There probably isn’t a day that goes by without us reading about the cost of living crisis and record high inflation. But what does this mean for businesses?
There is no doubt that we are continuing to see higher prices of goods, including the very sharp rises in motor fuel. For the cost of electricity and gas, unlike for consumers, there is no energy cap protection offered to businesses and therefore these costs will be driven by the market. Many of the pressures on prices are coming from factors outside of the control of business owners and therefore it is difficult for some to adapt and absorb these increases.
We are also living in a time where there is a shortage of workers. This is forcing employers to offer higher pay to get the right candidates as well as raising the wages of their existing workers as they are impacted by their own increased cost of living.
Although no business enjoys increasing their prices, all these factors have inevitably led to businesses looking very carefully at their own costs and in many cases having no choice but to pass on some of these raises to their customers.
The Bank of England are predicting the rate of inflation will continue to increase reaching 13% later this year before slowing down during 2023. Some other commentators are forecasting inflation to peak at as much as 18%. It’s therefore particularly important that businesses understand the costs they are incurring and how these are reflected in their prices now and in the coming months.
One important measure for businesses is the gross profit percentage. Although the costs which make up this will be different for every business, in basic terms it is the difference between the costs of buying and/or manufacturing the goods or services sold and the price paid by the customer. For example, if the costs are £50 and the sales price is £75, the gross profit percentage is 33%. When calculating this, VAT should be excluded from both the costs and sales price. It is important that businesses can calculate this percentage on a regular basis, so they ensure the sales price is set correctly and they concentrate on the goods and services which give the best return. Don’t forget that where there is a people cost in manufacturing goods or providing services, it is vital that these costs, including employers’ national insurance and pension costs, are included in this calculation.
This gross profit will contribute to the fixed overheads of the business and provide profit for business owners, as well as generating funds to be re-invested into the business.
All businesses will also have an element of fixed costs which will include items such as rent, electricity, salaries, and other expenses. Having a clear understanding of these costs, both now and what they might be in the future, is important so the level of gross profit which needs to be achieved is known.
Understanding the gross profit, outgoings and predicted sales will enable the business owner to have a profit forecast which is usually drawn up monthly and projecting at least the next twelve months. Keeping this up to date as costs change is important so any sales price adjustments can be made quickly to react to increases in costs and/or changes in sales. Although profit is important, cash continues to be king. Once the projected profit forecast is available, this can be turned into a cash flow forecast which will incorporate the difference in timing between purchases/sales and payment/receipts, as well as factoring in outgoings such as repayment of loans.
With any forecast I would recommend having different versions of the same forecast which ask the question ‘what if?’. These would include taking account of such things as increases in costs, changes in sales levels and receipt of cash from sales.
Understanding the costs of your business and having these robust profit and cash forecasts will enable you to react quickly to changes and plan for the future at a time when change is the only certainty.