How to build a successful business
Manage your business with the same principles as big business. Treat your customers exceptionally good by anticipating their needs before they ask.
An informed business owner should understand the financial and tax implications of everyday transactions.
Your current situation
Each of us do business in a certain way. This recipe of ours, includes good and bad ingredients. The sooner we identify disastrous habits and remove them, the better.
Calculate your business monthly income and expenses. This is an indication of your business performance in it’s current form.
Like a racing car, you can invest in better equipment or get rid of excess weight and see if the performance increase and by how much.
Take on acceptable and calculated risk. Do not risk everything you build up with one deal.
Build your own safety net by saving for future expenses like the next months overheads, December bonuses or a scheduled maintenance.
Have a plan A, B and C. Usually it’s plan D that works.
Calculate your break even point.
It is important to know how much your monthly turnover must be to be able to cover your costs.
Above the breakeven point, you make a profit.
This is your minimum monthly target. I would suggest to aim realistically higher and push yourself and your team.
Unfortunately some target break even sales in their monthly budget. It is very stressful if they do not make target, because they make a loss. And a loss must be financed from either their own pocket or a loan.
If you aim low, you will hit it all the time. Why not aim higher and sometimes you will hit the higher target and make profit.
Service company break even sales
- Calculate your business overheads (monthly business expenses)
Retail business break even sales
- Calculate your business overheads (monthly business expenses)
- Calculate Gross profit percentage
- Monthly overheads divided by GP%
|Sales or Selling price||R140,000 or R5,000|
|Cost of sales or Cost of item||R63,000 or R2,250|
|Gross profit or GP per item||R77,000 or R2,750|
|Gross profit %||55%|
|Break even sales||R140,000 or 28 units|
Margin of safety
Margin of safety = Actual sales less Break even sales
Margin of safety can also be calculated in units.
Margin of safety indicates by how much sales can drop before the business start making a loss.
Example: A business has a profit of R35,000 per month before director salary. Most people take the R35,000 leaving the business broke for next month.
Every month-end is a stressful and nail biting experience not knowing whether the business will survive. There are no cash reserves.
The director’s lifestyle expenses increase to R50,000 and the business cannot support it. The business qualify for an overdraft of R200,000 and the main supplier gives the business a R30,000 credit account.
The director thinks he’s a millionaire and continue with the R50,000 lifestyle. The business cannot grow because all the available cash is withdrawn as a salary. Every month the director borrow around R15,000 from the overdraft facility to supplement his salary.
Clients pay deposits for materials and the cash is used for other reasons. Materials are bought on the account and the overdraft is used for overheads and lifestyle expenses. This is a recipe for disaster.
Twelve months later the business finds itself in financial distress and needs to close down. Then a new company gets registered and 12 to 15 months later, the same tragic story.
If the director lived within his means, build up the business cash reserves and followed a strategy to increase sales, then the business could have survived.
Implement a savings plan for both yourself and your business
What would happen if you would decide to not withdraw all the available funds every month as your salary, but leave some cash in the bank.
Maybe start providing for holiday bonuses and build on that until you have a month’s overheads in cash in the bank. Imagine 3 months overheads in the bank.
You would have a lot less stress and be able to handle almost any crisis which arise like a vehicle breakdown.
Financial advisors reckon we should have between 3 and 6 months living expenses saved up. The more the better.
Why not work towards a month to 3 months business overheads saved up in a business investment account, with the funds readily available?
Start marketing your product or service while in a good financial position before it’s too late
Many businesses want to start marketing when the business is already in distress.
A successful marketing campaign takes time and money. None of which is available when the business is operating in crisis mode.
You can start a marketing campaign from the additional available funds. This will grow your client base and increase profit.
The tax issue
Equity = Assets – liabilities
We want to increase equity. An increase in assets or decline in liabilities will result in your business making profit which is taxable.
In South Africa a small business corporation pay tax on a reduces scale. My advice is that small business owners should discuss the benefits of the small business corporation with their tax accountants.
This legislation allows small medium business to build up assets and pay less tax legally.
Build an acceptable balance sheet
Business owners must see themselves as the chief executive officers of their own small to medium business. The same ratio analysis used to decide into which listed company we should invest, can assist the small business owner to better manage their business and make it more profitable.
Financial institutions use these ratios to decide if your business qualify for finance and if they should invest therein.
If these financial ratios can indicate whether a large corporation is well managed, then why won’t it work for smaller business?
There are more ratio’s and books on the topic and my opinion is that a lot more small business can grow into larger business and employ more if they would implement a basic financial management plan as well as implement a few internal controls.
Assets should obviously be more than liabilities, but there is more to it.
Ratio analysis can be used to see how well a business is managed and to compare businesses to one another or to the industry standard.
Ratio’s may be categorized into 6 groups:
- Liquidity ratios
- Asset management ratios
- Debt management ratios
- Profitability ratios
- Cash flow ratios
- Market value ratios
Current ratio or working capital ratio
The current ratio is a liquidity ratio which indicates the company’s ability to settle short-term debt. Short-term debt is debt that must be settled within the next 12 months.
Your aim should be to achieve a ratio of 1.5 to 2 calculated as follow:
- Current assets ÷ current liabilities
Current assets consist of:
- Cash in bank
- Customer accounts receivable
Current liabilities consist of:
- Supplier accounts payable
- Bank overdraft
- Vat and income tax payable
- Short-term portion of long-term liabilities (payable within the 12 months)
You can also use the quick ratio:
- (Current assets less stock)/Current liabilities
The reason for deducting stock is because stock can take time to sell before it can be convert to cash. And cash is used to settle the short-term debt.
Asset Management Ratios