Small Business Development Blog

Increase Profitability: A Process for Small Business

Overview: Learn a simple 5 step process designed for small businesses to increase profitability

How to Increase Profitability should be right at the top of your Must Do list. Ask yourself this question: What strategies and tactics do I specifically have in place to Increase my Net Profit? Ummmmm… Wrong answer! You, as any smart small business owner, should be reviewing your ‘Statement of Financial Performance’ (Profit & Loss Report, to you oldies) on a monthly basis, correct? If you are doing this then: Do you do the most important thing following that review?  …. TAKE ACTION TO IMPROVE!

Review your financials monthly, identify areas that need to improve, select your strategies and tactics, and then implement. Sounds like a dead easy process, right? Well, my experience from speaking with hundreds of small & medium business owners it is much harder in practice. Why? Normally because many people just don’t have the review scheduled as a MUST DO in their diary; that is scheduled time each and every month.

In this series of articles we’ll cover each step;

Article 1 – An Overview of the Process to increase small business profitability (this article)
Article 2 - How to Read, Understand and Review business financial statements for small business owners
Article 3 - How to Identify areas to improve profitability
Article 4 - Increasing Profitability: List of Strategies and Tactics for Small Business
Article 5 - How to Select strategies and tactics to increase profit
Article 6 - How to Implement profitability strategies and tactics

Increasing Profitability Process for Small Business

Step 1 - How to Read, Understand and Review business financial statements for small business owners

Financial statements don’t need to be rocket science. Business owners and MDs must have competence in reading and understanding them if they wish to increase profitability. It’s not your accountants fault if you don’t understand what you get once a year from them fully. It’s your fault! You should be reviewing YOUR financials each and every month. I say to my clients, “at a minimum we need the in-house financial statements ready for a monthly review by the 2^nd Tue of the month”. As time progresses you would ideally be able to have the financials on the MDs desk by 9am on the 1^st of each month. As a Director, by reviewing your financials thoroughly every month it will force you to increase your knowledge and understanding. Getting smarter makes decisions easier!

Step 2 - How to Identify areas to improve profitability

The simplest way to identify areas that could improve is by having a clear target for; i) each individual line item (a forecast and/or budget), ii) financial ratio, and iii) KPI (Key Performance Indicator). Then you can see very clearly the ‘difference from your target to your actual results’. You can view this as a percentage or as a real figure. Where a gap occurs is your cue to start asking questions…. Think like a three year ago…. “why?”.

Step 3 - Increasing Profitability: Strategies and Tactics for Small Business

With a clear picture of where your gaps are, you need a complete list of your strategies and tactics that you can use to improve the situation. A tool box if you like.

Step 4 - How to Select strategies and tactics to increase profit

One tactic does not fit all gaps. You must understand how to select the right tactic for the right issue. A little knowledge here will go a long way. The more you know about profitability, what affects the Gross and Net Profit of your business, the more likely you’ll select the best tactic…. And get the desired result, an increase in profitability.

Step 5 - How to Implement profitability strategies and tactics

All the analysis and planning in the world is worthless unless you can execute on your planned strategies, tactics, and tasks. The key to effective implementation is breaking each individual tactic down further into individual tasks, and then allotting a person with a deadline for each task. Think of it as Project Management. Whether you have 1 or 100 projects on the go at once, will depend on you personally and your company's resources… but the point is… they must be managed!

Action Points

1. Confirm you have quality timely monthly financial reports (Statement of Performance & Position at a minimum).
2. SCHEDULE the monthly review (even if you are the sole Director, take your business seriously, this is your life… so schedule the monthly review into your diary and NOTHING can break it). Advise people in your team you need the reports by this date every month.

Go for it!

 

Job Costing - Quoted Price vs Actual Price vs Invoiced Price

I Bet You Couldn't Tell Me What All Three Figures Are On A Particular Job Or Project In Your Business?

If you know all three figures, and the associated costs, you can work out your true Gross Profit for each to determine whether you own a business or a stressful charity. Figure out which jobs or projects you always make good "Actual" margins on and can "Invoice" the same amount so your "true" margins are good, if you can do this you will know which jobs to say yes to and which to say no to. It will also give you direction and focus to drive your business forward.

Learn how to take the first steps in the process...

Method 1: Back Costing

Take the last year, or 6 months, or 3 months, or 1 months (depending on how many jobs or projects you do for people) and get out the following; Your Quote Calculations (with your estimated costings of labor and materials/parts/product and then the predicted margins), get the Price Quoted/Proposed to the customer, get the Invoiced amount for the job, now you may or may not have the critical bit.... the actual cost... did you record the actual hours and the actual materials/parts?

Depending on the intern admin and processes of your business you may or may not have this historical data and in all likely hood you could be estimating this actual figure. Moving forward what we are looking to do is.... COMPARE the QUOTED with the ACTUAL.... if they are different there are only 2 reasons;

• The quote was wrong or inaccurate in the first place, and delivering to that timeline or materials budget was just way off.
• Or... the quote is correct and we have been pushed off budget by 1 of 2 things;
• o Environmental (act of god methodology) i.e. an exterior house painter, Jack, sets aside a whole month for him and his team to complete a job but it rains on and off all month and the stop start nature of this environmental event means it actually takes 2 months to complete, doubling his quoted labour costs and possibly eroding all the margin in the job.
• o The team isn't working as fast (for time components) or as efficiently (for materials) by using 3 litres of paint to do what 1 litre should have.

Get shocked into caring about this for your business

You can see the massive impact this has on the business, with huge differences in Gross Profit. In the above example $210,000 between quote and invoice or $450,000 between actual and invoice!!!!

Now let's say the above business has $650,000 of annual expenses, you could say that based on their Quoting structure they were aiming to hit $400,000 in Net Profit ($1.05m - $0.65m). But because of inaccuracies' between Quote and Actual they had significant Gross Profit Margin Erosion, because of increased Cost of Sales, in fact... the Gross Profit was only $840,000 which less expenses of $650,000 = $190,000 in Net Profit. A huge difference, almost 48% less! Enough to make any business owner cry!

Moving forward what can you do?

Quoting: Get more Accurate!!!!! Know your real costs, and put each job through a calculator, basically design a simple yet comprehensive spreadsheet to work out how much Gross Profit you will make on each job before you send of the quote, proposal or tender.

Now you're probably screaming "NO KIDDING, I know this and already do this". My challenge to you is, I bet you can still do it better, I bet you've got a bit slack and blasé  about it, I bet you've not allowed enough increase for inflation, so go back and make it better.

But the killer point is this...... in your calculations, check the figure against a value for your fixed expenses and the desired Net profit you wish to make if your entire business and all it's resources just did jobs like the one we are quoting on. How?

Now if you did a quote for a job and you determined you would make $2,500 Gross Profit off it (if everything went to plan), and next looking at your business resources (team and assets etc) you work out you could do 300 of these jobs a year if that was all you did. You now determine the fixed expense amount per job like this....

$650,000                Fixed Expenses pa
/
300                        Jobs pa
=
$2167                     Fixed Expense cost allocation per job


So...

$2,500                   Gross Profit
-
$2,167                   Fixed Exp allocation
=
$333                      Net Profit on this job (if everything runs to plan)

x 300 jobs = $99,900 Net Profit pa ... now you can make a judgement call on whether this is the type of work you want to do, whether your price is high enough to reach the end of year Net Profit Goal, and you have a very good understanding of just what you and your team need to do to "deliver" this job on time and on budget.

Doing the Work:Here it is just about recording accurately the costs (labor and materials/parts) to complete the job. If you outline clearly to everyone in your team the quote and budget, then hold them accountable to achieving that figure, you will have the whole team working toward the same goal and not just you!!!!!! Have consequences for the three possible scenarios, 1) Under Budget, 2) On Budget, 3) Over Budget.

This week's Action Points...

Run your numbers, get shocked, then get excited!

 

Billable Hours - How To Increase Your Billable Hours

If You Own A Service Based Business
Then You've Got To Be Measuring This...

Here is a key strategy to implement in your business to increase your profit margins and get more $ in the bank account. It doesn't matter if your business is a professional services firm (i.e. a law firm, accounting firm, or a consulting firm) or a trade services company (i.e. builder, plumber, mechanic, or painter) you'll be charging time for money and making a margin on materials/parts/products used or sold. Find out how to make sure you bill out more hours without increasing your costs...

Are you thinking? 

In a normal situation people work 8 hours a day 5 days a week, that's 40 hours a week, right? You pay your staff for all those hours, don't you?! The question is, regardless of whether it is just you in the business or if you have 20 service staff, are you charging out all 40 of those hours?

Consider this example

Just look at the huge difference, wait that's not bold enough, the HUGE difference just 1 hour per person per day can make to the Margin. When you take off your monthly regular expenses this difference is straight on the bottom line profit of your business.

What effect do public holidays, annual leave and sick days have?

Here's the thing....

52 weeks in the year, less

4 weeks paid annual leave = 48 weeks, less

2 weeks paid public holidays (actually it's 11 days in NZ, but let's just say it's only 10) = 46 weeks, less

1 week paid sick days (5 days in NZ)

= 45 weeks of actual possible Billable Time per person.

Here's how you increase your current billable hours %?

No smoke and mirrors here, just simply measure it! How? At two levels;

1) The Job/Project/Assignment/Task (whatever you call it) level

Each Job you do currently probably has a "Job Sheet"(or "Job Card", "Time Card", "Time Sheet"), somewhere to record the hours and materials/parts/products used for a Job. It's important to make this accurate, at least to the nearest 15 minutes. It's easy, whenever you or your staff work on a particular Job the hours that are done need to be recorded on the Job Sheet.

2) The employee level

This is where each employee accounts for their time throughout the day. They might have 2 hours 15 mins on Job 12345 and 4 hours 45 mins on Job 12349. That totals 7 hours for the day. Each time entry should correspond to the Job Sheet.

You see, if you ask your employees to account for 8 hours a day, you'll soon see who is charging out all 8 hours and who is not. Over any time period... daily, weekly, monthly, yearly...for those that are not charging out all 8 hours (for charge up type jobs) it raises couple of scenarios, either;

• They were training for those hours.
• They were sick.
• They were on annual leave.
• It was a public holiday.
• They were asked to do something non-chargeable or a non-job specific task.
• OR....They were not working efficiently.

Share these examples and information with your staff and ask them "what are the impacts on the business if we don't charge out all 8 hours?", help them ‘get it', help them understand. You will soon see a new focus; to charge out all hours they are at work.

Great! The only thing stopping you then achieving 100% billable for the actual hours of ‘work' (45 weeks per person per year) is either....

• You start to see an instant increase in the price of your Jobs (because more hours are charged to them) and feel uncomfortable charging your customers this amount, and adjust the invoice down tofewer hours. Remember if this happens and if your staff are doing this correctly (recording the correct hours and working efficiently), then this is the actual amount you should be charging and up till now your customers have been getting your services for less than your stated hourly rate.
• Or Sales are too low, the number of jobs you have is too low, i.e. not enough work to do. We'll cover this in coming articles.

This week's Action Points...

Set up a team meeting and discuss the importance of this issue, implement two things; 1. Accurate recording of Hours on Job/Project Sheets, and 2. Individual Billable Hours Notebooks for each service employee.

 

Profit Margins & Pricing Strategy

Have You Put Your Figures Through This Model To Find An Extra 17.4 - 41.4% in Net Profit?

If you are not prepared to implement this strategy, that only takes a bold and smart decision to make and 5 hours to implement, don't waste your time reading this article. Your accountant has probably told you this strategy, you've hear this before from other coaches and advisers, you are probably even thinking about doing it, but are you prepared to make the bold decision and get the benefits?

Calculate your own figures to see how different things could be...

Are You Feeling Your Net Profit Margin Eroding Away?

Each year the same thing happens. Always, just like the two certainties' in life of death and taxes, inflation happens every year... prices go up. Wages, kiwisaver, general expenses, suppliers costs, and what about the general personal cost of living... you'll need to pay yourself more as well this year. What does this all lead to? Net Profit erosion, from $50,000 last year to $35,000 this year, or $0 to -$20,000 or $250,000 to $200,000.... whatever the figures, there is a quick way to project and effect a different result and easily implement it.... take a look...  

The Profit Model

Take some time to study the below figures. What we are looking at here is a well performing business, they have entered some very basic data into the white cells and all the rest is automatically calculated. If you want a copy of this simple yet power tool download your copy now profit model template.

Let's examine the Original Position

Here this business makes $180,000 per year in Net Profit, that's a 18% Net Profit Margin based on sales of $1m. They had 400 sales or invoices or transactions last year so we can calculate that out to an average amount for each sale of about $2,500. What is particularly useful for businesses that are yet to make a profit is the next 2 rows, Breakeven Sales $, and Breakeven Transactions. This is a key target for businesses yet to make a profit, and can be broken down into monthly, weekly and daily targets so you can see how you are tracking.

Each business also has a conversion rate, some high (like most business owners think) and some low (like most businesses really are). Very few businesses actually measure this key figure, but it is very important and will determine the number of leads or enquiries your business needs. From this you can start to determine what marketing & advertising spend you need to bring in that many leads.

And what about the Projected Position

The Four key areas used in this Model to affect your Net Profit are;

• Price
• Sales
• Cost of Sales (COS)
• Expenses

Let's put up prices by 10%, not a huge amount just 10%, increase $50p/hr to $55 p/hr, a bottle of wine from $17 to $18.70, etc... Now assuming 3% inflation on Expenses and Cost of Sales (suppliers & service team wages) we can still loss, yes loss 10% of last year's sales transactions and achieve a 17.4% increase in Net Profit, that's an extra $30,000, for the business doing 10% less work!!!!!!

And what hourly rate are you now working at for working ON your business and making a strategic decision to increase prices and implement it? Well, it only takes a few minutes to run your own figures through the profit model and a few hours to organise a price increase, let's say 5 hours in total to get this strategy implemented. That's 5 hours to make $30,000 more in profit! But, what about the value of the business' goodwill, which is linked to the profit it makes by a multiplier? In an owner operator business it might just be 1 x Net Profit, a stock exchange listed company is likely to be 20 x net profit, in an average small business it is 2-3 x Net Profit. The more stable, systemised, and predictable future profits of a business are, the higher the multiplier.

Add the increase in goodwill value to the extra net profit, and you have a great hourly rate for working ON the business!!! Think about what your time is worth.

What if we didn't put up prices and just sold more?

Using this same example, you would need to do 15% more transactions and this also does account for an increase in marketing or advertising expenses to achieve this, it just assumes it happens organically, or by itself, without a increased marketing spend to attract more leads. Doing 15% more transactions would also have an effect on the in-house resources required to do that, so it's likely to increase expenses by more than inflation alone.

As far as valuation is concerned we are probably about the same, but with an extra 15% increase in sales I bet you'll be working another 5 hours per week, see what that does to your hourly rate below...

  

Are you saying I should put my prices up or not?

Can you always increase prices by 10%? No, normal supply and demand will see to that. The idea here is to see just where you are going to position your business; Economy (low price & high volume) or Premium (high price & low volume), both are fine, but what do most businesses do, price themselves in the middle, not taking the risk either way and in the process just become another ‘average' business that gets lost in a sea of like businesses. Play with the figures and shape your business to fit your targets, at a high price you better be awesome, at a low price you better have awesome scalable systems. In the middle, you've bored me and I've already change the channel.

This week's Action Points...

eMail me for your copy of this useful and powerful tool, and take a few minutes to project and shape the future of your business and not just take it the environment lying down.

 

Profit Goals - Not Making As Much Profit As You'd Like?

Are You Making Sure Your Business Is A Profit Machine By Using These 3 Simple Tools?

A Profit what? .... A Profit Machine! Your business should produce profit.... how much Profit? .... Whatever ‘Monthly Profit Goal' you decide you want! That means you also need to know your ‘Monthly Break-Even Point' at each different ‘Monthly Profit Goal' Level. You see as you increase your ‘Monthly Profit Goal', your business will need to be slightly different (more staff, more marketing, bigger building, etc ) to achieve that new desired ‘Monthly Profit Goal'... this means you also need to determine the ‘Profit Model' at each Level or stage of your business!

Ultimately what we are talking about here are 3 tools you need to be using to determine what "direction" you will be taking your business in. Why? So you can create a Profit Machine of course... that spits out profit predictably and sizably. If that interests you, then discover how to do these simple calculations and questions in your business today so you can proactively shape the direction of your business to print money!

Get REAL!

How about a Reality Check. Now, most people in business have some understanding about the numbers, but in my experience that understanding is based on the original figures they went into business with or assumptions which just aren't true. To determine the direction and what the impacts of you future growth will be, you need to do a few simple calculations and ask a few questions. And if you think that yes I already know this, I've done these before, ....well.... are you monitoring them, because in all likely hood they have changed since you last did them, and it could be that it is in fact impossible to get the growth in profit you want using the current ‘model' or structure. Stop thinking a 10% increase in sales or revenue will automatically yield you more profit. Did you ever stop to consider some of the following points in your calculations ...

Current Monthly Break-Even Point

Gross Profit (GP) = Revenue - Cost Of Goods Sold (COGS) | Eg1; $150,000 - $100,000 = $50,000

Gross Profit Margin % (GPM%) = GP / Revenue | Eg1; $50,000 / $150,000 = 33.33%

Net Profit (NP) = GP - Expenses | Eg1; $50,000 - $40,000 = $10,000

Net Profit Margin % (NPM%) = NP / Revenue | Eg1; $30,000 / $200,000 = 6.67%

Break Even Revenue = Expenses / GPM% | Eg1; $40,000 / 33.33% = $120,012

Ave Sale Value (ASV) = Revenue / # of Invoices | Eg1; $150,000 / 400 = $375

Break Even Invoices = Break Even Revenue / Ave Sale Value | Eg1; $120,012 / $375 = 320

Monthly (Net) Profit Goal

In.... 3mths = $15,000 pmth ...6mths = $20,000pmth ... 12mths = $30,000pmth ... 24mths = $30,000pmth (with a General Manager).

Profit Model

Work Backwards! Start at profit and work upwards through the key figures in the Profit & Loss Statement to determine the new Expenses with any extra resources needed (plant, equipment, vehicles, marketing level, buildings and staff).... then conclude if your GPM% will change or stay the same to get to your new revenue figure. If it's the same...

AT 3 MTHS: Is this Possible... $15,000(NP) + $40,000(Exp) = $55,000(GP) / 33.33%(GPM%) = $165,017 / $375(ASV) = 440 Invoices

Target Monthly Revenue = $165,017

So the real question is... Can we do 440 Invoices with our current resources (The Current ‘Model') or are we totally at capacity? To answer this we must determine our current Utilisation Rate (UR). UR does change and differ for every business, so you'll need to consider and look for different things, but here are some basic examples.

Utilisation Rate (UR)

Eg A - Retail Business Selling Widgets:

Can we handle this increase of 40invoices per month?

UR = Average Enquiries & Orders per day per customer services person to process

Current Enquires per day = 40

Current Orders per day = 400(Mthly Invoices) / 20 (working days per mth) = 20

Conversion Rate = 50%

Ave Time Per Enquiry = 3 mins

Total Enquiry Time = 40 x 3 = 120mins

Ave Time Per Order  = 6 mins

Total Order Time = 20 x 6 = 120mins

COGS = 8 hours per day

Revenue Activities = 120mins + 120 mins = 4 hours

UR = 4 / 8 = 50%

So by looking at this we could say that if this ‘customer services person' only had to deal with enquires and process orders then we could do up to double the number of invoices that we are at the moment. 400 Invoices at 50% UR, at 90% UR we could do 721 Invoices.

However, in most Small Businesses it is likely that the Customer Services Person will have other roles and responsibilities, i.e. they could be an admin person and additional to answering the phone enquiries and processing orders they may have the other 4 hours of the day totally packed with bookkeeping tasks, Accounts Payable, Accounts Receivable, Posting, etc... So ...

At the 3 Month Profit Goal we only need an extra 40 Invoices done which is;

Orders:  40 x 6 mins = 240mins / 20 days per mth = 12mins per day

Enquires: 40 orders / 50% conv rate = 80 Enquires x 3mins = 240mins / 20 days per mth = 12mins per day

Total extra time per day 12 + 12 = 24mins

So, can this person handle that? Or do we need to outsource some of the bookkeeping tasks to free her time up which will increase her ability to do more Customer Service work but also increase Mthly Expenses with a new bill for an Outsourced Bookkeeper? An increase in monthly expenses means we need to recalculate the Break-Even Point and then we'll need a new Target Monthly Revenue!!! Which means more Invoices, which means more time to complete those invoices and enquires, which means more pressure on resources!!! THINK ABOUT IT!

Eg B - Service Business:

Can our Operations Team handle this?

UR = Average Billable Hours per day per service person

COGS = 8 hours per day

Revenue = 5 hours per day (Doing Billable Work)

UR = 5 / 8 = 62.5%

If 62.5% = 400 invoices, then 100% = 400 / 62.5% = 640 invoices pmth, at 90% UR ( = 6.8hrs ... rounded to = 7 hours per day) = 640 x 90% = 576 invoices is probably a realistic capacity level at current ‘model' (staffing levels).

8 hrs x 5 technicians = 40 hrs x 20 days = 800 Total Potential Monthly Billable Hours

5 hrs x 5 technicians = 25 hrs x 20 days = 500 Total Monthly Billable Hours

7 hrs x 5 technicians = 35 hrs x 20 days = 700 Total Realistic Capacity Monthly Billable Hours

500 hours / 400 invoices = 1.25 hours per invoice

1.25 x 40 (extra invoices for Monthly Profit Goal 1) = 50 hours / 5 technicians = 10 hours / 20 days = 30mins each day.

Increasing technicians from 5 hrs Billable per day to 5.5 hrs Billable per day. So, it would seem that we wouldn't need to increase the operations staff or resources like new vehicles / building to handle the extra 40 invoices.

Can our Sales Team handle this?

Let's say we have a Business Owner who is the Sales Person as well as running the place, to get the current 400 invoices all sold in the first place, Mrs Business Owner spends 10 hrs per week as the sales person (in total they work 60 hrs per week so have no capacity or desire to increase the number of hours of total work). However, only 10% of work requires a sales presentation, the other 90% are handled by the admin team just taking a phone order.

40 more invoices is 10% more business from the current 440 invoices. So logic would state Mrs Business Owner at 40 invoices extra x 10% = 4 more invoices requiring a sales presentation, but she only converts 50% of the sales presentations so would need to do an extra 8 sales presentations over the month (4 / 50%). Well, at 10hrs per week x 4.33 wks per mth = 43.3 hrs (2598mins) pmth on sales presentations she must take ...

400 invoices x 10% = 40 sales presentation 'won' invoices pmth

40 / 50% = 80 sales presentations pmth

2600 / 80 = 32.5mins per presentation

8 extra presentations x 32.5 mins each = 260 mins pmth / 4.33 = 60 mins pwk extra.

Most business owners could handle an extra 1hr pwk (4hrs pmth) for an extra $5000 NP pmth, but only you can determine if this is sustainable and in all likely hood you will reach a snap point, when 60hours was ok, 61 hrs ok, 62hrs we flip out or melt down so we need to change the model.... what about employing a f/time sales person for $5000 per month, and you by back 10hrs per week and they are only running at 25% utilisation rate, but they are paying for themselves from day one?!?!

Can our Admin Team handle this?

!!!!!! remember they have an extra 10% more invoices to create (40) and also the extra load of more phone orders. Etc, etc....

Will our Marketing Expenses go up which will adjust our Break-Even Point?

Confused Yet?

Hey look, my point here is really to challenge your thinking, you simply need to ask more questions about the direction you are taking your business. You can see above how with the more information we gather we dig to a new layer of information, and again and again. Scratch Below The Surface To Find The Truth!

This Weeks Action Points...

Get out a piece of paper and / or use a spreadsheet, but start thrashing some figures around that go beyond the surface Revenue and Profit. Thrash about the figures that ask..."Is this possible with or current resources?" ... "What is the maximum revenue and profit using our current resource?" ... "What is our current utilisation rate?" ... "What extra resources will we need at that level?". Answer these questions and others on this tangent and you can get a true picture of where you need to be to create a Profit Machine to your desired level. Note: It's almost always bigger that you first thought.