Kerkko Jahnukainen
Problem: How to use the financial statement to improve your business
Learning Objectives:
- How to price your products (Break down a price)
- What is a balance sheet and income statement?
- How do determine the profitability of a business?
Keywords:
Financial statement
Financial Sustainability
Net sales
Liquidity
Assets and liabilities
How to price your products (Break down a price)
Basic rules of pricing:
- All prices must cover costs and profits.
- The most effective way to lower prices is to lower costs.
- Review prices frequently to assure that they reflect the dynamics of cost, market demand, response to the competition, and profit objectives.
- Prices must be established to assure sales.
When determening prices for your products you must first know all the costs of the enetire business. If the income doesn't cover the cost cash flow will obsiovly be ngeative.
To determine how much it costs to run your business, include property and/or equipment leases, loan repayments, inventory, utilities, financing costs, and salaries/wages/commissions. Don't forget to add the costs of markdowns, shortages, damaged merchandise, employee discounts, cost of goods sold, and desired profits to your list of operating expenses.
Every product must be priced to cover its production or wholesale cost, freight charges, labor, a proportionate share of overhead (fixed and variable operating expenses such as materials), and a reasonable profit.
Determeninf margin. Total sales - totala sale cost = margin. For example: 1000e sales - 300e costs = 700e margin.
Demand Price: The source where the products are being sold can greatly effect the pricing. For example wholesale can sale at much lower prices compared to a retailer as they order larger quantities. Price is determined by demand.
Competitive pricing: When there is a set price among different companies selling the same product, you must see whether you can either sell it at even lower price by cutting corners or perhaps increase price but then compensate for it by providing superior customer service for example.
Markup pricing: "Used by manufacturers, wholesalers, and retailers, a markup is calculated by adding a set amount to the cost of a product, which results in the price charged to the customer. For example, if the cost of the product is $100 and your selling price is $140, the markup would be $40."
When is the right time to review your prices? Do so if:
- You introduce a new product or product line;
- Your costs change;
- You decide to enter a new market;
- Your competitors change their prices;
- The economy experiences either inflation or recession;
- Your sales strategy changes; or
- Your customers are making more money because of your product or service.
(Entrepreneur, www.entrepreneur.com)
Aswell as knowing the costs of your business, know your customer, know your competition, know where the market is headed.
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What is a balance sheet and income statement?
Balance sheet is a financial statement that summarizes company's assets, liabilities and equity.
Assets = Liabilities + Shareholders' Equity
The balance sheets gets its name from the fact that the two sides of the equation above – assets on the one side and liabilities plus shareholders' equity on the other – must balance out. This is intuitive: a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholders' equity).
Assets include:
- Cash
- Inventory
- Prepaid expenses
- Accounts receivables (money which customers owe)
- Long-term investements
- Fixed assets (land, machinery equipment, building, etc.)
Liabilities:
- Dept
- Rent, tax
- Wages
- Customer prepayments
- Bank indebtness
- Pensions
Equity: Retained earnings and treasury stock
Balance sheet gives a snapshot of the current state of the company's finance. It alone cannot give an idea of trends as it needs to be compared to previous sheets. There are different ways to detremd these trends by using rations. For example the dept-to-equity ratio (Debt - Equity Ratio = Total Liabilities / Shareholders' Equity)or the acid-test ratio.
Income Statement: An income statement is a financial statement that reports a company's financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities. It also shows the net profit or loss incurred over a specific accounting period.
Also know as the profit and loss statement or revenue and expense. It's one of the three major financial statements. They must be submitted to the Securities, Exchange Commission and investor public. Other two are balance sheet and statement of cash flow. All provide financial information but only income statement provides an overview of company sales and net income.
The income statement is divided into two parts: operating and non-operating. The operating portion of the income statement discloses information about revenues and expenses that are a direct result of regular business operations.
(Investopedia, www.investopedia.com)
How do determine the profitability of a business?
Sales (Net profit margin/ gross profit margin)*
Pricing: Careful analysis of correct pricing is key to creating profit. Important thing to notice are competitor prices as well as considering what are the prices that customers are willing to pay.
Expenses: For a company to become profitable, income must exceed expenses. (Also, Comparative expense Analysis, which means comparing data from a few years back to current ones.)*
"Cost of staying in business: A consideration of a company's overall profitability is the cost of staying in business. Return on net worth shows how much profit a company generates on the money equity shareholders have invested. The return on net worth should at least be equal to the rate a business can borrow money from its creditors to achieve the cost of staying in business. A company that is showing a profit but has a low return on net worth still has profitability issues."
Measuring Profitability: Measuring profitability is the same as measuring the success of a business. Profitability ratios analyze the financial health of a business. A profitability ratio looks at how profit was earned in relation to sales, total assets and net worth.
(James Hunt, Chron, www.smallbusiness.chorn.com)*(QuickBooks, Intuit QuickBooks, www.quickbooks.intuit.com)
Sources:
https://www.entrepreneur.com/encyclopedia/pricing-a-product
https://www.inc.com/guides/price-your-products.html
https://www.investopedia.com/terms/e/equity.asp
http://smallbusiness.chron.com/determines-companys-profitability-16116.html
https://quickbooks.intuit.com/r/pricing-strategy/4-ways-to-measure-your-profitability/
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