“But I hate numbers; I like people,” said the small businessman. Then that no-longer-so-friendly banker called to say the loan payments were late, and the owner had to let some of his now-disappointed staff people go, and he had to get stricter with some of those nice but late-paying customers, and the ones who always came back for changes and even returns.
What happened? He ran the business like a social club, where relationships are all that matter. But a business needs cash to run. Without cash, the relationships disappear. When cash flow was weak, the foundation was tottering, but he refused to look down there. “Every time I look down there, I have to study things and make unpleasant decisions, so I don’t look any more. I just let my accountant look.”
If you don’t attend to your numbers, your business will fail. You should be eager to see how you’re doing! And eager to fix any problems, so the business can go on. It’s not hard to assess your business financial health, if you focus on “percent of revenue.”
You don’t need expertise in bookkeeping if your results are presented in a way that enables planning. You want these numbers to stand out: percent of revenue for every line, and the key lines are total variable costs, total fixed costs, and contribution margin. For a good way to present the information, see Owning Your Own Business Means Owning Your Own Books | Thomas H. Gray – Consultant, CEO, Director.
With your data in Excel, you can experiment. Copy it onto a new worksheet, or save it under another name, and then change the data to see how changes in your business would affect the bottom line — profit.
Sample Analysis: Profit Up 20%!
Assume you want a minimum profit of 10% of revenue, which will be something like 7.5% after income tax. If your fixed costs are 30% of revenue, then your contribution or operating margin MUST be 40% of revenue to cover that 30% overhead and leave a 10% profit.
If you can cut overhead from 30% of revenue to 25%, your profit goes up from 10% to 15%. Review your overhead or fixed expenses to see what changes make sense.
- You’ll see that small changes, such as not buying soda for the office refrigerator, have little or no impact.
- If you cut marketing (probably no more than 5% of revenue), what will happen to your flow of new customers? Is such a cut worth the risk?
- Maybe you can reduce nonproductive labor hours by changing work schedules. This is always worth examining. If this number is 5% of revenue including payroll taxes, cutting it to 3% raises profit by 2% of revenue, which is a 20% increase in profit from 10% to 12%! “Thanks for the raise,” says the owner.
Variable costs and revenue are usually the most fruitful areas to consider. The FIRST technique here is to understand the profitability of each product or product type. On a separate worksheet in Excel, consider each product type. Show the revenue for one unit, and the variable costs to produce it. Subtract costs from revenue to see product profit, and then show that as a % of revenue.
If this product profit is more than 40% — your 10% profit target plus 30% for overhead coverage — great! If it is less, you must do something. Your choices are: raise the price, reduce the variable cost, stop selling it, or accept a profit lower than your target.
- If you stop selling it, and you can replace the revenue by selling more of other products, your profit will increase as a % of revenue.
- If you can reduce the variable costs for the product, your profit will increase as well.
- One technique is to pay less sales commission on less profitable products – change your commission structure to be different per product.
- Another technique is to change your production process. This is the BEST approach, and there are many techniques. They all start with mapping out the process as it is today, and then imagining what might be changed. See
- A third technique is to move some subcontracted work in-house to use nonproductive hours, or move some work to other suppliers if you can offload the associated payroll hours. See Process Improvement | Thomas H. Gray
- Raising the price is the FASTEST way to improve profitability. A small price change may not be a problem for your customers, yet it will have a major effect on profit. For example, a 5% price increase would raise profits from 10% to 15%, a 50% gain! Even if you lost a few customers, the gain may be worth it. See Pricing Tips: Start High; Big Results from Small Changes | Thomas H. Gray – Consultant, CEO, Director.
- You can use Excel to change the price and revenue per product, and reduce the number of units sold to see how many sales you could afford to lose yet still be better off.
A word of caution: be careful of major investments that you hope will solve the problem. Examples include a major machine purchase, a major new marketing program, or moving to a larger newer location. They deserve their own careful analysis of costs vs. likely benefits. Your entrepreneurial optimism might be your own worst enemy with such major commitments!
Your numbers are begging for your attention! They control the life and death of your business. It’s not hard, if the numbers are presented the right way. When variable costs, fixed costs, and margins are presented in terms of % of revenue, you don’t have to be a bookkeeper or love numbers to see what’s out of line.
Have you tried this? What did you learn?
Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or firstname.lastname@example.org. See www.tom-gray.com