Operating a Profitable Business: A Starter KitSeptember 20, 2019 September 25, 2019 /
You don’t go into business in the hopes of being average. For most business owners, getting rewarded for their hard work with strong results in growth and performance is the goal.
With seven out of ten businesses failing within their first decade of business, this is a challenge that is best managed with a robust plan. It’s common for businesses to fail due to financial management issues, failing to plan for growth and not taking the steps needed to perform well against competitors
In this article, we are addressing some key areas that you need to manage effectively to ensure the profitability and growth of your business. As you look at each section, consider how your own business has planned to manage them.
Section 1: Taking control of your profitability
First of all, while most people know what profit means and that they’d like more of it, many haven’t taken the time to really understand it. This is important because when you know how it works, you can take steps to better control it.
Profit is what’s left over once everything else has been taken out. It is a consequence of the things that happen in and to your business. You can control some things that impact your profitability, but have less control over other factors. Your business doesn’t “just happen”; it’s important to take control of the things that are possible for you to manage.
There are four key factors that impact your profit:
- The price you charge for your products or services.
- The number and value of the sales that you make.
- The variable costs of buying or producing the products or services that you sell.
- The fixed costs that you incur just to “keep the lights on,” whether or not you sell any products.
You can take control of your profitability by increasing your prices or margins, increasing the number and/or value of your sales, and decreasing your costs. The thing to balance is that each of these factors impact one another. For example, raising prices might have the effect of reducing sales volumes. On the other hand, it is possible that a price decrease helps to boost sales volumes so much that it significantly improves profitability.
Strategy for improving profitability
There is no one correct formula for improving your profitability. You could work on a combination of strategies to improve margins and sales while lowering costs, but it really depends upon the specific circumstances affecting your business. For example:
- Your relative strengths and weaknesses
- The market conditions in which you operate
- The strengths and weaknesses of your competitors
- The types of products you sell and how they are sourced
- Your internal policies and procedures, and how they impact upon productivity
Any strategy to improve your profitability will have to focus on one or both of:
- Achieving a higher gross margin per dollar of sales. This is done by increasing prices and/or decreasing variable costs.
- Achieving greater sales per dollar of fixed costs. This is achieved by increasing the productivity of those things that have a fixed cost (for example, if a salaried salesperson could make more sales per day).
Even just a modest improvement across each of the four factors that impact profitability can make a significant boost to profits. We show this in the table below:
So if you want to take control of your business’ profitability, where should you begin? It’s important to understand that in most businesses that fail, there were signs that could have been picked up and improved upon from early on. One strategy for early detection is to conduct profitability audits.
In the same way that small improvements in those four factors can dramatically impact results in the positive, small changes to the negative can have the same impact the opposite way. Do you notice the impact of a 5% annual increase in fixed costs right away? Possibly not, but over time, if nothing else improved, you would start to feel the squeeze.
Regular profitability audits are a valuable tool for noticing these things early. A profitability audit is a strategic review process where you analyze each of the four areas that impact on profitability in detail. Most companies will do an annual audit of their business, but a profitability audit should be conducted more often – perhaps quarterly or semi-annually.
A useful tool for conducting your audit is a SWOT analysis. You can examine the strengths, weaknesses, opportunities and threats for each of those four areas. It can be helpful to break them down into subgroups so that you examine key factors impacting your business. For example:
- Financial analysis: you should look at how your key numbers are tracking over time.
- Customers: do you have the situation where certain customers take up a lot of your time but are not very profitable for your business?
- Suppliers: examine factors like quality, reputation and cost.
- Marketing: are you meeting your goals for ROI on marketing spend?
- Team: are there opportunities for improvements within your team? For example, training for sales staff.
- Internal systems and processes: how do these contribute to or inhibit profitability? For example, you might note that “X system is cumbersome to use and an expensive fixed cost.”
- Market conditions: what is happening that plays a role in your profitability?
- Competitor analysis: have competitors got any advantage over you, or a weakness that you can exploit to turn into a strength for your business?
Once you have conducted your analysis, you will probably already have some thoughts about how to improve your current state. The idea is that you need to know where you are starting from first, in order to truly take control of your profitability.
Section 2: Improving your customer numbers
Improving your customer numbers will help you to work toward boosting your sales volumes. Most businesses would love to see growth of customer numbers, but in terms of profitability, you don’t want just any customer.
We touched on it in the last section; not all customers will be a great fit for your business. Some customers will take up a lot of service time, but not contribute much to profit. What you really want is high-profitability customer growth. This might be customers who deliver a large volume of your business, but it might also be many smaller customers who require little in terms of resources to service.
There are three important questions to answer here:
- What do we do, and who do we do it for?
- What do those customers really want and how are we meeting their needs?
- Given the answers to the first two questions, what do our ideal customers look like? (You can look at the results from your profitability audit too – this may at least help you to define what those customers don’t look like…)
Advertising is an essential way to reach new customers and boost your numbers, however you can waste a lot of money on ineffective advertising. Many businesses still take a sort of “scattergun” approach to advertising. They push out ads hoping to reach big groups of people, but don’t really target any particular audience. Without being targeted, you run the risk of either appealing no one, or wasting a lot of time on enquiries from customers who are not a good fit.
Know your customer
If you want to be more effective with your marketing spend, then a good place to start is by clearly defining your target audience. Buyer personas are a good tool for doing this. Basically, these define your customers in-detail, including their demographic information, psychographic information and any other details about what appeals to them.
The example shown below from OptinMonster is just one way to define a buyer persona:
With a clear definition of who your target audience is, you can ensure that your advertising is posted through channels where you are most likely to find that audience. There is no sense in wasting money on newspaper advertising if the majority of your target audience are unlikely to read it! You can also ensure that your advertising is designed to appeal to the needs, wants, fears or hopes of that audience.
Know what your customer wants
This is also a good opportunity to examine what you are doing internally. Understanding what your customers really want helps you to look at how you are delivering for them. It’s important to narrow it down to the real problem that your customers want to solve. A mistake that businesses make is to think that they’re solving a particular issue, when the bottom-line problem is something else.
You can see many examples of this in the history of businesses. The railroad companies of America were large and prosperous; many couldn’t imagine that anything would threaten that. However, with the popularity of the private motorcar, they soon saw fierce competition. Instead of improving their services to be more appealing to the public, many slashed services to cut costs. This drove more passengers away from mass transit and eventually, many once-prosperous railroad companies declared bankruptcy.
One of the underlying problems was that railroad executives hadn’t counted the motorcar as serious competition in the first place. They saw themselves as being in the railroad business when, in reality, they were in the transportation business. The problem the customer needed solving was transport, not “catching a train.” Look at what the customer wants alongside solving the core problem (e.g. convenience, comfort, accessibility). This all comes into defining what your customer really wants from your products or services.
Sometimes delivering what your customers want may involve higher operating costs. The railroads opted to slash costs, but this ultimately cost them the business. It’s a delicate balance when you examine profitability. Can you cut costs and still improve customer numbers? Or, will taking a risk on higher operating costs result in better service delivery and more customers?
Deliver excellent service
One of the quickest ways to lose customer numbers is to deliver poor service. In fact, studies show that U.S. companies providing poor service are letting $75 billion per year slip through their fingers.
What does it take to deliver the level of service that will boost your customer numbers? This is another example where understanding exactly what your customers want helps. You can conduct market research or survey your customers to help gather useful data on what they expect from service.
For example, how customers prefer to make contact with a business has been evolving over time. Studies show that many are abandoning traditional methods for newer contact modes, such as via online chat or social media. This doesn’t mean immediately abandoning your phone lines, but it is important to assess how well your service delivery resonates with your target customers.
Efficiency and a strong service delivery rate highly among customer preferences. These are achieved through your customer service staff and through the systems they have to work with. Well-trained service staff is one way to help your customer numbers, but you may have to take a close look at your systems too. Is there anything impeding smooth service delivery?
This might involve some investment in terms of training and business systems. Again, this is something to balance with profitability. It could be that your training or systems give you a strong competitive advantage, or at least put you in a position to match key competitors.
It is worth noting here that looking after and keeping your current customers is a key for profitability. Conventional wisdom dictates that gaining new customers will usually cost you more than keeping your current ones. Make that advertising spend worth it by working to keep customers once you have them.
The added-bonus when you delight your current customers is that you may not need as much advertising spend to bring in new ones. If a delighted customer tells other people about their experience, your business reaps the benefits of word-of-mouth.
Section 3: Tips for improving your sales numbers and fixed costs
Let’s talk sales numbers. There are two ways to improve profits here:
- Increase your total number of sales.
- Increase the average value of each sale.
The caveat here is that an increase in sales may also involve an increase in your variable costs. The aim is that these don’t increase in proportion to your sales numbers, or that you make more per dollar of your fixed costs. (We look at improving margins in the next section, then costs in the last one).
As we discussed in the last section, improving your sales numbers can come with boosting the number of customers you attract, but not always. A common issue in businesses is getting the customers in the door, but failing to close the sale. Why? There can be any of a number of issues at play.
Barriers to closing the sale
Here are a few common barriers to closing the sale:
- The skill of the salesperson. Selling seems to come naturally to some people, while others have to work on it. Regardless, it’s important that your salespeople have regular training to keep their skills sharp.
Whether it’s a fear of failure, criticism or rejection, or difficulty making a connection with customers and uncertainty about the product or service when they do, training and practice can significantly improve the situation. Salespeople need to be able to clearly and effectively communicate the value of the product or service to the customer.
- The customer’s availability. Everyone is busy these days, and it can be difficult to set aside the time to evaluate product or service recommendations. Businesses that think strategically should consider the profile of their target customers. How will you meet their needs in terms of availability?
- Barriers within the sales process. For example, an online process that is difficult to follow or the customer’s preferred method of sales is not available. Data from Hubspot shows that only 29% of people want to talk to a salesperson to learn more about a product, while 62% will consult a search engine.
- The customer doesn’t see the value of your offer. This might be related to the skill of the salesperson, but it might in fact be an issue with your product or service. Sometimes needs evolve. You don’t continue to sell walkmans if everyone is using a music streaming service!
Price can be another issue that comes into the value equation. If you are more expensive than competitors but the customer doesn’t see any difference in quality, you may have to do a better job of focussing on your key differentiators.
Improving your sales numbers
There are many different strategies you can employ to improve your overall sales numbers. A good place to start is to assess your products and services to ensure that they are built to meet customer demand. Some questions to ask include:
- Does this product/service meet the core need/s of the customer?
- Have there been any changes (for example, technological advancements) that we have not kept up with?
- Do competitors offer a similar product at a better price? Do we have any sort of added value over competitors?
- Are there any improvements we can make to better meet customer needs?
Secondly, look at how you are set up to make sales. If you rely upon salespeople to close the sale, do you have well-trained people on-staff? Do they have everything they need to make the sales process as easy as possible? Do they have the skills and confidence to sell your big ticket items?
This second part might include assessing your sales systems and processes too. Have you ever been to a store to purchase an item and found that their system to get to the final sale was tedious and long? This can be enough to put the customer off. It’s easy to say “I don’t have time for this right now” when the process is lengthy!
Include any online systems you have in your overall assessment. Abandoned shopping carts are very common online and a big reason for this can be the checkout process. Some tips to look out for include:
- Simplicity. Is the checkout process easy to follow? Do you have clear instructions showing the next step?
- Concision. Are you only asking for information that you really need?
- Convenience. Are you offering payment options that suit the typical customer?
- Security. Do you have reassurances in place that the customer’s information is secure?
While we’re at it, is your business selling online at all yet? Around one-third of small businesses don’t have a website, while many that do don’t sell from their website. 87% of shoppers begin their search online – if you’re not found online, there’s a high chance you’re missing out on sales.
If yours is the type of product or service where you really can’t close the final sale on a website, make sure you’ve made it easy for customers to get hold of you via your website. Your contact information should be very visible. It’s even better if the customer can get hold of you without leaving the website.
Pricing and competitor analysis is another consideration for your sales numbers. However, any pricing adjustment should be made with some good baseline data to back it up. Many business owners assume they can close more sales by lowering the price, but have you calculated how many more sales you need to make in order to simply meet the same initial profit?
For example, if your gross margin is 30% and you reduce your prices by 10%, you will need your sales volume to increase by 50% in order to make the same profit as before. On the other hand, if you were to increase your prices by 10% on that initial 30% margin, you would have to lose 25% of your customers before your profit reached the same level as before.
Lastly, closing more sales often comes down to having a good follow-up program. Some people will come to you ready to buy, while others are just making enquiries. It’s important that you have a robust system for following up with those people. CRM (customer relationship management) software can be an invaluable tool for ensuring leads don’t slip through the cracks.
Improving the average profit of your sales
Another way you can improve profit from sales is to either sell more of your most profitable items, or sell more items per sale. Many companies put a lot of focus on the initial sale of a core product, but forget about the extras that can boost the value of the sale.
For example, if you own a restaurant, you can maximize your sales by recommending cocktails, desserts, cheese platters or coffee. You don’t just assume that people are done once they’ve finished their main meal.
When you sell products, you think about the extras that might go with that product. Consumable items are a good example, such as toner for printers or anything that requires a refill. A popular business model now is to offer some kind of subscription so that you enjoy recurring revenue.
If you sell online, you can make use of tools such as “recommended with this product” or “other people who bought this also bought…” You might also include special offers in the cart if shoppers choose to add extra items.
How can you increase the average value of your sales?
Section 4: Improve your margins: Inventory and purchasing
Improving your margins is another great way to improve your overall profitability. Your profit margins are calculated using the percentage difference between gross profit (profit before costs are taken out) and revenue (the total amount you received). If you sell a product for $100 and your total costs per product are $40, your profit margin is 60%.
From this, you can infer that you’ll improve profitability either by increasing your sales price or decreasing your costs. We’ve talked about pricing in previous sections, so here, let’s talk about your inventory and purchasing practices.
Reduce inventory costs
First of all, can you find ways to reduce inventory costs without compromising on the quality of your end product? Here are a couple of possible ideas for doing this:
- Buying in bulk. Most manufacturers will offer discounts for bulk purchases as, overall, it doesn’t cost them a lot more to produce a bigger batch. You can negotiate with suppliers to get better deals for bulk purchases. Sometimes you will find that you are offered better pricing the longer you are with the same supplier. Most would prefer to keep reliable accounts and are prepared to offer more in return.
- Invest in a robust inventory management system. How does this improve your profitability? For starters, it helps you to avoid stock-outs, which can cost you dearly in lost sales.
Inventory management issues such as stock-outs, overstock and returns are estimated to cost retailers a massive $1.75 trillion per year. Stock-outs can occur when you miss your reorder window for your products. Your sales velocity may be such that you have two week’s worth of stock left, however the lead time for a new order may be three weeks. This leaves you out of stock for at least a week.
Overstock happens when you overestimate how much stock you will need. The problem with this is that is money left sitting on a shelf somewhere. Your funds may be tied up in products that aren’t moving fast enough – you then end up discounting and cutting into your profitability.
Another issue with overstock is that the shelf space your products are sitting on may be costing you money. Warehousing of goods comes at a price, so if they’re not selling, they’re increasing your costs.
A strong inventory management software helps to take any guesswork out of overseeing your inventory. The best programs are intelligent and notice patterns in your inventory. You get alerts for reordering and alerts for stock that is slow.
- Negotiating with or changing suppliers. A surprising number of businesses just stick with the supplier they’ve always had without trying to renegotiate on pricing. If you’ve been a reliable customer of theirs for a while, it can be worth having a conversation to see if they can cut you a deal.
If not, it doesn’t hurt to check whether you might get a better deal at other suppliers. As long as you’re not compromising on quality, it may make sense.
Assess your products and services
Another way you can improve the profitability of your products or services is to conduct an assessment. You’re looking for your most popular and most profitable items, versus any that are not profitable or popular.
The Pareto principle often applies here: 80% of your profits often come from just 20% of what you offer. This may be an opportunity to drop products or services that are neither popular, nor profitable. (If something is popular but not profitable, assess that too. Are you using it as a loss leader? As long as you have clear data that it is leading to more sales, it may be worth keeping.)
You can also assess whether you can make any changes to how the product is made or how the service is provided to improve profitability. For example, some chocolate companies have reduced the size of their product so that they can maintain the same retail price without losing profitability when costs have gone up. This can also be a strategy to improve profitability when costs are stable.
If you source or sell your products overseas, your profitability can be exposed to currency fluctuations.
There are ways to try to mitigate currency risk and protect your profitability. For example, you might require payment in your local currency, putting the currency risk onto overseas buyers. This won’t help you if you source from overseas though, unless you can make agreements for pricing in your local currency.
Another device you can use is forward contracts on foreign currency rates. This is when you make an agreement with your bank to buy foreign currency in the future at a set exchange rate. For example, if you are purchasing equipment from Germany and you know it will cost you €500,000 in six month’s time, you can sign an agreement today for the rate you will pay. This fixes your costs so that you are better able to budget.
Section 5: Improve your margins: running costs and marketing
Another area where you can improve your margins is to look at your running costs. Both fixed and variable costs may be able to be lowered to improve profitability. We looked at variable costs (those incurred when buying or producing your products or services) in the last section. This time, we’re looking at fixed costs.
Achieving more sales per dollar of fixed costs means improving productivity. Can you get more sales for the same amount of fixed costs? Alternatively, can you lower your fixed costs for the same number of sales?
Assess your fixed costs
When you look at your fixed costs, you’ll usually find that some are discretionary, giving you the option to cut back. For example, you can reduce printing and storage costs by transitioning to a fully-electronic document management system. Other costs will be committed and unavoidable. For example, where you have signed a contract for a fixed period of a service.
Ask yourself three critical questions about each fixed cost:
- What service does this provide us? Can we source the same service at a lower cost?
- Is it feasible to switch providers? Will I get the same service quality and the same or better quality outcomes for my product or service?
- If I were to spend more on this service, would it generate additional gross profit that exceeds the additional cost?
Consider where you might be able to streamline costs. Typically, staffing and travel can be major costs to manage. Thinking about ways to make the most of your spend on staffing can help. For example, can you save on travel and on overheads by implementing a remote work policy? Is there any way you can trim staffing costs, or be more productive for the same costs?
We mentioned your marketing in the second section. Honing your marketing spend so that you are very targeted can both save you money, and get better ROI for the same spend. Outside of paid marketing, look at low-cost methods such as email marketing and social media.
Section 6: How Coker James helps businesses plan for profitability
Business growth and profitability are key goals of companies. The concepts seem very simple, but they can be difficult to action effectively. Your business needs to take a strategic view of profitability, encompassing multiple facets.
Coker James can help with this. We provide services to improve your business performance, preserve your wealth and see you successfully into the future. You can expect quality service from a team with more than 30 years of experience with the financial needs of businesses.
Our services can include things like:
- Profitability analysis
- Tax planning
- Financial reporting and management
- Financial planning and wealth preservation
- Business succession planning.
We can even provide the services of a fractional CFO for those companies that need the expertise of a CFO, but don’t have the capacity for a full-time role.
Some FAQs about Coker James
What types of businesses do you work with?
We typically work with businesses that have annual gross revenue of between $5 million and $300 million. Those businesses may operate domestically within the US, as well as internationally in countries such as Mexico, Canada and the United Kingdom.
Who will I be working with?
An engagement team, including principal in charge, is carefully chosen to address your specific needs. Our principal-to-staff ratio is 1 to 5, significantly higher than the industry standard. This means you receive the highest level of personalized attention, advice and technical expertise. You can be assured that the right people will be assigned to work with you.
What can I expect from working with Coker James?
We seek to build a long-term relationship with you, and will serve you with integrity and innovation. We’ve been able to help our clients identify areas to reduce expenses/increase revenue, plan for expansion and succession, and otherwise improve business performance – all so that they can confidently capitalize on opportunities to grow their business.
How do we get started working with Coker James?
There are three ways you can get hold of us to set up a conversation; call us on 770-916-9900, email us at email@example.com, or fill out our contact form here and we will be in touch.