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Just because you have money in your bank account at the year-end doesn’t mean you are profitable. How to determine if your nursery really is profitable, how to calculate your margins and set the correct price, what you can do to increase profit, what expenses you should not cut in an attempt to increase profit (and why), the power of the 1% rule, process inefficiencies, understanding the numbers, and creating a profit bank account.

Not Focusing On Profits

A profit-focused setting will work out how much profit it intends to make on its income. Then make every effort to ensure this profit target hits the bank account.

Making a profit is the financial point of your Nursery – without it, all your deeper purpose of changing the lives of the children will not be possible unless you are profitable. Yet, in my experience, far too many childcare providers don’t really understand or focus on profit. And the accounting model of Income less Expenses = Profits does little to help matters.

In his book Profit First, Mike Michalowicz makes a compelling case for opening another bank account and transferring your profits before you make payments to anyone. So, if you’ve worked out that your net profit on every sale is 10%, then a safe way to see and secure those profits is to transfer it straight away to your “profit bank account”. That way you are forced to make do with the remaining 90%.

Margins

Margins are an important indicator to profitability, but it’s vastly ignored or misunderstood among most settings. Is your childcare making the level of profit margins you want? And how does that compare with the industry averages? The next time you get your accounts, take the direct labour costs and direct expenses (food) out from the revenue. Then divide that number by the revenue. That is your gross profit margin. Let’s say your revenue is £12,000 and direct labour or direct expenses are £8,000. The difference of £4000 divided by £12,000 revenue gives you a margin of 33%. This means that for every £1 of child income, you are making 33p in gross profit. This tells you how profitable you are at the gross margin level. You can also compare this 33% to the industry average to gauge where you are at. If this margin is so low, then you’re unlikely to be making net profit because there won’t be enough to cover your overheads.

Wrong Calculation of Price

Whether you charge per hour or per session, how do you determine this rate? And has that rate been profit tested? Let’s say you’re happy with the 33% margin above. If your hourly cost to serve a child is £10, then a common mistake I see apply 33% on the £10 to get £13.30. If you take your £10 costs from the £13.30 price you get £3.30. Now divide that by £13.30. You now get 25% margin. You’ve just lost 8% profit margin without even blinking.

And this mistake will make its way down to the net profit figure causing you to be less profitable year after year.

Price Increase Procrastination

Having realised that your hourly or session rate are low, or that the minimum wage and pension costs have gone up, another classic mistake is to put off price increases for fear of losing parents. Yes, you might lose some parents but let’s do some maths.

Let’s say you have 20 Children and your annual fee per child is 12,000. (£240,000 revenue) If you put prices up by 5%, your new revenue will £12,000. If you lose 5% of your parents (1 parent x 12,000 = £12,000), your revenue will drop to £228,000 but you now have one less child and less resources needed to service the remaining 19 children. And depending on how you approach the price increase and how you communicate it, you might be pleasantly surprised that no parents will leave. . Will they take their kids elsewhere due to 5% rise to cover increase pension and minimum wage cost?      

Cutting The Wrong Expenses

Ok, your setting needs to cut costs to make profits. Where should you start? Not all expenses will have a greater impact on your profits. A study by McKinsey and Co (global consulting firm) revealed that whilst a 1% reduction in fixed costs can have around 2% increase in profits, the same reduction in direct costs has a bigger 7% increase in profits. So instead of going for cost cutting at all cost (no pun intended here) conduct a cost benefit analysis and focus on direct costs first.

Ignoring the power of 1

Incidentally, the same studies also revealed that increasing pricing has a bigger influence over your profits than reducing costs or increasing sales volumes.

But here is what most nurseries do not consider doing: Assessing the power of a mere 1% increase in price, 1% increase in sales, 1% decrease in variable costs and 1% decrease in fixed costs. The impact can be huge.

Would you lose a lot of parents due to a mere 1% increase in fees? When was the last time you considered whether costs could be reduced by 1%?

Process Inefficiencies

Admin, planning and procedures take long in the childcare industry and they appear to be in the top 3 concerns for the sector. How efficient are your processes? Are you using the latest technologies? Have you carried out a review of the seven wastes (Transportation, Inventory, Motion, Waiting, Overproduction, Over-processing, and Defects – Google ‘MUDA’ for more on this) that exist in all businesses and considered how they apply in your setting?

Flying Blind

“When it comes to finances, nothing is more dangerous than flying blind”(Michael Hyatt) When it comes to profits, the biggest mistake is not knowing the profit numbers that matter in your nursery. Your gross profit margin, profit per staff, profit per child, net profit margin, breakeven number and your occupancy rate. If you currently speak to your accountant once a year only to be told how much tax to pay with no access to your key numbers, then it is unlikely you will be able to improve on your results.

The good news is that with so many online accounting apps on the market, (FreeAgent, QuickBooks and Xero), owners should no longer be flying blind in their settings.

Despite the 30-hour funding crisis and the various challenges you face as a Nursery owner (people, planning, regulations, paperwork and getting parents to pay on time) you remain optimistic and want to open up one or two more settings.

However, you don’t fancy the traditional route of bank finance.

Perhaps you need £50,000 to employ more people, pay the rent and invest in sales and marketing?

 This article looks at ways to expand your setting including 7 alternatives to a bank.

• Recruiting and Rewarding Staff

Parents want their children to be looked after by the best staff and they appreciate continuity of staff. As a nursery owner, you know the feeling at month end when your biggest cost gets paid out.

To avoid the temptation of allocating a fixed budget of your funding to fixed amount of hours worked irrespective of output, try introducing incentives that drive performance.

You can look at performance and tax efficient employee share option schemes.

Imagine a scheme where you’re able to retain senior staff for say 3 years, they get incentivise to drive performance and they get more money in their pocket. In addition, you get to reduce your monthly outgoings and PAYE bill. All of a sudden you will find that you don’t actually need to that  20k funding for staff.

This means you can keep the bank manager at bay and still expand your setting without losing too much cash up front.

There are a few tax efficient incentive plans and certain conditions to meet. Please do explore these with your accountant or tax advisers to guide you through the options.

• £10k Internal Funding. Avoid Cash Leakages

Very often the hidden cash within most setting is vastly ignored and the temptation is to seek for extra cash elsewhere.  Many settings struggle with cashflow due to a combination of lack of marketing, low profits and lack of fee collections.

For example did you know that if you make say 10% profit margin and a parent owes you £1,000 and never paid, you have actually lost a whopping £10,000? So in other words, you will need to get a fee of £10,000 to make back that £1,000 you lost (10% of £10,000 = £1,000)

And what this means is that if you don’t make that £10,000 in fees, then you’re having to borrow to fund that amount to keep you going. This is one leakage that need to be blocked so that you have less need for funding.

• Funding Options For the Property

For most settings, rent is the second biggest cost you incur in running your nursery. Just as you did with recruiting and rewarding staff, are there other ways to fund the property and rent? Perhaps low rent including subsided church building, local authority properties and empty premises might offer a good start to get the second setting up and running. Or if you have to pay market rent for a commercial property, could you leverage the building and get additional income streams by offering after school clubs, parties at the weekends, or using the space for clubs in the evenings?

And have you thought of a tax efficient way to acquire the commercial property personally and rent it to the Nursery? 

• Attractive Tax Breaks For Investors

If you run your setting through a limited company, another avenue to explore is to attract investors to fund the expansion of your next setting. Investors are always looking to reduce their risks and one way to do this is to offer them a tax efficient investment where they can reduce the amount they put in through tax backs.

Imagine persuading an investors to invest £100,000 but then they get £50,000 income tax relief back (provided they’ve paid that amount of tax already). So they only have £50,000 of their money at risk. Let’s assume things don’t go well with their investment and they are a higher rate (45%) tax payer. They can claim an income tax loss on the remaining £50,000 (£50,000 x 45% = £22,500). So out of their original £100,000 they now have a total of £72,500 back (the original £50,000 + the subsequent £22,500). This represents a massive 72.5% tax relief.

Many investors would not mind investing, would they?  

There are a few tax efficient investment options. Please do take advice before proceeding.

• Alternatives To A Bank

Apart from the bank of friends and family and personal funding, here are 7 alternatives to a bank

• Business Angels
• Crowdfunding
• Grants and government-backed loans
• Kickstarter funding
• Incubators and accelerators
• Venture capital
• Peer to peer lending

• Franchising or Licensing

Rather than go it all alone, franchising or granting another person a licence to use your Nursery’s name and systems can provide a quicker and less capital intensive route to expand your setting.

This is where someone else provides the funding needed to open another branch in your name. They pay you an initial amount for training and on-going fee based on income. The duration could be 3-5 years after which you both review to see whether the relationship is worth carrying on.

If you go down the franchise route, always advisable to seek advice and test the market first with what is called a Pilot Franchisee.

You will need to invest some time or money into getting your systems right but this will always benefit your Nursery even if you don’t end up using this route of funding.

• Collaborating With or Acquiring Your Competitors

Have you thought about collaborating with or simply acquiring your competitors? I mentioned the 30-hour funding crisis at the start of this article because according to a recent survey, about 49% of Nurseries do not make a profit and more nurseries are closing their doors partly due to the 30-hour funding. Instead of starting another setting from scratch, would it make sense to talk to some of your competitors to see if you can either collaborate or help them out by taking over their setting? This way you avoid the long haul. Plus you don’t need large sums of money to buy another Nursery. You will be surprised what deals you can make. Very often and depending on the motive of the vendor, you may be able to simply release them from stress and provide some form of continuity for the children without putting a lot of money down. You can then look at areas to improve the setting and use the current fees to fund working capital.

But please do proceed carefully with this and involve your professional advisers to ensure you minimise your risks.  

How to reward achievement in a way that is tax efficient for you and doesn’t burden the staff member

At a recent nursery event and speaking with a dozen of nursery owners, it was very clear that recruitment, rewarding and retaining staff is the number one concern for childcare businesses. According to Gallup’s research, only one in three workers strongly agree that they received recognition for doing good work. Further, employees who do not feel adequately recognized are twice as likely to say they’ll quit in the next year.

So what if the tax rules allow you to reward achievement in a way that is tax-efficient for the business and doesn’t burden the staff member?

Here are some ideas to consider and discuss with your tax adviser.

• £12,000 Tax Free Incentives To Join

You want to attract the best to come and work for you. You’ve considered offering an initial financial incentive to achieve this. However, a payment to induce someone to take up employment with you will count as salary payment with tax implications for you and the employee. But what if the payment you make to the employee is deemed as a compensation for the loss of some right they had which is not connected with you? Here’s what HMRC has published (ref EIM00710) “a lump sum paid to an employee on becoming a director/employee of the company he worked for was held to be compensation for the transfer to the company of the valuable business connections he had built up for himself. It was not taxable as earnings”

Although the payment won’t be taxed as salary, it will be taxed as capital gains tax. And because everyone is allowed £12,000 tax free allowance, the staff member receiving upto this amount will not be burdened by tax.

• £8,000 Tax Free Expenses

If you take on an employee who lives more than a reasonable commuting distance from the nursery and they move closer work, did you know you can pay them up to £8,000 tax free amount to cover relocating expenses like moving costs, stamp duty, legal fees and new furnishings?

This recognition may well set the tone for the new relationship and there is no tax or national insurance to pay. Plus the business gets to deduct this expenses against its income.

• £5,000 Tax Free Award?

You want to recognise a staff member for their outstanding contribution to your business and for going beyond their call of duty.

Did you know you can pay your staff tax free income for suggestions that benefit your business? Yes you can and actually there are two kinds of awards:

• encouragement awards – for good suggestions, or to reward your employees for special effort
• financial benefit awards – for suggestions that will save or make your business money

Encouragement awards are tax free up to £25. But financial benefit awards are exempt up to £5,000. That’s right £5,000.

But before you go ahead and pay the staff member, please note that as will all tax reliefs and tax exemptions, there are conditions to meet. Refer to HMRC reference EIM06600.

• Tax Efficient Vouchers

If you give your employees cash vouchers, the amounts would need to be put through the payroll and subject to tax and National Insurance. However non-cash vouchers up to £50 may be exempt under the trivial benefit rules. Where the voucher exceeds £50, you will need to report these on a P11D form to HMRC.

• Tax Free Gratuitous Payments

Normally payments made to staff for their outstanding services would count as salaries unless specific exemptions apply. Once such exemption is a genuinely gratuitous payment that the employee was not expecting and had no right to receive. And a payment made merely to recognise their generous nature. There must not be a regular pattern to these payments and do check with your accountant before proceeding.   

• Tax Free Gifts To Employees

Gifts you give to your employees are normally exempt from tax and NI. However this exemption only applies if the gift is deemed to be trivial. For a gift to be considered a trivial benefit, it must cost £50 or less, and not be part of the employees’ contract or a reward for performance. It must also not be a cash reward as HMRC will tax this as earnings (payroll tax). So classic gifts including a bottle of wine or box of chocolates would be exempt from tax.

• Tax Efficient Share Schemes 

Employees want to feel valued and part of the business. According to Gallup and the Harvard Business Review, employees want to work towards a purpose driven common goal. So if you want to follow the success of John Lewis in creating the ownership mentality, then there are tax efficient ways of doing this. They are called Approved Share Option Schemes and something to discuss with your accountants.

• Tax Free Medical Cost

Where an employer pays for the cost of staff medical insurance, the staff member will be taxed on the value of the insurance as benefits in kind. However there is a specific exemption that allows the employer to pay for employees to have private medical check-ups without any tax implications on the employee. So this could be health screening assessments, medical check-ups or eye tests.

• Up to £1,000 Long Service Award

Let’s say you have an employee who has worked for you for a very long time. And it’s time to move on. Did you know you can give them a non-cash award of upto £1,000 if certain conditions apply? Think about the goodwill this will create among existing staff members. Search HMRC’s site for long service award for more details.

• Tax-Free Holiday (Business Trips With Perks)

If you or your employee decides to look for business opportunity or take your laptop with you while on holiday, no element of this holiday costs can be claimed. However where the purpose of the trip is for business with perks including sauna, round of golf, free dinner and the likes, there will be no tax implications for you or the staff member.

And Finally….Just Say Thank You and Mean It From Your Heart

Staff recognition and reward isn’t one size fit all. Besides money or incentives are not the only form of recognition. Why not try a simple, sincere and meaningful THANK YOU.