Profits

/Profits

Accounts Receivable Turnover

By | 2017-11-03T18:05:42+00:00 November 2nd, 2017|

Do you know what your AR is costing you?

 

Why accounts receivable?

  • Increase sales.

Downside of Accounts Receivable

  • Bad debt

  • Opportunity cost of cash

  • Additional staff required to maintain accounts

  • Interest cost if business has to take loan to meet working capital needs

  • Background checks/ collection services

  • Office supplies like paper and ink sent to customers who owe

Credit card and accounts receivable

When you offer your customers the choice to pay accounts receivable with credit cards, you increase your cost of credit. One of the main functions of accepting credit cards is the ability to collect payments faster.

AR WITH CREDIT CARDS DEFEATS THIS PURPOSE.

How Did We Get Here?

  • MOST TIMES WE SIMPLY DO WHAT EVERYONE ELSE IS DOING WITHOUT THINKING ABOUT THE BEST APPLICABLE SOLUTION FOR OUR BUSINESS.

Available Options

  • If you accept credit cards FOR AR, think about adjusting your policies where customers pay before they get the final good or deliverable.

    • In exchange for credit card fees, you should reduce your chances of accumulating accounts receivable.

  • BE INNOVATIVE – YOU DON’T HAVE TO DO THINGS LIKE EVERYONE ELSE

ACCOUNTS RECEIVABLE TURNOVER

The turnover ratio computes how many times accounts receivable is turned to cash in a year. The higher the ratio, the shorter the collection period.

Accounts Receivable turnover example

  • Accounts Receivable Turnover = Sales/ Accounts Receivable

    • Sales = $1,000,000

    • Accounts receivable = $250,000

    • AR turnover = $1,000,000/ $250,000 = 4 times

  • Number of days to collect = 365/ accounts receivable turnover ratio

    • 365/4 = 91.25 days

  • This means it takes an average of 91.25 days to collect.

    Next let us compute the cost.

COST OF CREDIT SALES

  • Every month you keep your accounts receivable there is a cost

Summary

In exchange for credit card fees, you reduce your chances of accumulating accounts receivable. If you are not in the credit business or your credit sales does not increase total revenue in any way, then you are spending way too much on accounts receivable.

Get more detailed analysis:

http://www.retirefrommybusiness.com/product/module-2/

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What is Return on Assets?

By | 2017-10-29T23:29:52+00:00 October 29th, 2017|

To truly understand return on assets, you must first be able to differentiate between operating and non-operating assets.

Operating Assets

Operating assets are economic resources owned by the owners of the business. Operating assets are bought to generate future revenue and can usually be converted to cash in the future. This means they can potentially be resold after use. Operating assets often include:

  1. Cash – at a minimum your must have cash to cover your break-even expenses
  2. Equipment/ machinery/ vehicle for smooth running of your operations or improve productivity
  3. Buildings – you can choose to own or rent your office space. If you choose to own your building that will also be classified as an asset

Non-Operating Assets

Non-operating assets are assets that are not required to continue operations. For example, a business might own some real estate that is not used in operations. The business might have invested in it for operations but later chose to move the business. Alternatively, a business might choose to invest in real estate to generate non-operating income.

Another example will be a vehicle initially purchased for business purposes but has since been converted into a vehicle for personal travel.

Computing return on assets

The efficiency of the assets you accumulate is measured by the return on your asset. Return on asset is measured by net income divided by total operating assets. So, if you made 10,000 last year and your total operating assets were 5,000, your return on operating assets will be 10,000/5,000 = 200%. This means that you were able to double the amount you started out with. Your assets are being put into good use.

Before computing your return on assets, it is important to make an adjustment for non-operating assets. Including this in your calculation can distort your results.

Assessing effective use of your assets

Not only is it important to watch profits also it is important to manage your assets. Keeping assets idle, lowers the return you can get on your investment. You should know how much assets you need to run your business and maintain growth. Excessive assets should be re-directed to other investments so non-operating income can be generated for the business.

Assets in your business should be producing more than you can make from saving your income in a CD or savings account. If you can invest the same amount of resources somewhere else and get a higher return, then running your business is not your most profitable choice.

Let us assume you had $10,000 and you had a choice to start your own business or invest in an alternate opportunity. If you estimated you can double your investment in running a business then investing in a business is more desirable. On the other hand, if you can earn more somewhere else then running a business will not be the smart way to go.

 

Business

Alternate Investment

Initial investment $ 10,000 $ 10,000
Time

1 yr.

I yr.

Income $ 20,000 $ 5,000
Rate of return

200%

50%

You want to establish a minimum return for each asset you invest in. If not, you could easily find profits decrease as income increases. This is because expenses like depreciation and interest expense normally associated with assets will increase while revenue stays the same or decline. Managing the return on your assets is just as important as managing profits. Operating assets must possess the ability to increase revenue or decrease expenses: The owner should either spend less overtime by owning the asset or the asset should increase productivity allowing the business to take on more customers.


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Focus on improving margins before working on growth.

By | 2017-10-21T19:54:49+00:00 October 21st, 2017|Tags: , |

Margin management attempts to manage risk by evaluating both cost and revenue simultaneously rather than as individual units of risks.  Margin management involves the management of revenue, expenses and taxes all simultaneously. Looking at each factor in isolation does not always yield the most margin effective decision. For example, you could have a strategy that raises revenue by $5, cost $3 to obtain and after-tax effect will leave you with $2.55. By thinking of all 3, you could research if any tax credits are available concerning the expense, more effective ways of obtaining the same benefits.

First develop the best strategy best fit for your business and then look for alternative ways to fulfil the requirements of the strategy. A business owner who is too concerned about tax savings, could end up with les profits. Strategy that gives rise to the tax savings might not always be right for your business. Take a look at this calculation:

Strategy First Tax First
Revenue $ 50, 000 $ 50, 000
Expenses $ 10,000 $ 20,000
Net $ 40,000 $ 30,000
Tax (15%) $ 6,000 $ 4,500
After Tax Income $ 34,000 $ 25,500

Even though the tax first strategy allowed the business owner to save $1,500 in taxes, the business owner ended up with $8,500 less after-tax profit. This will not be a problem if the additional $10k was spent on business growth/ sustainability. However, what I see is business owners splurging in other to reduce their tax liability. Keeping $34,000 is a lot better than $25,500. This could be cash you could potentially reinvest in the business. The lesson here is to choose the strategy that will maximize your profits first and then find ways to minimize your taxes.

We will take a look at 3 margins that should be managed within your business:

  • Gross margin
  • Net Profit margin
  • After tax profit margin

Gross Margin

Your gross margin is your revenue less your cost of goods sold. Your gross margin percentage is your gross margin as a percentage of revenue. Your gross margin tells you how much you make after you deduct directly what it cost you to purchase the product and get it ready for sale.

Let us say you buy 1,000 units of widgets for $10 each and you sell them for $40 each. Your direct profit on each unit will be $30. This $30 is your gross margin and it is profit before any other business expenses. The goal of the gross margin is to determine your direct profitability.

At $30 profit per unit, your gross margin percent is 75% (30/40). This means for each unit you sell, you keep 75% of the profits before other expenses are accounted for. Remember, gross margin only has to do with the direct cost of buying and selling the product.

Revenue $40,000 100%
Cost of goods sold $10,000 25%
Gross Margin $30,000 75%

The example above only took into account the cost of the product. But in reality, all expenses used to get the product ready for sale are part of your cost of goods sold. It is important to trace the direct costs of producing a product or a service to that product or service. This helps you accurately figure out gross margin. In a retail business, the cost of goods sold will typically include the cost of purchasing the inventory and any incidental expenses associated with the purchase. In a manufacturing business it will include direct materials, direct labor and manufacturing overhead allocated to the production process.

Cost of goods sold is usually the biggest expense most manufacturers and retailers have.

Net profit margin

Net profit is defined as revenue minus total expenses. Or we could restate it by saying net profit is gross margin minus operating expenses.

Revenue

$40,000

100%

Cost of goods sold

$10,000

25%

Gross Margin

$30,000

75%

Other expenses (Selling & Admin expenses)

$25,000

63%

Net profit

$5,000

13%

In the example above, we can compute net sales either by subtracting cost of goods sold and other expenses from revenue, or by subtracting other expenses from gross margin. Either way we will arrive at net profit. We see percentage wise, this business owner only keeps 13% of the revenue he or she brings in. Whether this is a good or bad number depends on the industry the business owner operates in.

After tax profit margin

Taxes are paid on net profit margin and is computed by subtracting the tax you pay from your net profit as shown below:

Revenue $ 40,000 100%
Cost of goods sold $ 10,000 25%
Gross Margin $ 30,000 75%
Other expenses (Selling & Admin expenses) $ 25,000 63%
Net profit $ 5,000 13%
Taxes (15%) $ 750 2%
Profit after taxes $ 4,250 11%

We see after all is said and done, the owner only gets to keep 11% of total revenue.

It is important you keep track of the tax rate and what tax changes affect your business. Some questions to consider that could help you reduce your tax rate are:

  • Is there any credit available to you are not taking?
  • Are you paying taxes on income that could be deferred to a year when your tax rate will be potentially lower?

You want to examine how your effective tax rate increases over time. The effective tax rate is the rate you actually pay on your taxable income. On the other hand, your marginal tax rate is the rate you pay taking into account your income level. These two often defer because there are tax benefits businesses can use to reduce its actual tax.


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Lifestyle CPA

Financial Keepers, LLC
Innovate Springfield
15 South Old State Capitol Plaza,
2nd Floor Springfield, IL 62701
Telephone: 417-812-5945

Phone

417-812-5945