Potential Challenge – Are Costs Impacting Your Profits?
When “times are good” in business, one of the biggest fallacies that play out is businesses can succeed in spite of themselves. This isn’t a statement directed to any one business, (so we aren’t pointing at you) but during times of growth, it is a lot easier to not pay attention to margins and other key metrics of the business and still succeed. Sales are strong and there is plenty of money in the bank, credit lines are loose, and life is good. Or so it seems…
With unemployment at a 16 yr low, we are entering a potentially dangerous period for employers. The shortage of labor could start a bidding war among businesses from a limited labor pool, especially those skilled in specific areas. That coupled with the rising costs of employee benefits, particularly health care costs and other factors has a lot of our clients concerned about what this is going to mean to their margins as their input costs rise.
The challenge in so many small businesses is they really are not sure what their profit margins are. Their larger publically traded counterparts may not always make the best decisions when it comes to strategical moves, but they usually have their margins calculated out to the .0001% as they are making them!
What do you do when costs impact profit margins?
The simple answer is to raise your prices when your costs go up to maintain a profit margin that keeps your business healthy. But when it comes to pricing, we tend to live in a world where we’ll race each other to the bottom of the barrel with pricing in the face of competition. Even when there is limited competition and margins are shrinking “but acceptable”; businesses are often afraid to increase prices to cover margin lose for fear of losing existing customers.
Improving efficiencies and doing more with less is also is a quick reply to improve profit margins. In most small businesses this is one that usually has a big gap between where they are currently performing and what is attainable. The challenge in this area is it is easy to state one needs to improve their systems and processes but actually doing it is another story. Change usually breeds resistance.
During times of economic growth, most businesses sales are strong enough that even if their margins are shrinking they may get overlooked because the growth in sales offsets the reduction in margin and net profits still look great even though the percentage of profit is down. Sound familiar? Unfortunately, this can be a dangerous trend – and not leave any room for error should things slow down (which they will…).
Know Your Numbers…
There is an old saying that CFO’s and CPA’s love, “The numbers don’t lie”. When it comes to running a healthy business there is a ton of truth in the statement. You really need to know your numbers, your true costs, what your profit margins are. Not just gross profits and net profits, but what your numbers mean in all areas of your business. Unfortunate, what typically happens during good economic cycles is businesses can be sloppy managing their numbers and still be profitable.
We would challenge you that if your business is prospering in this period of growth, now is a great time to dive into your numbers and get clarity on your financials. It is a lot easier making adjustments when there is margin to work with and demand is high than to try and find margin when you’re facing a soft market and pricing pressures from the competition. Get clear on your margins now, when you have a buffer to work with, not when your business is backed up against a wall in panic mode.
Numbers to know in your business…
This varies with companies. But every business needs the basics, a current balance sheet, income statement, and an understanding of their cash flow. Once you have them completed and you’re sure they are accurate, make sure you understand them yourself. There are a lot of business owners who don’t take the time to understand their numbers, you don’t need to know every detail, but you need a good general understanding. If your CFO, bookkeeper, or CPA is not able to explain them in a way that makes sense to you find someone who can help.
Once you get past the basics you can start looking more directly at the margins in each area of your business and start thinking more strategically about your business and the areas you should or should not be focusing your energy and efforts. It also allows you to more strategically think about future projections as well.
What are your thoughts? How are your margins this year? How much are costs impacting them? Are you sure? We would love to hear your thoughts on this in the space below.
Chris Steinlage Kansas City Business Coach