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.