What each figure tells you about performance

The table sets out what a movement in each measure signals, before you go looking for the cause.

1. Revenue rising while profit falls means the business is selling more at a worse margin, because it has discounted to win those extra sales or each sale now costs more to supply.
2. Gross profit and gross profit margin test the product itself, before rent, wages and marketing are paid, so a fall means either it costs more to make or the price charged has dropped.
3. Net profit and net profit margin test the whole business once overheads are paid, so a healthy gross margin sitting above a weak net margin places the problem in running costs rather than in the product.
4. Cash-flow figures answer a different question, whether the business can pay its bills as they fall due, and a profitable business can still run dry while it waits for customers to pay.

Why one figure means nothing on its own

1. A figure becomes performance only when it is set beside something else, and three comparisons do that work.
   1. Against last year: this gives the direction of travel, which tells you more than the level does.
   2. Against a rival or the industry average: this shows whether a 4% net margin is weak or normal for the trade, since Aldi and Lidl work on far thinner margins than a jeweller does.
   3. Against the forecast or target: this shows whether the plan the owner set, and may have borrowed against, is being met.
2. Two shops both made £40,000 net profit this year, but one made £20,000 last year and the other made £80,000, so the identical figure hides a doubling in one and a halving in the other.

Worked interpretation: a gross margin falling while the net margin holds

1. A business had a gross profit margin of 40% last year and 34% this year, while its net profit margin stayed at 12% in both years.
2. The gross margin lost six percentage points, so either the cost of making each item rose, through dearer ingredients, materials or wages in production, or the price charged was cut to keep sales moving.
3. Net profit is what survives of gross profit once overheads are paid, so a net margin holding at 12% while the gross margin fell six points means overheads must have been cut by roughly six pence in every pound of revenue.
4. The owner has paid for a weaker product margin with a cut in running costs, which is a one-off rescue rather than a recovery, so three questions come before any decision.
   1. Why the gross margin fell: a supplier price rise is imposed on the business, while a deliberate discount is a choice that can be reversed.
   2. Which overheads were cut: cutting marketing or staff hours protects this year's net margin and can shrink next year's sales, so the same trick will not work twice.
   3. Whether revenue grew: 34% of a much larger revenue can be more pounds of gross profit than 40% of a smaller one, so the percentage on its own does not settle whether the year was good.

What the figures do not tell you

1. Financial information is backward looking, because it describes the year that has ended while the business is judged on the year that is starting.
2. The accounts are also silent on three things that will shape next year's figures.
   1. Staff morale: high labour turnover, weak training and a demotivated team reach the accounts a year late, through slower service and lost custom.
   2. Customer satisfaction: complaints, reviews and repeat custom predict revenue in a way that this year's revenue figure cannot.
   3. The market and rivals: a competitor opening nearby or a shift in what shoppers want can undo a strong year, as Wilko found when it entered administration in August 2023 after trading since 1930.