Matters Column

Find the sweet spot to maximize profit

December 2, 2016
TAGS CPA / profit / tax
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The first thought that comes to mind when you say CPA in December to a small business owner is tax planning — absolutely necessary and needs to be done. There is an equally important task for your CPA in December, and that is to create a crisis next year trying to figure out what to do with all the profits.

Projections and budgets are the tools of control. Great businesses do not come about by a flash of genius alone. I saw many great ideas wasted by a lack of willingness to do the grunt work. Projections and budgets are not as much fun as advertising, product development and public relations. I have to use a football analogy, because that is what registers with me. In football, the running backs, quarterbacks and wide receivers get the attention in the press, and that is because they are the ones who score touchdowns. Even if you have only a moderate understating of the concept of football success, if the linemen don't block, the stars will not shine.

I always felt that if you could predict your sales, you could predict your profit. The number I loved to look for was the gross profit percent. When analyzing pricing finding, that sweet spot where you have maximized your gross profit is important. The concept is that as price goes up, your units sold goes down, and when the price goes down, the units sold goes up. At what price do you maximize your revenue?

I have no idea if this story is true or not, but QuickBooks — generally the accounting software used by small businesses — originally was supposed to be priced at several thousand dollars. Consider once the software is developed, the duplication costs are minimal. Supposedly, someone came up with the idea of selling millions of programs at a price in the low hundreds as opposed to thousands of units for a price in the low thousands. Even if the story isn't true, the concept is.

When evaluating the profitability of the business, make sure you properly identify your compensation for work and your return on investment. There is a tax reason to separate out the numbers. The IRS uses compensation vs. investment earnings for several issues, especially for S corps. The reason you need to examine that designation is in the evaluation of your investment in the business. You need to know your return on investment for the value you have invested. There may be a better place to invest your money.

Once you have projected your sales and costs, you need to do a line-by-line analysis of your overhead. There is a concept called fixed and controllable expenses. Fixed expenses are long term. When you sign a lease, you are creating a fixed expense. No matter what your sales volume is, that expense remains the same. Overhead are those expenses that do not go directly into the cost of the product. Office wages, office supplies, etc. are variable overhead.

So, there are all these terms and concepts that are new to you or that you have ignored — ignorance is not an option. You might look at your financial statement and see something similar to the Dead Sea Scrolls. After more than 40 years as a small business accountant, that statement doesn’t look Greek to me, but it might be Greek to you. Accounting and finance has its own language. So, if I read Greek and you read English, what do we need? An interpreter, or CPA. Have your CPA interpret the statement for you. I looked at an EKG at my cardiologist one day and immediately came to the conclusion I had died 10 minutes ago.

Set up an appointment with your accountant. What you’re looking for is understanding. You want to know what happened last year. You need to know what has happened before you can control what will happen.

A caution: If the numbers are not right, then the conclusions you come to may not be right. You may find that the cost of goods sold is inaccurate. There are inventory, accounts payable cut off and math errors that may give you wrong information. Advance cautiously knowing you need better information is superior to charging ahead thinking incorrectly you are well informed. When looking at anomalies in your budget creation, you may find you have an accounting problem rather than an operational problem. If you don't look at the numbers at all, I guess it doesn't make any difference. 

 Work hard. Think hard. Project a great year then go make it happen.

Paul Hense is the retired president of local accounting firm Hense & Associates and past chairman of the Small Business Association of Michigan.

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