Ask any small company what it costs them to do business per hour. This may seem like an obvious and simple question, but I can assure you, you’ll be surprised at the answers you get. The fact is, most small businesses, about 80% don’t know how much it costs for them to put the key in the door. This is a really big problem that leads to many other problems within their business and can lead to them closing the gates for good.
From the point that you get up in the morning and start working, every minute of every hour of every day that you do business costs money. How can you expect your business to survive if you don’t know what your costs are? Well, to tell you the truth, many small businesses operate this way. Many are lucky to survive their first year. Some make it over the 3 year hump, and some make it to the 5-year “the honeymoon is over” stage. By that time, they’re either out of business or so far in debt that they either have to make a drastic change or go bankrupt. I’ll tell you how to get a grip on this as it comes down to how you handle your books.
When I talk to business owners about the inner workings when I’m trying to help them, one of the first questions I ask is the cost per hour to operate. Depending on how fast they answer the question will tell me a lot about their bookkeeping practices. And, their bookkeeping practices will tell me a whole lot about how they run their business. I’ve met business owners that don’t do any internal bookkeeping and only rely on bank statements and their accountant to salvage them at the end of the year during tax time. Sounds crazy? Well, it’s true.
I know, this is not the most exiting topic for many of you. Some people just hate numbers or find it boring. It not as exiting as marketing or working on your next project. But, it is probably one of the most important parts of your back office. How will you know how much money you need to make or how much to charge your clients if you don’t know even this simple answer? How do you estimate your jobs? How do you know if you can hire new personnel, buy a new company vehicle, or reinvest in your company? How will you know your profit margin?
I’m not an accountant, but I do know many of the important factors here in order to get you started on your path to profitability. Here are some basic things you need to do to know your costs and then take the next steps in planning for profitability:
- First and foremost, get to know bookkeeping. Either hire an admin with bookkeeping experience for $15-$20 per hr, or do it yourself. You’ll be happy you did. Some accountants offer bookkeeping services as well.
- Make it a point to know the three most basic reports and what they tell you: Profit and Loss Statement (Income Statement), Statement of Cash Flow, and the Balance Sheet.
- Make sure your chart of accounts are in order. Out of the box, something like Quickbooks will do this for you. Consult your accountant for additional recommendations based on your industry.
- Make sure your items are configured correctly. For example, if you sell spark plugs, when you set up the item, you have to enter the cost of the item, the vendor you buy them from, select the correct cost of goods sold account, the gross profit margin amount you want to make, and the Income account. I won’t get into inventory as that is a more in-depth subject.
- Note that you will have to set up your vendor first and configure them to the correct chart of accounts under a cost of goods account.
- The services you provide is also an item. For each type of service, you have to know what your costs are. For simplicity, ask your accountant what your fixed costs were for last year (overhead). Divide that number by 1950. That will give you your hourly fixed expenses for last year. Add how much you pay your employee for that hour, plus what it costs you per hr for his/her benefits. You put all those numbers together and that is your cost to calculate labor rates, which goes under cost of goods sold. Now, for your pricing you enter the gross profit margin you want (price per unit hr). That will be your labor rate. Connect that to the Income on chart of accounts.
- Make sure you set up your customers correctly. Basic information and tax or exempt requirements.
- Always create a new job for every client engagement.
- Always create an Estimate under that job first, so that you can create a PO for a vendor and an invoice to the client directly from that estimate.
- Always enter any expenses you may have. This can include any bills you receive, petty cash, credit cards, loans, etc.
- Enter every line item from your bank and credit card statements.
- Then reconcile the accounts.
- Do this at the very least, monthly
- Everything must balance to the penny.
At a very basic level, this is the set up you need. As you enter the items on the estimate, you create PO for the vendor, then invoice the client. This process insures that things are being recorded where they need to be in the books. When you do this and data is collected, you can run a profit and loss report. Under the heading Total Expense, that will be your total fixed cost within that frame of time. You can try to calculate your hourly rate by dividing that number by the number of days for the period. This will give you an estimated cost per hr. By the end of the year, you will have the accurate number and can use that for your rates for the following year.
As far as profitability, you’ll see what is left over after expenses in the Statement of Cash Flows. It’s basically Income after Expenses.
I’ll be doing a video on this in the near future on YouTube. You can follow me here: YouTube Channel