Profitability By Peter Baskerville 24/04/2019

Building your startup Three distinct phases: Build the infrastructure Build the business (customer acquisition) Build the profit (owner benefit – management, cost control) Infrastructure to make the business fly – CAPEX BUDGET Business to attract sufficient customers – CASHFLOW PLAN Profit to deliver returns to stakeholders – PROFIT BUDGET

Money In … Money Out OUT IN Goods & services used up to earn revenue = Expenses Goods & services purchased but not yet used up = Assets $ from customers who buy our Goods & services = Revenue $ from investment by the owners in the business = Capital OUT IN

What is Profitability? the ability to generate revenues in excess of the expenses used up in producing those revenues a measure of business success The ability to provide financial rewards sufficient to attract and retain financing – a competitive return on invested capital – sustainability (capacity to endure).

Types of Revenue Merchandise sales – retail, wholesale, manufacturer Service Fees – consultants, tradespeople, freelancers Investments – shares in businesses, interest on deposits Other – Donations, government grants

Costs – sacrificing cash Cost Vs Expense Interchangeable – business and economics. Accounting - specific Cost = sacrificing resources (money) to acquire items of value (includes CAPEX) Expense = Using up the value of those items in order to generate revenue for a business Costs – sacrificing cash Expenses – used costs

Cost Vs Expense Cost per ream – $10 Cost = sacrificing resources (money) to acquire items of value (includes CAPEX) = 6 x $10 = $60 Expense = Using up the value of those items in order to generate revenue for a business = 4 x $10 = $40 Asset = Items of economic value with potential to earn future revenue = 2 x $10 = $20

Fixed Vs Variable Expenses Required for budgeting – cashflow & break-even Fixed expenses – expenses that DON’T change in relation to sales volume or business activity (rent) Variable expenses – expenses that DO change in relation to sales volume or business activity (purchases)

Direct Vs Indirect Expenses Costs required to prepare an item for sale (purchases, freight in, direct labour) and which are easily identified as relating to the product sold. Indirect expenses - Overheads Expenses that do not relate directly to a specific product and so must be shared equitably between all products produced by the business (Rent, insurance)

Profit calculations Gross profit = revenue less direct expenses (purchases, direct labour) Operating profit = gross profit less overheads (not including depreciation, income tax or interest) = EBITDA Net profit = Operating profit less interest, depreciation, extraordinary gains/losses EBIT = Earnings Before Interest, Tax. Your Business Profit & Loss Budget For the year ended 30 June 2013 $ Revenue 200,000 Less direct costs 100,000 = Gross Profit Less fixed expenses 40,000 Less variable expenses 20,000 = Operating Profit Less interest 5,000 Less depreciation 2,000 = Net profit 33,000

Calculating mark-up (mark-on) Mark-up or Mark-on Used to calculate a selling price Cost price + (Cost price x mark-up) = Selling price $10 + (10 x 100%) = $20 selling price Mark-up = 100%

In budgeting we use Gross Profit % Margin Calculating margins Used to calculate the amount of gross profit in a sale i.e. What % of the sale is our gross profit? (Selling price – cost price) ÷ Selling price = Gross Profit (GP%) (20 – 15) ÷ 20 = 25% GP margin Sell price = cost price ÷ (1-GP%) Difference from 100% = Cost of good sold % In budgeting we use Gross Profit % Margin

Applying GP% margins Setting a selling price Given a cost price = $20 Given a targeted GP% = 60% Selling Price = Cost Price ÷ (1 – GP%) Selling Price (Example) = $20 ÷ (1 - 0.6) = $20 ÷ 0.4 = $50