Many business owners are so consumed working in their business that they don’t get to work on it so aren't in the habit of interpreting the critical numbers that drive revenue, profitability and cash flow in their business. There are two overarching ways to improve profitability in any business:
1. Reduce costs
2. Increase revenue
There's only so much cost cutting that can be done, so let's focus on increasing revenue, because, let's face it as long as cash flow can support it, there is no limit to which you can grow top line revenue. But to do so, you must get a handle on the key drivers.
In short, you can increase revenue and profitability in most businesses by increasing one or more of the following: the number of customers, the number of times they buy and the amount they hand over each time they buy.
So the first rule to make sense of the numbers is to learn the answers to 3 simple questions about your business:
- How many customers do I have?
- How many times a year do they buy from me?
- What is my average transaction value?
Once you get a handle on where you stand right now, it is reasonably easy to increase one or more of those numbers. If it’s more customers you need, focus on lead generation and sales conversion activities. Or, perhaps the real problem is you are losing too many customers, in which case look at your customer support processes. Similarly, you might identify that your average transaction value is, say, $561. Set a target of $600 and implement strategies to move it there (and beyond), such as increasing your prices on non-price sensitive lines, or introducing internal systems to upsell or cross sell additional products during the sale.
There are three key things to look at here also. Firstly, your gross profit percentage. It is a critically important number to make sense of. Put simply, if you buy something for $60 and on-sell it to your customers for $100, you make a gross profit of $40 for each product that you sell. That equates to a 40% gross profit percentage, and it is the contribution towards your general business overheads. Things to consider are:
- Is my gross profit percentage increasing or decreasing?
- Do I have any product or service lines that are actually unprofitable?
- How do I stack up alongside industry benchmarks?
Next, look at your breakeven point. Analyse how many units you have to sell before you break even (meaning, cover all of your fixed and variable costs). Anything above that number is profitable.
Then, take a good look at your costs and view them as investments. Your role here is to ensure that you are getting the very best return on investment for every single expense in your business. Most businesses can cut out 5-10% without negatively impacting operations, marketing or customer service. Of course, those savings will drop straight to your bottom line.
Cash flow drivers
If you wonder why your profit is sometimes very different from the cash you have in your bank account, make sure you ask us and we'll prepare a diagram to show you the difference. For example, you may have pulled out excess dividends or drawings that are shown BELOW your taxable income line. Or perhaps your customers are paying you more slowly than they previously have, meaning you are making sales and raising invoices, but not collecting the cash. The two most common cash flow drivers in small business (other than high profitability) are days in receivables, or the length of time on average it takes a customer to pay you, and days in inventory, a measure of how much stock, inventory or WIP you are holding. Both of these measures indicate cash locked up.
To give you an example of how the numbers work, if you are a $1M business with days in receivables of 60 (meaning on average, customers take two months to pay you), if you could reduce that to 50 days, you would free up almost $25,000 in cash flow during the year. For many small business owners, that is well worth doing and would take a lot of pressure off.
Making sense of numbers
Please speak with your Hanrick Curran adviser for further clarity on any of these points, or call 07 3218 3900 and ask for Matthew Beasley, Tim Taylor or Tony Hunt to make sense of your numbers then get a plan together to measure where you are now, set some targets to agree the strategies to get you there.
Thanks to Colin Dunn for contribution to content.