A business might be busy with orders, have loyal customers, and high sales, yet still not make much profit. This can be confusing for owners who work hard to bring in more money but don’t see much left over at the end of the month. The issue usually isn’t a lack of customers. Instead, things like pricing, the cost of running the business, how much profit is made on each product, how much it costs to serve customers, and how cash is managed can silently eat up the money earned from sales.
The growth of the Small Business Marketing Software Market mirrors the increase in the use of Web-based technologies for customer acquisition, relations management, and the enhancement of sales activity. Increased sales and increased technology do not equate to increased profit. The nature of the revenue generated by a small business-what happens to it following a transaction-may even be more critical than increasing revenue.
Look Beyond the Sales Figure
You should first tell a revenue figure apart from profit. Revenue is the proceeds a company creates through the business of selling products or services, while profit is the income left after related expenses are subtracted. For instance, the owner of a firm could pull in 400,000 of sales annually but still have just a modest profit margin because of considerable associated costs.
A business might, for example, have $400,000 in revenue with $250,000 in cost of goods and $130,000 in wages, building lease, technology, and other overhead-leaving only $20,000 before other relevant costs and adjustments are made.
While sales may seem impressive, the business only has a 5 percent profit margin-meaning business owners should try to not rely solely on revenue for success in their company, since it may mask declining margins.
Find Out Which Products and Services Are Profitable
Not all that is sold makes money. One line of products may have huge sales volume, but very little remaining after materials, distribution, labor costs, etc are accounted for. A different product may have moderate sales volume but a very solid contribution.
The same may occur in service businesses.
While an apparently highly profitable job might have looked like a 2,000 income, meeting extensive revisions, research, and sub-contractors required may make that proposition not very attractive at all. An analysis by product line or service will allow you to determine whether one item or service really is that profitable. Subtract from the selling price the directly involved costs. For example, this could range from raw materials, wholesale purchases, direct labor, packaging, shipping and payment, sales commissions, and the rest.
This will identify where your money is being made and where there appears to be huge sales but low profit.
Revisit Pricing Before Chasing More Customers
One of the first areas worth looking at if sales are high but profits are disappointing is the area of pricing.
Costs don’t stay still – prices for raw materials might increase, and wage bills can grow too as other cost prices (e.g. Transport, insurance, packaging, utilities) rise over time. If customer prices remain static for years, this makes your margins disappear incrementally.
Therefore, any pricing review should be based upon current costs, not upon what the costs might have been expected to be years ago.
It’s not that all product prices need increasing. Some prices may well be appropriate, and the issue will be overheads or inefficiency. However, a business needs to be aware of the absolute minimum profit required from any individual product or service and currently achieve that through its pricing.
In a well-performing business, it can take only a relatively small price increase to dramatically improve profits compared to an increase in the overall level of business.
Examine the True Cost of Discounts
Discounts increase sales volume, but reduce the returns gained from each sale.
Suppose the selling price of one item is 100 and the cost of that item is 60. The gross profit made per item before all overheads is 40. If the company offers a 10% discount, it will be selling the item for 90 and making only 30 profit on it.
The company therefore must look at new additional volume to overcome this difference.
Discounting will not automatically lead to the company making less profit- it could enable a company to sell off old stock, acquire new customers, or boost order size. The most essential consideration is that a promotion must be judged on the profit produced rather than on the quantity of units sold.
Companies must examine revenue, direct costs, fulfillment requirements, and marketing expenses for any campaign. If more work provides little extra profit, then a company is undertaking activity but not creating value.
Identify Costs That Are Slowly Eating Into Profit
Big ticket items get more attention due to their obviousness. The smaller recurring expenses are often where things get left unaddressed. A company might be paying for various software applications, dormant services, surplus storage, redundancy within their IT infrastructure, or professional help they no longer need.
None of it is a huge sum, but when added together, the numbers start to add up and affect profits considerably.
Conduct reviews of recurring expenses at the end of every quarter or at year-end. Question if the cost is still worthwhile for the services rendered. There’s no mandate to reduce your outlays, in general. A critical investment might be in a necessary system, and removing it will likely do the opposite of the desired financial gain.
Just aim to identify and eliminate expenditure that’s become redundant, inadequate, or excessive.
Understand What Customers Really Cost to Serve
Same Money, Different Profit: Two customers could bring exactly the same money, but very different profit. One may be a simple order-taker who pays quickly and never needs any attention. Another may require hours of communication, tailor-made jobs, urgent turnarounds, several rounds of revisions, or significant post-sales support.
Examining the profitability of a customer can quickly show you differences like these.
You might not wish to stop serving costly-to-support customers. However, by examining the true cost of providing that customer with services, a business might identify opportunities to streamline services, improve client management processes, or negotiate different terms.
Make Sure Growth Is Not Creating Financial Pressure
More sales can mean more costs. A business experiencing growth might require more staff, stock, equipment, storage space, or delivery facilities. A growing business also might require more working capital if working to supply goods on credit, where staff must be paid before the customer settles the bill.
Rapid growth can sometimes mean a business experiences cash-flow problems – even when profitable on paper at the start.
Do your homework: if you are to increase sales by 20%, what kind of increase – 5% or 30%? – will staffing costs have? Will your stock requirements increase drastically, and will you experience lengthy payment times with customers, and when do you pay staff and a supplier? Such questions help answer whether the business is likely to improve and achieve a profit result or just the business to become busier.
Use Break-Even Analysis to Find the Pressure Point
Break-even analysis is an easy way to link sales volume and costs. It is calculated using the formula: Break-even sales volume = fixed costs contribution per sale. Contribution per sale is the selling price less the variable costs of the individual transaction. If monthly fixed costs are 12,000 and the business earns a contribution of 30 from each transaction, a total of 400 sales are needed per month to break even.
If, for example, it is making a turnover of 500 sales and making hardly any profit, simply selling more may not be the solution.
In this case, it is necessary to improve the contribution made by each transaction. This can be done through price changes, reduced direct costs, or a greater emphasis on higher-margin products and services.
Keep an Eye on Cash Flow as Well as Profit
Profit and cash flow are not the same metrics.
A company might make a profitable sale today, but not get paid for it for 60 days. But it may still have salary and supplier payments to make, not to mention rent and operating costs.
Inventory is one mechanism which may cause the same problem for a company – the money spent on products awaiting sale in a warehouse is not accessible for other needs.
The U.S. Small Business Administration has pointed out the lag between incoming and outgoing cash flows, recommending cash-flow projections to help businesses spot cash deficits. (sba.gov)
Companies are also advised to track unpaid bills, company payments to suppliers, company commitments regarding merchandise, tax accounts, and forecasted account balances, in parallel to tracking profit.
Focus on a Few Financial Measures
Entrepreneurs don’t have to spend years developing sophisticated metrics to evaluate business performance. A simple analysis, reviewing gross and operating margins and profits as well as expenses, combined with a snapshot of your revenue throughout the month, will show the profit picture. For specific business models, consider a review of things such as average order value and contribution per sale, and an examination of operating expenses, as well as looking at your inventory turnover and aged receivables.
The key element here is stability in the metrics over time to detect subtle shifts in margins.
The SBA believes reviewing these types of figures, including working capital turnover and cash flow, will guide business owners to better decisions (legacy.sba.gov). Financial information is of no value unless used to do better business instead of simply more paperwork.
Improve Efficiency Instead of Cutting Blindly
Weak profits often lead people to look at cutting costs. However,r costs cut without being understood can generate even bigger problems.
Start by looking at how work is actually done. There might be a great amount of wasted time on inputting into various systems; dealing with queries they should not receive or carrying out many administrative functions duplicated time.
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