How Bookkeeping Makes Your Small Business More Profitable: Knowing your Expenses

Keeping your Small Business books in good order is something that we’ve hammered home to our readers over the last year - but there’s more to good business than just keeping your books up to date, in fact, that’s only the beginning! 

Good bookkeeping is the gateway to making your business go from good to amazing and it will allow you to turn small successes into huge gains.

So.... What is profitability?

Well it’s not just your top line that is important. That is to say, profitability is not measured only by your INCOME, it’s more than that.

Profit is an absolute number that is calculated by subtracting the total expenses from the total income.

So your profit margin is a solid number, while your profitability is a relative one. If this sounds more like math theory than business practice, don’t worry, stick with us and we'll explain...  

In the most simple sense, profitability is a metric that a company will use to determine how well they use resources to generate revenue in excess of their expenses. You can also look at it as a business’s ability to produce a return on a given investment.

An example of profitability in a real life setting would be knowing the profitability of your advertising - you know that if you spend X amount of money on advertisements in a given month, it will result in about Y amount of increased income.

Knowing your Expenses

Make sense?  Okay now for the fun part.... How YOU can use your books to build a more profitable Small Business.

This discussion starts not with what your income is, but actually with your expenses.

We all know the old addage... It takes money to make money.

And to a certain extent it is true....  If you want to make money, you have to spend some. But you want to make absolutely sure that the money you are spending is providing value.

Here’s where bookkeeping becomes extremely valuable to you as a business owner - but FIRST, you need to have all of your financial transactions recorded and categorized to understand them. If you don’t know how much money is being spent and what you’re spending it on, you can’t tell what your profit is!  And you can't improve your numbers.

The first step towards maximizing your profitability starts with understanding your expenses. If your bookkeeping is current, you can start right away by printing out an income statement and gathering your bank statements for all of your business accounts.

Trim the Fat

Once you have all of the above statements AND your books are current, it’s time to grab your Small Business Scalpel and start making some sharp decisions.

Start going through your expenses line by line. Yes, that does seem a bit excessive but stay with me! If you’re doing your own bookkeeping, you know that each expense is going to be categorized already, so you should have a decent idea of what you’re already looking at.

Now we’re going to do a slightly different sort of categorization - you’re going to go through each expense on your bank statement and decide whether or not it is necessary meaning directly contributing to profit, unnecessary or replaceable. You should also make a note of any recurring expenses.

Some expenses won't be quite as easily labeled as others. There are some expenses that are very much necessary that can still be trimmed down! Utility costs are a great example of this: you will always be required to pay for power, water, internet and the like, but you may be able to save money by implementing energy efficient policies or negotiating with your vendors.

Once you’ve broadly categorized these expenses it's time to do a little bit of thinking. You can easily cut out any expense that you've labeled as unnecessary, but like the above example of utility costs, you'll have to spend some time analyzing your recurring and replaceable expenses. You can also calculate your monthly expenses, operating expenses, and your labor costs. With these numbers at your disposal you'll be much more empowered when it comes time to make decisions and plot the course for your small business.

Lean, Mean, Money-Making Machine

So once you've been through all of your expenses and know what the absolute minimum monthly costs are to running your business... you can start planning.

Whether your plan is to reduce your debt or change your sales methods, you have all the baseline information you need to build from!

You can now remove unnecessary expenses from your budget and replace costly methods with those that better suit your needs and your budget. If you've decided to change some things around the workplace in response to reviewing your expenses, you should start implementing those plans.  Get your team onboard.  Make a game out of it.  The more you can save, the more you'll have to share with your team.  

Most importantly, you can make truly informed decisions about your business spending and continue your journey of building a more profitable business.

We Hope to See You Next Time!

Next time we’ll continue our series on Small Business Profitability with some great information on knowing your income numbers and what you can do with that knowledge to make your business even more successful.

Disclaimer This article presents general information and is not intended to be tax or legal advice.  Refer to IRS publications and discuss possible tax deductions with your tax preparer.