s the cash cost. I’ve got to lay out some cash in order to purchase the materials, have them available so that I can then complete my job.

That shrinking profit can come at a business owner in lots of different ways, and it’s important for them to really understand what those cost drivers are in their business and what the real cost is. Not just the dollars laid out for that employee per hour or that pile of materials. Then adjust their pricing accordingly.”

More pricing strategies

We unpacked fixed-price billing versus hourly-priced billing.

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Identify your high-value, low-cost services

“In every business you can think about where your high value, low cost items are.

For our house cleaner [when she cleans our windows twice a year] it does take her more time. She spends more time when she does the windows, but if she thinks about the amount of work it is to do the windows versus the amount of work it is to clean the rest of the house, the time spent on the windows is not as much as the time spent on the house. But we pay almost the same amount for the windows to get done as we do for the house to get done.

It’s a one off so I don’t mind paying a little bit more. It’s a high value service, and I really want it done and I don’t want to do it myself.”

Understand your margins

“If you’re doing low margin work, it has to be high volume otherwise it’s not worth doing.

Grocery stores have relatively low margins on a lot of their stuff. Costco especially. Really low margin. The reason Costco is so profitable? Massive volumes, so that’s why they make all their money.

High volume is hard to do if you’re a small business. If you’re a service business, it’s near impossible. So you need to focus on some of the higher margin work so you’re making a larger amount on the amount of the work that you do. You just have to be careful that you don’t cut out the low margin stuff to the detriment of everything else.

A lot of times the low margin stuff gets you the high margin work.”

On that note, be strategic with loss leaders

“A loss leader can be a great thing to do. But think of it like marketing. My loss leader is to get me the customer. Then I need to, not bait and switch, but upsell.

If for example if I go back to the lawn care business, my loss leader might be that I’m going to cut your lawn for the first month at $10 per week. But you’re going to sign a six month agreement with me. We’re going to sign an agreement for the whole summer and all the rest of the jobs are going to be at the $40 a cut.

An AC company I might do the inspection and your first filter replacement is free. First inspection and I know your filter is going to be need replacing so I’m going to replace that one on the house the very first time. But we’re going to continue on for the rest of the year and it’s going to be X amount for the other services.

So you use it to gain the customer and go from there. Businesses do it all the time. Groupon is famous for that. That’s what Groupon is, right? Groupon is a loss leader. You get somebody in because they bought a Groupon and now I’m hoping that I can sell them additional services to actually make some money.”

3. Smart ways to gauge business health

Don't rely on your bank account

“Looking at your bank account is a bad way to manage your business. It’s the way that many people do it because that’s the only piece of information they have. Having the right bookkeeping or the right information is vital to being able to assess the health of your business.

I think that the key is to understand what your revenue is on whatever period you’re looking at—whether that’s week, month, quarter, year—minus your expenses so that you know your profit.

That’s what’s really important: How much am I making? What is my profit? Because I can have money in the bank looking at my bank statement. I’ve done a bunch of work, I’ve collected a lot of it so my accounts receivable, money I’m waiting to come in, is really low. And I’ve got money in the bank but I have no visibility on that stack of invoices that I have to pay. Because I’ve done a bunch of work but I haven’t paid my fuel bill yet, and I haven’t paid all my employees or my contractors yet. And I haven’t paid the repair bill for the lawn mower yet, and I haven’t paid my credit card bill. So I have lots of money in the bank which is wonderful, but when I add up all of my bills all that money and then some goes away. That’s problematic. I haven’t actually got anything.

Whereas if I can look at my revenues and my expenses to get my profit, I know whether I’ve made money or not based on that assessment.”

Should I hire an accountant or bookkeeper?

If you’re wondering who does what and which you need we have the answer.

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Set smart business goals

“It’s great to grow your top line revenue number but if it comes at the expense of a whole lot of other things like profitability, like wages to the owner, like health, like quality, it’s kind of pointless. It’s great to say that I’m a million dollar company today and I’ve hit a million dollars in revenue. But if I’ve hit a million dollars in revenue and I lost $20,000 because my expenses were higher than my revenues, that’s problematic. As compared to, ‘when I was doing $450,000 in revenue, I was making $50,000 a year.’ That’s a way better position to be in.

Going after just a revenue target for the sake of the target, doesn’t really make a lot of sense. It has to be planned with profitability. At certain times a business will go through that knowing ‘we’re going to grow this revenue and we’re going to take on some more people to get us there and we’re going to lose money early on. That first year we’re going to hit that million dollars and we’re going to lose money because we have more people than we need to do a million but we need all those people to get there because really we’re going to get to a million and a quarter.’

When we get to a million and a quarter, all those people will be fully busy and we’ll be making money again. In that scenario I can see pushing for a top line revenue target and deciding you’re going to run a loss or make some investment in some people because the longer term is worth it. Still some risk, but it’s worth it. But just a revenue target on it’s own, no I wouldn’t recommend anybody go after that. I would be targeting profitability whether that’s number maybe but more of percentages.”

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Can I now get to the point where I'm paying myself fair market value for what I'm doing? Which quite often is much higher than what you think because business owners work almost 24/7.

Shabir Ladha, Partner, KBH Chartered Accountants Quote

Ask yourself a few important questions

“First of all, can I get to be profitable? Can I get to a point where I’m paying myself as the owner something? Can I now get to the point where I’m paying myself fair market value for what I’m doing? Which quite often is much higher than what you think because business owners work almost 24/7. Because they go home after mowing the lawns and have to do paperwork and do the bookkeeping and the marketing and figure out their schedule for the next day and all those things. There’s more than just my time mowing the lawn. Can I pay myself fair market value?

Then can I create what we call entrepreneurial earnings? Can I pay everybody including myself fair market value and have profit beyond that to show that my business is worth much more than just me working? And that’s where as business owners start to think, ‘I’m going to sell this and I want to get out. What’s my business worth?’ It’s worth what I’m paying myself and some kind of multiple on my profits.”

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