What do we mean by understand your numbers?

Mar 03, 2021 by Roger Scherping



At ProjectionSmart we talk about how important it is for you to understand your numbers, but what do we mean by that? Understanding your numbers means knowing what numbers are critical to your business, exactly how each number affects your profitability, and how to impact those numbers to make your business more successful.

Let’s think about a baseball team. Imagine that this team kept no statistics (i.e., numbers) about how they were doing. During the game the players and the manager didn’t know the score. They didn’t know how many pitches the pitcher had thrown. They didn’t even know the count or how many outs there were. How would you like to manage a game under those circumstances? How would you know whether to send a runner home? How would you know it’s time to pull the pitcher for a pinch hitter? If you didn’t even know whether you were winning or losing, how would you know to turn up the pressure or just play it safe?

Imagine that your won-loss record was known to you and your fans. You’d want the fans to keep turning up for games, so you’d want to keep winning. Without any statistics, though, how would you know what to do? You wouldn’t know what had contributed to your record, so how would you know what changes to make? You wouldn’t know the batting average of any of your hitters or the ERA of any of your pitchers. How would you know who to play? You wouldn’t know who your best fielders were or who on your team had the most stolen bases. I sure wouldn’t want to put together a lineup card in that situation!

You don’t want that to be you managing your business! You want to know ALL of your numbers so you can make the right plays and drive up your wins. So I thought I’d put together some real life examples that I’ve seen of companies not understanding their numbers and the terrible impact that had on their business, profitability, and cash flow.


Top Line

Many business managers believe that the most important number on the income statement is the top line, sales. They tend to focus heavily, or even exclusively, on sales. The problem with that is that sales is not the same as profitability. How much you sell is not nearly as important as how much PROFIT you make on what you sell! Too much emphasis on the top line with no attention to the bottom line often means that a company works harder and harder to sell more but makes less profit. No one wants that. You should shoot for the opposite: make more profit on everything that you already sell.

I talked to a business manager once who received only one number every month: sales. No gross margin, no overhead expenses, no profitability. I can’t imagine running a business looking just at the sales figure. Sales isn’t really what matters. What really matters is the amount of cash you put in the bank, and profitability is a much better indicator of cash flow than sales is. Focusing exclusively on sales is dangerous.

Another thing I’ve seen is where a company knows what their total sales are but can’t break it down at all. They know their total sales but can’t tell you how much sales came from each product, product line, or job. They just see one big fat sales number. How do you know which are your highest selling products, biggest customers, or biggest projects? How do you know the best place to go to get more sales?

Without more detailed sales information you can’t see where you are having success and won’t be able to direct your efforts to continue or expand that success. Try to capture your sales information down to the lowest possible level: part number, product line, customer, job, or project.


Gross Margin

It’s good to know your sales. The next key number to know is your gross margin. Gross margin is how much money you are making on your sales after deducting all of the costs you incurred to generate those sales.

Often I see a company record their sales and then just deduct all of their expenses. They combine the costs of producing their products – materials, labor, and overhead – with all of the overhead costs of running the business – office salaries, business insurance, and telephone. Separate the production/factory costs from the office/overhead costs, then deduct the production/factory costs from sales, and that gives you gross margin. Your gross margin will tell you how profitable your operations are.

You can express your gross margin as a percent of sales. That will tell you for every $1 of sales, how many cents of profit you make. If your gross margin is 33%, then for every dollar of sales you make 33 cents in gross margin. How does that compare to last year? Are you doing better this year or worse? Are you taking lower margin work this year? Or conversely, are you increasing your gross margin percentage because you are watching your production costs more closely? Gross margin percentage is a key lever to know and understand so that you get the most out of every sale you make.

Now that you know your gross margin, let’s get more detailed. You know you’re making 33% gross margin, but can you break it down? Do you know how much margin each product is generating, or each product line? Do you know how much margin you made on each of your construction jobs? If you don’t track your gross margin with more detail, then you don’t know which of your products or jobs are winners and which ones are losers! So then how will you know what to tell your sales people about getting more business? You want them to pursue the kind of opportunities that will return the best gross margin.


Costs

I mentioned that the importance of understanding your cost of producing your products. This is really important! You would be surprised how many companies simply don’t know their costs.

It’s obvious how dangerous that can be. I have seen examples of companies that were so clueless about their costs that they were actually selling their products for LESS than it cost them to produce those products! You need to know your numbers for what it costs you to make your products.

Another problem I’ve seen is not having adequate control over setting prices. I saw a company once where the company let the sales people set their own prices! Well, sales people like to sell things, so with no controls in place you can imagine the deals they were giving their customers, and you can imagine the disastrous impact this had on the company’s gross margin.

Another very common mistake of not understanding your numbers is misunderstanding the difference between markup and margin. Markup means calculating your expected costs and then adding a layer of profit, or markup. So $100 in costs with a 50% markup means that you’re selling it for $150. People often think that means that they will make a 50% margin. Not true! Your margin will be your sale price of $150 less your costs of $100, for a margin of $50, or 33%. I have seen lots of companies make this mistake and end up making far less on a sale than they had planned.


Still More

Cash management is rife with mistakes when people don’t understand their numbers. First rule: Remember that profit is not the same as cash flow! A veteran business owner once told me, “There were years when I made lots of money, but I was broke.” There are many things that could reduce your cash flow and make it much lower than your profit, including loan payments and owner distributions. Make sure that you watch both your profit number AND your cash flow number.

Entrepreneurs this one is for you: Startups need to understand their numbers even BEFORE they launch. Don’t launch your new business until you can answer questions like:
 

  • Will my new business concept be able to make a profit?
  • Will it be able to pay me what I need to earn?
  • How much cash will I need to set started?
  • How long before my new business becomes profitable?
  • How long before it reaches positive cash flow?

If your new business venture wasn’t going to be able to make a profit, wouldn’t you want to know that now, before you invest your money? That’s why entrepreneurs need to know their numbers.


At ProjectionSmart we can help you understand your numbers. It's not difficult, and you don't have to be an accountant. We have simple, easy-to-use tools that will help you understand your numbers and be more successful.

Roger


 

Return