Critical components of your financial model
Making sound business decisions and achieving long term financial viability is dependent upon you having an understanding of the following components of your financial model:
- Net Profit
- Break Even Point
- Cash Flow
Net Profit is calculated as income less expenses equals profit.
There are only two ways to increase profits:
- increase revenue and/or
- decrease expenses
The break even point is when total income equals total expenses. Understanding how much income is required to cover expenses over a period of time is critical to knowing if you have a viable business.
Many business owners could not tell you how much it costs them to operate their business on a daily, weekly or monthly basis. There is no point being pleased with generating income of $2,000 for the day when it cost you $2,500 to operate the business that day.
When you hear business owners speak about their business they will usually discuss how much revenue they are generating on an annual basis, giving no reference to the expenses, or profits of the business.
A business with an annual turnover of 1 million dollars making $200,000 in profits is far more attractive than a business generating annual turnover of 2 million dollars with a profit of $150,000.
Cash Flow
A profitable business with poor cash flow will create many headaches for a business owner as cash is the lifeblood of a business.
Factors that impact on cashflow include:
- amounts owing from customers
- amounts owing to suppliers
- tax payments
- amounts owing in PAYG Withholding and Superannuation
- loan repayments