Do you want to take control of the Profit from your business?
In Part 1 of this blog post which you can find here, I explained how there were Six Key Variables which generate your business’s profit and if you turn the Profit and Loss Account on its head, you can begin to control the level of profit that your business generates and understand the Profit Formula.
In this Part 2, I want to give you more specific information about how you can do this.
So what do we do now?
Understand your Gross Margin
Well, firstly as you know your gross margin, you know what level of addtional sales you need to cover each of these variables – its a single figure. If you reverse Engineer this you can calculate your Sales Gap to identify how much more sales you need to achieve to reach your target level of Profitability.
Of course, additional sales will increase your salary costs (if productivity remains the same) and your variable and tax costs. It is not a zero sum game.
So now turn your attention to your Labour Costs. I am not advocating widespread redundancies – you do need to invest in your people to grow your businesss. There are two ways to improve this area; directly reduce costs or improve productivity.
However you should certainly review your entire employee base to see whether you are over staffed in some areas. However, I would also propose you take a more intelligent and proactive approach.
For staff who are client facing, directly billable or who can have a direct impact on the revenues of the business, greater productivity can lead to higher sales so you should be looking closely at how this can be achieved.
For back office staff, improvement can come through process improvements to enable them to achieve more or the same in a shorter amount of time. It amounts to the same thing. Of course this may need investement in training or technology but this would be a strategic outcome of this process and the investment would lead to a long term improvement in the business.
These are more difficult to change in the short term but you should certainly be looking carefully to see where you can make changes over the medium term to improve things in the long term. Take these on an item by item basis and challenge yourself to find ways to reduce these costs without having a negative impact on the business
This is the area which is probably where there is the most to gain. I would strongly advocate a complete review of all your suppliers and internal policies to make sure that you are getting the best value for money.
Renegotiate better terms with existing suppliers. When contracts come up for renewal make sure that someone in your organisation (possibly you) shops around to make sure you get the best deal. Some of the biggest and easiest savings are to be found in your utilities bills.
Ensure that all the bills you pay from your suppliers are correct. You will be amazed how many have errors in them.
Look carefully at all your allowances and expenses to make sure that you have as tight a control over these.
A major area is Marketing. Of course this is an area which requires investment but you need to make sure that you are getting a measurable return on your investment. Don’t keep running advertisements or going to exhibitions simply because this was what you did last year. Make sure that this line of expense is earning you multiples of its cost in new sales.
The basis on which your business is funded must contribute to the sustainable level of Profit. Too much debt and the interest costs will draw financial resources out of your business and reduce your ability to use this money to grow the business.
If you can grow your business without debt then you can devote all your financial resources to growth. After making sure you can pay your taxes (he waits for no man) building the financial strength of your business so that not only are you debt free but you have an element of cash reserve in your balance sheet should be a primary medium term goal.
You make think that this is one area over which you have no control but this is not the case. The Taxman taketh away but he also gives. Your accountant or specialist tax adviser should be making sure that you are taking advantage of all the allowances to which your business is entitled and these will offset and reduce the tax you have to pay.
Many businesses do not do this – the tax codes in most countries are incredibly complex and difficult to understand. By all means pay Ceasar his coin, but do not pay him more than you are legally expected to.
A final word on Sales – Prices
One of the ways to improve your profitability of course is to increase your prices. In the current highly competitive economic environment this may appear to be easier said than done.
Review all your products and services and work out their true gross margin? Is there a disparity. In the Six Simple Strategic Steps Framwork, this is part of the Business Appreciation phase. When matched with an analysis of Sales you will soon identify which parts of your business are the most profitable and which lag in this regard.
Have a close look at what your Competitors are charging?
However a strategic appraisal of your pricing strategy may identify areas where your customers are going to be relatively insensitive to a change in prices.
You may be able to start charging (new customers at least) for services you currently provide for free.
Can you provide additional value added products or service which will have a relatively low marginal additional cost for you but high perceived value for your customers?
The Profit Formula – Putting it all together
Now that we have completed our analysis you can see how you can start to strategically design your business to be sustainably profitable.
Profit after Tax =
- Financing Costs
- Variable Costs
- Fixed Costs
- Labour Costs
= Gross Margin
6. Cost of Sales
You now have the Six Building Blocks to designing a profitable business. What are you waiting for?