Skip to main content

Edition 512 – Wrong Numbers

Written by Dean Robinson.

In some ways, I see the share prices on some publicly listed companies as a form of gambling. Why? How else can you explain the exorbitant share price that some companies command, when they’re either in a perpetual loss situation, or don’t really have much to back them asset wise. A classic example to me is Tesla – I could never understand the share price being so high when, for years, the company fell short of production targets, and didn’t turn a profit. Perhaps I’m a simpleton!

I’m pointing this out as recently, I had a conversation with a family business client who is playing around with a future budget for their business, and is using percentages, rather than actual numbers, to endeavour to drive a profit outcome.

If your Fixed Costs (or Overheads) currently represent 30% of your total revenue, and perhaps have done so for a while, that may change for any number of reasons moving forward. Yet, to be wedded to a percentage formula, rather than an overall number, can mask what is happening inside a business from a financial perspective. For instance:

  1. You may move to new premises, which could increase, or decrease your occupation costs.
  2. You may take on a large new project, that requires additional administration support, or new IT.
  3. To attract the right staff moving forward, you may need to offer salary packages that include luxury motor vehicles, with the associated costs of that, including Fringe Benefits Tax.

If I budget a revenue increase from $3m to $4m, and I want to keep my Fixed Costs at 30%, that means I’m prepared to budget for a $300K increase in my fixed cost structure and, in essence, I have that much “room to move” on those elements in my business. But, what happens if you can increase revenue, without increasing fixed costs? Do you mindlessly budget for the $300K fixed cost increase and, in essence, give your management team carte-blanche to incur additional costs, even though the business doesn’t necessarily need to?

Similarly, to generate that leap in revenue, you might need to increase your fixed costs by $500K, because it involves a strategic re-pivot of the business. If you stick to your 30% fixed cost mentality, does that limit the potential for your business to increase its revenue by $1m, simply because you can only make a $300K fixed cost additional investment, and not $500K? If so, is that additional fixed cost investment enough to generate that leap in revenue? Or, will you fall short, as you might need to “spend now” to generate a higher profit two, three or four years down the track.

Beware of relying on simple percentages, or numbers, to drive a business’ financial strategy. The budget is a detailed process that involves a whole series of factors that are different from business to business. However, for every business, they should be focussed on:
Setting a profit target.

  1. Setting a profit target.
  2. Knowing what percentage gross profit your various revenue line items generate.
  3. The number of employees you need (in terms of “production”, management and administration) to generate that revenue.
  4. The fixed costs your business needs to incur, to generate that revenue, and employ all those individuals, in the location you are based.

Yes, there’s a bit more to it than that. However, they’re the basics, and you need to know each of those in hard dollar terms, not in percentage terms. At the end of the day, its dollars in and out of the bank account, that will be a contributing factor to the success of your business, not percentages on a spreadsheet

This Week’s Tip

“By the third year of preparing an in-depth Family Business Budget, most businesses have their cost structure down pat, to the point it’s then all about how you drive additional profit, or other benefits from the business, by tweaking your revenue targets.”