By Mike Giles, Marketing Director, The FD Centre
Interestingly, this is a common pattern with growing businesses: sales increase, staff numbers increase and profits decrease.
Although there are a range of different factors which come into play when reviewing a business to determine profit opportunities, fundamentally there are only 4 things a business can do to increase profit:
1. Sell more
2. Sell more often (i.e. incentivise your customers to buy from you more frequently)
3. Increase prices
4. Reduce costs
The issue is not in understanding the premise of how a business should increase its profitability but in the careful execution of a strategy, which enables it to happen.
In other words, as a business grows and starts to take on a momentum of its own, the business owner often ends up getting swept along and this means that urgent daily tasks take precedence over quality strategic thinking.
You may have had experiences of your own where you end up embarking on a new product launch, which you run for months (or even years) only to realise through subsequent analysis that the product is barely generating profit.
This usually occurs due to a lack of detailed strategic planning. Profitability of any particular product or project should be evaluated in the concept stage, in the launch stage and then periodically thereafter. Waiting too late into the process (i.e. when it is clear things aren’t working) is the most common mistake.
Business owners often know instinctively when a product or project isn’t working, but often look at increasing sales as the way to fix the problem when a more technical/detailed appraisal of the situation is required.
90% of the time increasing sales is the right thing to be doing, but the point here is that the critical metric is profitability. There is an opportunity cost of spending time marketing and selling unprofitable products.
Failing to generate sufficient profit can stifle a company. A great product and an industrious team can create the illusion of a successful, growing business. It can be very frustrating to inject time, energy and resource into production and innovation to discover down the line that the underlying metrics don’t work.
Although profit and cashflow should not be confused it often follows that poor profitability leads to poor cashflow. When profits are low and cashflow is poor businesses can quickly descend into a downward spiral. Increasing prices is often part of the solution but CEOs tend to worry that higher prices can lead to a decrease in sales volume. This can compound the problem.
Lack of resources leads to a tighter marketing budget, little time to source more cost effective suppliers and an inability to incentivise staff through attractive bonus schemes. Bringing in external help to absorb some of the workload and implement systems to avoid a reoccurrence is seldom an option due to lack of cash reserves.
This exacerbates the problem.
As with many challenges facing growth businesses the solution lies in good planning on the one hand and an ability to stick to the plan, month in, month out, on the other.
Profit improvement should be seen as an ongoing project. It takes some time to establish systems, which enable your business to maximise its profitability, and then it takes focus and resource to maintain the monitoring process. Here are some of the key procedures businesses need to follow in order to maximise profitability:
• Analyse every area of gross profit to understand where the biggest opportunities lie and to determine how to reduce less profitable activities
• Analyse profitability by isolating data by customer, product, revenue, skew etc to gain full visibility
• Analyse return on investment on capital and product development expenditure
• Ensure management information is up to date and in a format which is useful and reliable
• Systematically analyse important KPIs (Key Performance Indicators) and trends to identify potential hazards before they become a problem
• Educate the senior team as to the importance of Critical Success Factors (CSFs)
• Review arrangements with key customers to see if there is a more profitable way to supply them
• Review pricing arrangements with existing suppliers
• Research alternative suppliers across all areas of the business
• Research sources of grant funding
• Determine eligibility of R&D tax credits
• Develop effective incentive schemes for staff to encourage productivity and to manage risk
• Prepare customer surveys to understand what the market really wants (and then sell it to them)
• Analyse competitors to find out what is working well and what isn’t and course correct accordingly
• Review significant overheads and isolate opportunities to reduce expenditure
• Investigate exchange rate hedging and planning
• Create a realistic and achievable action plan
• Communicate the action plan to all employees
• Increase prices
• Explore online selling
• Explore more cost effective ways of marketing (strategic alliances, joint ventures etc)
• Arrange for business mentors to give advice and share experiences
• Review organisational structure and delegation procedures to maximise efficiency
• Develop customer retention strategies to prevent loss of revenue
• Evaluate business location and determine possible alternatives (to save costs on production, delivery etc)
• Consider building a team of sub-contracted staff to absorb seasonal fluctuations
Benefits To The CEO, MD And Senior Team
Most business owners would refer to profit as the number one reason they are in business. Everything else (passion, purpose, mission) is subordinate.
Profit is an expression of getting the most out of your business for the least amount of effort. It is a reflection of your efficiency.
Building a large company and being able to cite impressive turnover figures are often the wrong drivers for business owners. Again, this is not to say that increasing sales is the wrong approach – on the contrary – it is merely to point out that selling lots of product without a full understanding of the profitability of the product can be a waste of valuable resource.
A compact, efficient business which operates under tight management procedures is nearly always a happier place to work than a chaotic business which is able to boast big turnover figures.
Expanding overseas, taking on more staff and resourcing up may well be the right way for you to take your business. Our role is to help you make these important decisions as it could equally be the case that you may be able to enjoy increased profitability (and an improved lifestyle if this is an important driver) without expanding rapidly, but simply by improving profitability.
Part of our role is to ask some of the bigger questions about why you are in business and what your real objectives are.
Our team of high calibre FDs always look at the whole picture. The support we offer is not reduced down to just ‘financial support’ (although clearly this is a major part) but we look at the broader questions of why you got into business in the first place and what it is you are really looking to achieve. We are not ‘just accountants’ but entrepreneurial FDs with extensive experience in the SME and corporate sectors. The value we bring goes way beyond simply looking after the strategic direction of your finance function.
To find out how we can help businesses significantly increase profit go to: www.thefdcentre.co.uk