Predicting Net Income with Confidence

For the most part no one likes surprises; unless it’s your birthday! Same goes for a business owner who thought they had a good month, then see the profit & loss statement, and “surprise,” you’re in the red! OUCH! You can minimize surprises and predict, with a level of confidence, your bottom line if you take the time to analyze and understand two important predictors in your business.

Predictor # 1 – Consistent Gross Profit as a Percentage of Sales:

For most businesses there is a pricing, or quoting system, that determines selling price based on the cost to provide a product, or service, along with a targeted gross profit dollars or percentage. Examples are retailers using markups, or service firms using overhead multipliers. The idea is to consistently price your products and services so they produce a predictable gross profit percentage. Looking at the Sample Profit & Loss below you can easily see how various levels of Sales yield predictable gross profit dollars , and provide the gross profit percentage remains around 40% ($1,000 = $400, $1,200 = $480 etc.).

Predictor # 2 – Consistent Fixed Costs per Month:

This predictor is expected provided the accounting folks follow a system. Most businesses have recurring monthly expenses (rents, utilities, phone etc.) along with supplies, and other operating expenses. Have your accounting staff create a checklist to insure all expenses are recorded for a given month. In the Sample below, fixed costs average $400 per month so each month an owner, provided there are no unexpected payments, can compare actuals to an average and determine differences.

Results – Predictable Net Income for a Given Level of Sales:

When your gross profit percentage and fixed costs are predictable you have the ability to forecast your net income based on your level of sales. The Sample Company below shows at $1,000 in sales they essentially breakeven with -0- net income. They can predict sales levels above $1,000 will result in positive net income while below $1,000 will result in losses. Management can now focus on improving sales, improving gross profit percentages, or reducing fixed costs to improve bottom line results.

Sample – Profit & Loss
$000s Jan Feb Mar Apr Predictors
Sales $1,000 $1,200 $950 $1,050 <–Levels of Sales
Labor @ 60% 600 720 570 630 <–Variable Costs
Gross Profit 400 480 380 420
40% 40% 40% 40% 40% <–Key Predictor #1: GP as % of Sales is consistent
Fixed Costs:
Rent & Utilities 100 100 100 100
Salaries-Admin 225 225 225 225
Supplies 75 75 75 75
Total Fixed Costs 400 400 400 400 <– Key Predictor #2: Fixed $$ Costs per Month
Net Income (loss) $0 $80 ($20) $20 <– Predictable Net Income for a given level of Sales

It’s not difficult to predict net income provided you understand your pricing and manage your fixed costs. Leave surprises for your birthday and manage your bottom line with confidence!

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Todd Rammler

Todd Rammler is the President and founder of Michigan CFO Associates.  Todd is a Certified Management Accountant (CMA), and holds an MS in Accounting from Walsh College (cum laude), and a BBA in Finance from Western Michigan University.

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