Understand Your Business Numbers – Dragon’s Den Style

The simple numbers that show whether your business is making money, growing and sustainable

A lot of business owners bury their heads in the sand when it comes to their numbers, because they feel confused, overwhelmed or totally unsure. 

Sometimes they bury their head because they’re afraid the numbers will paint a picture that their business is failing.

Without looking at their numbers though, how would anyone know whether they’re doing well or not?  How would they make any adjustments to improve things?

If you’re an entrepreneur going into Dragon’s Den, you’ll be hauled over the coals if you don’t know your numbers – it’s a crime!

Investors don’t look at number because they enjoy spreadsheets – other than accountants, very few people actually do!

They look at numbers because numbers answer very important questions about the business.

Investors look at the numbers in a business and gauge whether the business is: 

• Making money
• Growing
• Sustainable

Now you might not be looking for investment in your business, but you should still know your numbers. 

What ‘numbers’ are they though?  There’s lots of numbers involved in every business, and complicated things like Profit & Loss Accounts, Balance Sheets and Cash Flows showing all different things that are just too involved and complicated for a lot of people.

In this article we’re going to cut through the noise and discuss the headlines numbers you need to know, in order to determine the health, wealth and sustainability of your business.

The numbers we’ll discuss may be simple, but they’re the powerful indicators of your business’s performance.

No one number will give an overall answer to the health of your business, but together these simple numbers will tell you if you’re making money, growing and/or sustainable.

Revenue

The simplest number on the list is revenue.  This is sometimes referred to as sales, or turnover.  All of these terms are interchangeable and refer to the same figure.

• Sales
• Revenue
• Turnover
• They’re all the same thing!

And they’re an indicator of the size of your business.  Reviewing your sales figure year on year is usually a nice indicator of growth as well.

Sales last year were £150,000…sales this year are £170,000 – great, there’s a £20,000 increase in sales year on year.  Or a 13% increase in sales year on year.

Your sales figure can highlight whether or not your product or service is something desired.  A reducing or flat sales figure can suggest that people don’t want your product or service, or that it’s a one off and not something people want to repeat buying.

A dipping sales figure, or one that isn’t growing, could also indicate that attracting customers to your business is something you’re struggling with.

It’s because of all these factors that this is only one of the numbers we’re focusing on.

What revenue doesn’t tell you though, is whether the business is actually making money.

Gross Profit

Gross profit is the amount of money left from the sales when direct costs are taken away. 

Direct costs are sometimes called cost of sales, or cost of goods sold – because they’re the costs you have to incur in order to make your sales.

The very simple formula is: Sales - Direct Costs = Gross Profit

If your business is a service-based business, you potentially won’t have very much in the way of direct costs, meaning your gross profit could be very high. 

If your business sells products, meaning it buys in raw materials, or products, before turning them around into something you sell on, gross profit will be a very important measure for you.

Gross profit is the first real insight number for your business.  It tells you whether or not your product or service is actually profitable, and what the factor of error is in the profit margin. 

For example:

            Sales                              £1,000

            - Direct Costs                 £   600

            = Gross Profit                 £   400

            Gross Margin                       40% (£400 ÷ £1,000)

You could also think of this as 40p is left from the sale at this point, if that helps.

If this margin is small, that’s not a great sign – it shows that the cost of selling the product or service is a lot, and there isn’t much left over for the business.  

It also suggests that if any of the costs within the direct cost category increase at all, that continuing to make any profit at all could prove difficult.

Depending on who you’re selling your products or services to, your customers may try to squeeze this margin, meaning they’ll try to pay you less for your products and services – which has a knock on effect for your business’s overall profitability.

Maintaining a steady gross profit is really key to the health and sustainability of your business.

Net Profit

There’s a phrase that says ‘turnover is vanity, profit is sanity’ – it means net profit!

The calculation of net profit is simply: Gross Profit - Overhead costs = Net Profit

Overhead costs are all the other costs your business must incur to trade.  It’s costs like insurance, accountancy fees, software costs, marketing costs.

If you’re not sure of your cost split between direct costs and overhead costs, the calculation could be shown as: Sales - All costs = Net Profit

Net profit is the overall amount the business has made during whatever period you’re looking at.

Turnover being vanity and profit sanity is because you could have a business turning over millions, which initially looks great, but if it’s not making any profit on the bottom line that business actually isn’t that viable.

Businesses have to make profit in order to survive long term – they have to be sustainable.  A business can only survive so long without being profitable.

It’s common for businesses to make a loss in their first year of trade, and sometimes even the first 2 to 3 years, while they establish themselves.  However, if a loss can’t be turned into a profit, it’s unlikely a business would be able to survive that.

So, remember, your sales figure is an indicator, but your profit figure is a real measure of the health and sustainability of your business.  It’s also likely that, depending on how you trade (limited company or sole trader), that the profit figure is also your money to pay yourself.

The same as gross profit can be expressed as a percentage, so can net profit.  Net margin is a simple calculation of: Net Profit ÷ Sales x 100% = Net Margin

This is an efficiency measure – it tells you how much profit you keep from each £1 of sales.

For example: 

Sales                £80,000

Net Profit          £20,000

Net Margin             25%

This means that for every £1 the business sells, it keeps 25p (£80,000 x 0.25 = £20,000.  0.25 is 25p or 25%.)

For context, 10% net margin is commonly used as a rough viability benchmark for a business.  This is the sort of margin investors, or Dragon’s, would look at.

Typically, less than 5% net margin is considered weak or vulnerable, whereas 10% is strong and healthy and 20% or more is really strong and attractive.

Not that you’re likely to be pitching to investors, but context is helpful isn’t it – knowing what good and bad looks like.  Having a target for this is a good thing as well, so now you have some context, why not have a think about a target net margin.

Cash

The saying continues: ‘turnover is vanity, profit is sanity and cash is reality’. 

You may also have heard the term ‘cash is king’.  This is why the final number we’re talking about is cash.

Profitable companies can still collapse because they run out of cash.  There are elements that are seen in cash flow that aren’t seen on the Profit & Loss Account, where you’ll find your Sales, Gross Profit and Net Profit.

These are things like loans, VAT (if you’re VAT registered) and other forms of financing, outstanding invoices that customers owe – these can all impact your cash flow. 

Very simple you need more cash coming in than is going out to survive and grow.

If your customers aren’t paying you, you’re going to struggle to pay the things you need to pay.

If you’ve taken out a huge loan to support expansion, then expansion doesn’t happen as planned so your incoming cash doesn’t increase as planned, you still have a huge loan to repay.

Even large companies collapse because they run out of cash.  A well-known example was travel company Thomas Cook, which collapsed in 2019 under huge debt repayments.

So, you should know your cash figures – and you should have more cash coming in than going out!  Otherwise, you won’t be able to afford to pay yourself!

What They All Mean Together

You shouldn’t avoid the numbers in your business because they’re confusing, overwhelming or they just don’t make sense to you.

And you don’t need to be an accountant to understand your business’s numbers.  You just need to know which numbers actually matter.

Hopefully this has helped with which numbers actually matter, and helped them make more sense to you, so you can track and monitor them.

The truth is that numbers are all just signals.  One alone can’t tell you whether or not your business is working.

Together, they paint a fuller picture.  Together they help you answer:

• Is this working?
• Should I change something?
• Where is the profit leaking?
• Where is the cash leaking?

Instead of ‘I just feel busy and I’m not sure if the business is working or not’.

Numbers create clarity instead of guesswork.  And when you understand your numbers, running your business becomes far less stressful.

And, as we always say, clarity creates control.