Brendan Burgess
Founder
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This is very much a work in progress. Suggestions and corrections are very welcome. If anyone would like to post a "Money Makeover" question for limited company that would be very useful. In particular, links to relevante online resources would be welcome.
For simplicity, this thread assumes that the business is operating through a limited company. I may compile a version of it for sole traders later.
A lot of people are faced with the decision on whether to keep a loss-making business going or to shut it down. Most of the people I have spoken to who face this decision said that their accountants were of little use to them. They just prepare the accounts and do the tax returns. This article is to help you to decide if it’s worth keeping a struggling business going.
Analysing the true profitability of a business
The management accounts should show profits before directors’ salaries separately from profits after directors’ salaries.
Example 1
Turnover €900k
Gross margin: €400k
Staff salaries: €200k
Rent: €50k
Overheads: €100k
Profit before director’s salary: €50k
Director’s salary :€90k
Loss after director’s salary: €40k
If the company is making a profit before paying the directors a salary, then it could be an indication that the company is viable. If you close down Company 1, then the director will be losing a salary of €40k
The right strategy in the above company is to reduce the director’s salary to the profit generated by the company.
Many companies have been bankrupted by the directors taking salaries in excess of the profits of the company.
Is it a real profit?
Don’t leave it to your accountant to calculate the profit. Make sure you understand all the assumptions made. Profit is the net result of a series of estimates. Issues which can affect it significantly include depreciation, provisions for bad debts, valuation of stocks.
It is best to be conservative when estimating profits. If you are taking legal action against a debtor, then that debt should be written off. You can always write it back again if you get paid.
Profit versus cashflow
It can be difficult to understand why a profitable business has an ever increasing overdraft. Get your accountant to produce a cashflow statement for you.
If you are paying your creditors quickly but your debtors are slow to pay you, you may be profitable but your cashflow is suffering.
How profitable has the company been in the past?
If the company has been struggling during the economic boom, it’s unlikely to survive in the current depression.
Has competition increased or decreased?
In some cases, the market has changed dramatically with new technology or new entrants making the business less viable.
Can the business be restructured to make it viable?
Which parts of the business are profitable? Are all product lines profitable? If some result in a lot of management time and high capital requirements, then maybe they can be discontinued.
Are you stuck with a high level of overheads? Can they be reduced?
Can you move to a more suitable premises?
If you are stuck in your current premises, can you sub-let part of it?
Can you sell any surplus assets which you no longer need?
You can get a good basic tutorial on understanding financial statments [broken link removed]
For simplicity, this thread assumes that the business is operating through a limited company. I may compile a version of it for sole traders later.
A lot of people are faced with the decision on whether to keep a loss-making business going or to shut it down. Most of the people I have spoken to who face this decision said that their accountants were of little use to them. They just prepare the accounts and do the tax returns. This article is to help you to decide if it’s worth keeping a struggling business going.
Analysing the true profitability of a business
The management accounts should show profits before directors’ salaries separately from profits after directors’ salaries.
Example 1
Turnover €900k
Gross margin: €400k
Staff salaries: €200k
Rent: €50k
Overheads: €100k
Profit before director’s salary: €50k
Director’s salary :€90k
Loss after director’s salary: €40k
If the company is making a profit before paying the directors a salary, then it could be an indication that the company is viable. If you close down Company 1, then the director will be losing a salary of €40k
The right strategy in the above company is to reduce the director’s salary to the profit generated by the company.
Many companies have been bankrupted by the directors taking salaries in excess of the profits of the company.
Is it a real profit?
Don’t leave it to your accountant to calculate the profit. Make sure you understand all the assumptions made. Profit is the net result of a series of estimates. Issues which can affect it significantly include depreciation, provisions for bad debts, valuation of stocks.
It is best to be conservative when estimating profits. If you are taking legal action against a debtor, then that debt should be written off. You can always write it back again if you get paid.
Profit versus cashflow
It can be difficult to understand why a profitable business has an ever increasing overdraft. Get your accountant to produce a cashflow statement for you.
If you are paying your creditors quickly but your debtors are slow to pay you, you may be profitable but your cashflow is suffering.
How profitable has the company been in the past?
If the company has been struggling during the economic boom, it’s unlikely to survive in the current depression.
Has competition increased or decreased?
In some cases, the market has changed dramatically with new technology or new entrants making the business less viable.
Can the business be restructured to make it viable?
Which parts of the business are profitable? Are all product lines profitable? If some result in a lot of management time and high capital requirements, then maybe they can be discontinued.
Are you stuck with a high level of overheads? Can they be reduced?
Can you move to a more suitable premises?
If you are stuck in your current premises, can you sub-let part of it?
Can you sell any surplus assets which you no longer need?
You can get a good basic tutorial on understanding financial statments [broken link removed]