Understanding these five numbers – adjusted cash balance, days sales outstanding, break-even point, margins and industry benchmarks – can help you successfully grow your small business.
Here’s a guide to what these numbers tell you and how to work them out for your business.
1. Adjusted cash balance
This number quickly tells you where you stand today and whether you have enough cash to pay for any immediate costs.
How do you work out adjusted cash balance?
If your accounting software is up to date, you can check adjusted cash balance using that. Start with your bank account balance (log on to NetBank or CommBiz). Deduct any cheques written or payments made that haven't cleared, such as salaries, rent or regular bills. Then, add back cheques deposited and other unprocessed receipts.
2. Days sales outstanding (DSO)
This is the average time it takes for a customer to pay you after issuing an invoice. The smaller the number the better, as it means you’re getting cash quickly to pay bills or reinvest into your business.
If your business offers credit, DSO can also show the efficiency of your collection process and warn you of potential cash-flow difficulties. Even if sales increase, your DSO should stay the same. If it increases, find out why and try get it down.
How do you work out DSO?
Days sales outstanding = (Total receivables outstanding x Number of days in period) / Total credit sales over the period
Example:
If you have annual credit sales of $547,500 and $60,000 in accounts receivable, then
DSO = ($60000 x 365) / $547,500
= 40
How do you improve DSO?
- Improve your invoicing process
- Negotiate better terms with your customers
- Invoice for progress payments that match your clients’ payment cycles
3. Break-even point
This is the point where your revenue covers expenses. The total profit at your break-even point is zero.
Break-even analysis can help you work out:
- Profitability of your product
- How much you need to sell before making a profit
- Effects of changing your price or volume of sales
- How far sales can drop before you make a loss
- If costs increase, how much to sell at current prices to cover costs
How do you work out break-even point?
Break-even point = Fixed costs / Gross profit margin
What are fixed costs and gross profit margin?
Fixed costs include wages, rent, leases and administrative costs. They don’t include the variable costs of sales. For the example below, let’s assume your fixed costs are $100,000 a year.
Gross profit margin is the percentage of each sale left over after costs of that sale have been covered. It equals total sales minus variable costs, as a percentage. For the example below, assume you’re selling a toy for $100 that costs $60, so the gross profit is $40 and gross profit margin is 40%.
Example:
- Break-even point = $100,000 / 40% = $250,000
- You need to sell $250,000 worth of toys to break even each year
4. Margins
Products and services with the highest margins are generally the most profitable. Once you know this, you can focus on making the most of them. Don’t confuse margin and mark-up – margin is a percentage of the selling price, while mark-up is a percentage of the cost price.
How do you work out margin?
Margin = (Gross profit x 100) / Sales
How do you work out mark-up?
Mark-up = (Gross profit x 100) / Cost
Example:
If a new product costs $100 to buy and you need to make 40% to break even, you should sell the product for $166.70, since a profit of $66.70 on a $166.70 sale gives you a margin of 40%.
5. Industry numbers
Every industry has benchmarks and averages so you can compare your business against your peers, measure how you’re performing relative to competitors and identify problems. Compare how you’re going using the ATO’s small business industry benchmarks.
