There’s one thing that always amazes me: the number of business owners who view profitability as a matter of luck. They tend to think that extremely profitable businesses got that way because market conditions were right, or they happened to have a product or service the world was dying for.
But let’s get real. Do you really think that corporations like McDonalds, for instance, are run by individuals clutching rabbits’ feet and keeping their fingers crossed, fervently hoping for another good year?
The truth of the matter is that the profitability of your business can be managed and purposefully grown. In fact, it must be managed if your business is going to reach its full potential.
While there is no magic formula for increasing profitability, there is a step-by-step process that can be applied to your business to discover the unique path that will result in the growth of your enterprise.
This process begins with an understanding of what drives profit and how you can affect those drivers in order to achieve your goals.
Put your focus where it belongs
Yes, there are uncontrollable factors affecting the profitability of your business. For instance, you can’t do much about the state of the economy or whether or not there is a labour shortage in Alberta.
Now, you can choose to lose sleep over the unpredictable nature of being in business. You can cross your fingers and toes, hoping that your financial statements will show a profit for this year in spite of skyrocketing rent and labour costs.
Or you can recognize that much of life is unpredictable and that success comes to those who focus on what they can control.
What can you control?
There are only 4 factors affecting the profitability of any business, including yours, and you have some level of control over all of them. These profit drivers are:
- The price you charge.
- The quantity (or volume) you sell.
- The costs you incur directly in producing the products and services you sell. These arevariable costs because they increase or decrease as your sales increase or decrease.
- The costs you incur whether or not you make any sales. These are fixed costs (sometimes called overhead) because they do not change with changes in sales volume – at least not on a day-to-day basis.
In order to make more money, you may have to increase your price, increase your volume or decrease your costs. It sounds simple, because it is simple.
Now, I’m not recommending you simply dive in and change your prices or switch suppliers. Action without a plan is never a good idea, especially in business. Without some understanding of the potential ramifications of a particular action, you may end up taking some serious risks.
But doing nothing isn’t the way to go either, especially if you did nothing last year. And the year before. (I like to say that doing the same thing year after year and expecting different results is the definition of insanity!)
You cannot just hope for your profits to increase, because they won’t. Profitable businesses have owners or chief financial officers (CFO) in the driver’s seat, steering intently toward planned growth.
Here’s the bottom line
There are only four ways to increase the profitability of your business:
- Increase the number of customers you serve.
- Increase the number of times customers come back.
- Increase the average value of each sale.
- Increase the effectiveness of your operations.
Within each of these areas there is a myriad of actions you can take. For example, in order to increase the average value of each sale, you can increase the price of your product or service, or you can create packages that will increase the amount each customer buys in a single visit.
Regardless of which route works best for you, the important point is that a small increase in the average value of each sale will affect your gross margin and your net profit.
A modest increase in each of the above areas—a few more customers, a few more visits per customer, a slight price hike and a couple of changes to your operations—can result in a dramatic increase in the profitability of your operation.
In my next posting I will talk about using this information to develop a strategy for improving the profits in your business.
In my last post I talked about the 4 ways to increase the profitability of your business. It is great for you to understand what these 4 ways are, but it is BEST if you can use these in your business.
Increasing profitability requires a well-thought-out strategy based on calculation and the development of what-if scenarios. After all, a change in one factor is going to affect other factors.
For example, what if you increased the price of your products and/or services by 20%? How will that affect your volume? If the number of sales drops, will profits increase? Only the numbers will tell.
There’s no point sitting in the driver’s seat if you don’t have a map. A profit strategy is your map, built on the unique requirements of your business. It allows you to make informed decisions as to which actions you will take in order to increase your profits.
Taking it step by step
Understanding what drives profit in your business and the 4 ways to increase profitability are the first two of nine steps to developing a successful profit strategy.
Step 3 – Evaluate your profit potential
Your next move is to quantify the amount of profit currently hiding in your business. How will changes to the four profit drivers impact your profits? How big of an increase can you realistically see this year?
Step 4 – Lay out your strategy
With analysis completed, it’s time to choose a course of action and solidify your plan. How much more money do you want to shoot for? How will you get it? Will you increase prices or try to create packages in order to increase the value of the sale? Will you work on streamlining operations? Be specific.
Step 5 – Determine changes required in the business
What else needs to get done in order to implement your profit improvement strategy? Will you need to create new marketing material? Will you have to upgrade your computers and software?
Step 6 – Take action
This is the most important step, and the one where many owners fall down. Fear, resistance, life getting in the way—those are just a few of the reasons we offer for failing to take action on a plan.
Success requires that you just do it. But don’t feel that you have to do it alone. Many people use friends, mentors, partners or coaches to keep them on track and motivated.
Step 7 – Measure results
Again, very important, and again, often skipped. How are you going to know if your actions are working? Measuring results allows you to make informed, accurate decisions based on what’s really happening in your business.
Step 8 – Evaluate and revise
Did your profit strategy work? Why or why not? Use what you learn to refine your strategy for further growth.
Step 9 – Re-measure
The process of taking action, measuring, revising and measuring again will go on as long as you’re interested in improving the profitability of your business.
How to take control of how much money your business makes
As a business advisor and external CFO who works with various businesses in a variety of industries, I see business owners overlooking the factors they can control every day. But once I explain that profitability is not a matter of luck and show them what they can do to make more money regardless of external uncontrollable factors, they are able to turn their businesses around. Most are nothing short of amazed at the profits they are able to generate by taking control.
How to get the information you need to manage your business
Your numbers are trying to tell you something. Are you listening?
In my experience, most business owners aren’t. At least, they aren’t listening hard enough. Let me explain.
Every piece of information you need to make decisions regarding your business can be found in your numbers. Want to know where to spend your marketing dollars? Your numbers can tell you. Thinking about streamlining and dropping some products or segments? Listen to your numbers to discover which ones to let go.
But here’s the problem. You’re not going to get that information from your year-end financial statements. And unfortunately, the creation of those statements is about all the accounting the average business owner does.
In this article, I’m going to discuss the accounting method most business owners use and why it’s almost entirely useless for decision-making purposes.
Then I’ll tell you about another way of looking at your numbers that will—100 per cent guaranteed—make you a more effective manager and substantially improve your business.
Peering through a keyhole
Ever tried to see what’s going on in a room through an old-fashioned keyhole?
With a limited view, you might get the general idea—who’s in the room, what the person is doing. But there’s plenty outside your field of vision that, if seen, would give you more insight into why that person is behaving that way.
Your year-end financial statements work in the same way. They provide a general overview of what’s happened in your business but can’t tell you why. Yet for most business owners, they are the source of the only numbers used to make business decisions.
What is the purpose of accounting?
In short, the purpose of accounting is to provide relevant information to decision makers, both internal (management) and external (bankers).
For most small and medium-size businesses, the focus of accounting is simply the preparation of year-end financial statements for tax purposes and, possibly, for outside parties.
When you receive your year-end statements from your accountant, you are simply receiving a record of how your business did last year and how much tax you owe.
How do these statements help your business?
In a nutshell, they don’t. There are two reasons for this…..stay tuned for my next post to find out more…
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How to get the information you need to manage your business
In my last post I started to talk about getting the required information to help you manage your business…
The information you receive through your year-end financial statements is outdated the minute its in your hands. Your financial statements are prepared anywhere from 3 to 6 months after your year-end. How useful can 6-month-old numbers be for decision-making purposes?
Not only is the information old, it’s quite limited. The statements are prepared for outside parties who typically do not require details. If you’re using these statements to make important decisions for your business, you’re basically wandering in the dark.
As a business owner, it’s your job to steer your business and make decisions that will affect future profits positively. This is extremely difficult, if not impossible, to do with the limited and out-dated information contained in your year-end statements.
As big business well knows, managing a business requires access to details so you can analyze your products and services, your cash flow or any other aspect of your operations. This analysis is the only way management can get the information they need to make effective decisions.
Information divided into pre-established categories can shed new light on your business. For example, it’s all well and good to know the profit margin for your entire business for the year—a number you can get off your year-end statements—but what can you do with that information?
By digging deeper, you can discover the profit margin of product A and compare it to the profit margins of products B, C and D. This allows you to make decisions about your product lines in order to increase future profits.
Through a detailed breakdown of information, you can discover:
Opportunities for growth
- Which products or segments to drop or promote
- Where you may be able to, or need to, increase your prices
- Areas for cost reduction
- Problem areas that need your attention
Try getting all that from your year-end statements!
3-steps to obtaining the numbers that will help you grow your business
- Decide what information you need to achieve your business goals.
- Establish a system to collect that information.
- Generate useable information frequently so it is always current.
Small steps to success
There is no end to the types of information you can collect about your business but setting up to obtain the numbers you require isn’t always easy.
I recommend taking small steps and slowly creating information management systems. You don’t have to begin collecting every piece of information immediately. A little is always better than nothing, so just begin with one change and see what happens.
For example, I have a client actively pursuing growth, who decided to make a small step in this direction. After determining the kind of information he wanted, he divided his customers into four market segments. Then he kept track of sales made to and profits realized from each of those segments.
After several months, he noticed something surprising. The numbers were clearly telling him that a hot segment of the market was responsible for a relatively miniscule number of his sales.
Somehow, he’d missed taking advantage of the growth in that particular market segment. His numbers were practically shouting: Here is an easy way to increase profits! Luckily, he’d tuned in to the message soon enough to take advantage of the situation.
The client responded by directing his sales team to focus on that market. Not surprisingly, sales increased substantially.
One small step. One big return. Next year, he can, if he wishes, add to the amount of information he collects to further strengthen his management capabilities.
There is no doubt this process requires more effort on your part. While the actual duties can be delegated, you are the one who needs to determine what information will provide the most benefit, how you will keep track of it, and what reports will need to be generated.
More importantly, you are responsible for putting what you learn from your numbers into action.
But please don’t let the thought of the extra work keep you from making changes to your accounting system. Start collecting some additional information today and see what results.
In my next post I will give you a ‘real life’ example of how applying the concepts from my first few posts were implemented in a business and helped transformed that business.
In my last couple of articles I talked about using your numbers to help you manage and grow your business.
The following is real life example of how a client used this concept to help grow his business…
Several years ago I was engaged by this client. During my initial conversations with the business owner, he admitted to me that he really didn’t understand his financial statements, nor did he trust they were correct, largely because he didn’t understand them. He also admitted to me that he certainly did not use his numbers to help him manage his business. Really, how could he, if he didn’t understand what his numbers were telling him?
In looking at his numbers and more specifically his internally generated profit and loss statement, it was clear to me this information could provide little value for decision making.
The business, at the time, generated sales of approximately $1.5 million, to what turned out to be, different business segments or classes of customers.
After being engaged by the client, the first initiative that was undertaken was to do what I call a ‘horizontal analysis’ on his profit and loss accounts. Instead of the traditional vertical income statement I analyzed his profit and loss accounts and classified these accounts into the different segments within the business. We were then able to quantify the sales levels, both in sales $$$ and volume of jobs, gross margin $$$, gross margin %, average transaction value, average gross per job for each of the business segments.
This analysis showed us that each of these segments yielded very different results from each other. Further, we were able to identify that the activities to grow each segment were in fact quite different.
After doing this analysis, we applied the ‘4 Ways to Grow Your Business’ to each business segment and developed a profit improvement plan for the entire business.
Afterwards, we re-structured the company’s chart of accounts so we could accurately monitor the results of the profit improvement plan on a go-forward basis. This process and thinking has been continued year over year for the past 5 years.
The results of implementing these basic, yet most often over looked and underutilized concepts has been nothing short of outstanding. Over the past 4 years the business has grown 135% in sales and profit has soared to reach a maximum of 7.5% of sales.
See, I told you it was simple!
Okay, savvy business owner. Here’s a question for you. You have to get from point A to point B in an unfamiliar city. What one item will virtually guarantee your successful arrival?
The humble map is indispensable when it comes to travel. It points you in the right direction and provides a reference point by which you can gauge your progress and determine if you’re still on course. And if you’re not, the map shows you at a glance how to get back to where you need to be.
When it comes to travel we all understand the need for maps in order to reach our destinations as quickly and painlessly as possible. Now, you’re probably wondering what this has to do with business, and why a CFO-to-go is yammering on about sightseeing.
What’s in a name?
You see, whenever I talk about strategic planning to clients, a funny thing happens. Eyes glaze over and formerly excited business owners eager to improve their profits lose all interest in what I’m saying.
I know it’s the phrase ‘strategic planning.’ It’s one of those phrases that have become jargon, losing all meaning. You hear it and immediately think of futile exercises with no earthly practical purpose, exercises that keep you from what you need to be doing—running your business.
So I try not to use the phrase, at least not right away. Instead, I explain that there is an exciting, energizing tool you can use to bring focus, vitality and direction to your business, giving you a map leading straight to success.
One of the reasons strategic planning has developed a bad reputation is that a large part of the process involves dreaming. Business owners aren’t supposed to sit around daydreaming! They’ve got work to do, businesses to run, fires to put out.
We tend to view action as the required ingredient to success. Planning is omitted because, hey, there are only so many hours in the day and you’ve got to spend them getting things done.
It’s true that action is critical if your business is going to reach its full potential. Planning on its own gets you nowhere. But in the same way, action without defined purpose—a plan—is not going to allow you to move forward. Instead, you flail about, using trial and error and taking the long road to a destination you may not have desired.
You need to know where you’re going
Visualizing what you want in the future is the only way to develop a plan that will allow you to reach your goals. Would you laugh at a group of tough, grizzled army generals sitting together and daydreaming? That’s exactly where strategic planning came from. The military wanted to ensure that the enemy would be met under the most advantageous conditions. So they brainstormed in order to identify those conditions and formulate a way to achieve their goals.
The term was adopted by business in the 1960’s to describe a thoughtful, analytical approach to improving companies. It is now the most valuable management tool in existence. Realistically, you simply cannot experience growth in your business—and increased profitability—without strategic planning.
In my last post, I discussed how critical strategic planning is to creating success in business. It is absolutely fundamental, and yet most business owners fear and avoid the process. In fact it isn’t all that intimidating when you break it down and approach it logically. The strategic planning process involves exploring and answering three key questions:
- Where is the business today?
- Where do you want the business to go?
- How are you going to get there?
You aren’t trying to create an operational plan. The objective is not to detail each and every step required to achieve your goals, but rather to ensure that you understand the ultimate aims for the business and have a general map leading to the realization of those aims.
For example, you may be strategically planning to introduce a new product within the next year. The plan will include all the major steps to introducing that product—source suppliers, create collateral material, etc., but it won’t list each and every step involved, such as telephone supplier A and interview three graphic designers.
Set aside a large chunk of time, like a day or even a weekend, for your strategic planning session. Step one has to be done before the session, so evaluate how long you anticipate this step to take and mark a future date as strategic planning day.
During your session, you won’t be involved in actively running your business. You need to focus on the future, not on the day-to-day. This is your opportunity to work on your business, so avoid the possibility of interruptions by getting away from the office.
A word of caution—strategic planning really can’t be done alone. Find someone who can keep you on course, assist you in evaluating your ideas and provide both feedback and support to join you for the entire session.
Step One: Where are you now?
While dreaming is required in strategic planning, it must be based in reality. If you don’t understand exactly what’s going on in your business today, any plans you make for the future are no more than pipe dreams that will never be realized.
A systematic evaluation of the entire organization that looks at both the internal and external factors affecting the business will tell you everything you need to know so that your planning session is based on fact rather than fiction.
Perform this analysis in the days, weeks or months leading up to the strategic planning session.
Step Two: Where do you want to be?
This is the most exciting part of the process. During this step, you’ll clarify the vision you have for your business, as well as its mission. Where do you want your business to go? What do you want it to look like? How much profit do you need?
After considering general economic factors as well as those specific to your industry, you can make assumptions about the future that will allow you to develop your goals for the business and formulate a workable plan.
Step Three: Getting there
You know what you want. Now you have to determine how you’re going to get there. In this step, you’ll create specific action steps that will allow you to achieve your goals and move your business forward.
I also recommend establishing timelines and detailing levels of responsibilities so all parties know what’s expected and when.
In the future
Life goes on. You’ll change; the business will change; the economy will change.
Revisit your strategic plan on an annual basis in order to evaluate progress and determine if the contents of the plan are still applicable. Scheduling at least one strategic planning session a year will keep your business flowing smoothly and ensure growth occurs exactly the way you want it to occur.