Your business is a machine, and profit is the fuel that keeps it running. Profit is vital to business success, particularly Gross Profit – which represents the true income that the business is able to generate.
However, it’s easy to lose focus on increasing profit: for example, do you find yourself focusing on increasing sales, more than increasing profit?
Do you feel that you are flying around working all the hours you can but not moving forward very quickly? How often do you find that you are working for your business rather than your business working for you?
An Idea to improve your business this week.
Instead of focusing on maximising your sales, how about focusing on maximising your Gross Profit?
What is Your Gross Profit?
Gross Profit = True Income
If you use an accounting solution such as Sage One it is really easy to find it or just look at your most recent Profit & Loss account. If not you can work it out as follows:
Gross Profit = Sales minus Cost of Sales (the costs that directly relate to making a sale)
Gross Profit margin or Gross Profit % = Gross profit divided by Sales multiplied by 100
This simply shows the percentage of Gross Profit you make in each sale.
How do you improve your Gross Profit this week?
1. Ruthlessly monitor and control cost of sales.
Identify your cost of sales or direct costs. These are the costs that vary according to how much business you are doing. They are typically:
– Purchase of stock/inventory
– Production costs of turning the raw material into a product or service
– Direct labour such as hourly paid labour that fluctuates depending on your level of activity. (Salaries that are the same every month are overheads; ignore these for now.)
– Delivery costs to get your product/service to your customer.
Increase profit by lowering overall costs in these areas:
How can you buy raw materials cheaper?
If you have direct labour are you utilising the labour as efficiently as possible?
If you have delivery costs how can you create the most efficient route to save on time and fuel?
In this area of your business every penny/cent counts because every improvement is compounded each and every time you make a sale.
2. Don’t discount!
People who are new to business often assume that the best way to raise profits is to reduce prices or offer discounts whenever possible. This makes logical sense, after all, and sometimes it works.
But in reality, the opposite is just as often true: increasing your prices can generate more customers. It all depends on the type of customer you are appealing to and the type of product or service you are offering (more on this in the next section).
That said, here are a few important questions to consider. How many times have you given a 10% discount to a customer without being asked? How many times have you created a special offer to drive sales by reducing prices?
And how have these initiatives worked out, have they revolutionised your business?
Probably not. Look at the actual impact of these discounts on your business.
Imagine your business has a Gross Profit Margin of 30%. You discount your prices by 10%. This discount would have to raise your sales by 50% just to maintain the total gross profit you had before the discount.
So in reality, by giving a 10% discount you have to work 50% harder just to maintain your income.
In short, experiment to find what works for you, but don’t assume that discounts will improve profit.
If you are working harder shouldn’t you be increasing your income?
The table below shows crazy impact of discounting
3. Experiment with raised pricing
Imagine again your business has a 30% Gross profit Margin.
You raised your prices by 5%
You would have to lose 14% of your sales before your Gross profit (your true income) would be affected.
Think about the following questions:
1 – How likely is it that you would lose a full 14% of your business after a 5% price increase?
If you did lose some business because of the price increase:
2 – How likely is it that the lost business comes from your least profitable customers?
This loss could actually be a gain because not only do you get rid of potentially unprofitable business but those customers will now go to your competition and cause them problems- bonus!
As business owners we are often reluctant to increase our prices due to the paranoia that our customers won’t accept it, but the reality is often very different. If you are providing a great service to your customers you should follow a process of regular small price increases, and carefully measure the results (in terms of profit and the types of prospects you attract) to help your business machine to continue generating profit.
The table below shows the reality of what has to happen in order for a price increase to reduce your true income.
Focus on maximising profit and over time you will working less and earning more.
It also results in you building a business that is not only more sustainable and capable of delivering on the goals you set out to achieve, but also creates a business that is more capable of dealing with the inevitable unpredictable events that hit all businesses from time to time.
Your business is a machine — manage it like one and make it work for you.
Author: Jonathan Dowden