Business Lesson: Calculating the cost of Mistakes
Mistakes are part of life and part of business. Some of the biggest lessons learned come from mistakes. We can all agree on that. However, in business, excessive mistakes can not only be costly, they can potentially destroy the company. We have to learn from our mistakes…or run the risk of repeating them.
In many of the recurring functions of business, mistakes are often the results of not following (or not having) established procedures or processes. In most cases they are avoidable mistakes. Examples of this would be errors in billing, shipping errors (sending a dog to the wrong country), sending a tech to the incorrect address, and so on. Any example like this is going create a situation that will require resources from the business to correct the mistake and the business will not be able to charge for it. It is unbillable labor and/or materials and over time it can end up costing a business a lot of money.
The cost of mistakes…
Businesses have different ways of tracking these mistakes; unfortunately, we have found one of the most popular ways is to not to track it at all. For companies who are serious about it, they may have a targeted % of sales or other metric they monitor in this bucket on their chart of accounts. Though there are a lot of nearly perfect businesses out there (I am sure yours is one!) we have yet to hear of a business that doesn’t make the occasional mistake. Mistakes happen and if you want to have a place to track them the best place is a line item on your financial statement.
The bigger issue is how many businesses value this dollar amount at the end of each month, quarter, or year. They completely undervalue the impact it is having to the bottom line profit of the company. A business may see that number and view the impact of that amount as whatever the dollar amount is; be it $1,000, $100K, $1M, or $5,600. But, that number is only part of the story and doesn’t get to the real impact.
The rest of the story….
The problem is that these mistakes come right out of your bottom line. Those dollars were part of sold work and were already part of the bottom line profit of the business, think of them as literally in your bank account. So if the amount is $5,600, unless your profit margins are 100%, the impact on the financial health of your company is significantly more than that single dollar amount. Since your customers aren’t going to be paying you for resolve these mistakes, the only way you can replace that bottom line profit is with additional sales of your product or service. So depending on your profit margins, that $5600 can take on a whole new meaning.
The quick calculation…
Loss Amount / Profit Margin = Sales Required to recover from the mistake
To put that into perspective using the $5,600 amount, a business operating with a 15% margin it is going to need $37,333 in new sales just to get the business back to where it had already been financially had these mistakes not occurred! That starts to feel a lot more significant…
If you have an employee profit sharing program, the next $37,333 in sales will just get them back to where they already were prior to the mistake. And by the way, while you’re fixing those mistakes, you are using resources that would better be spent growing your market share and selling additional products or services. The mistake is also impacting your ability to grow your business. It’s pretty easy to see that the cost of the mistake is much greater than that original number that you had to write off.
You’re not going to be able to run a mistake-free business, but what you can do is track those mistakes, figure out what caused them and start implementing systematic ways to guard against future versions of those same mistakes. You’ll still get new ones along the way, but that’s a lot better than getting new ones plus repeating the old ones…!
So what do you think? Does your business track the cost of mistakes? Have you ever thought about the total cost of a mistake? Do your employees understand how preventable mistakes impact the health of the business? How it can affect a profit sharing program? Do you consistently review mistakes and look for ways to prevent them in the future? As always we value your thoughts in the space below.
Chris Steinlage Kansas City Business Coach