Why More Money isn’t always More Money…

 

photo by Tax Credits via Flickr

photo by Tax Credits via Flickr

I met with a business owner last week who had a record year for revenue last year.  He worked really hard, he spent a lot of time and effort on sales and marketing, he aggressively went after any opportunities he could find and if any customers wavered on sticking around he gave them a great deal so they would stay…even the ones that complained all the time and required a lot of extra work.

Final result for the year?  He was up 25% to 30% in Revenue during a tough year.

Great success, right?

If you dig a little bit deeper, it turns out that his bottom line…the money that he actually was able to take home was basically flat from the year before.

He worked a lot more hours, hustled more than ever, sold more than ever, but none of that translated to his personal bank account!  On the Effort vs. Success chart – he basically just went straight up…more effort but no additional success.

Focus on Profitability…

This business owner fell into the trap of focusing (almost exclusively) on revenue growth.  Revenue is easy to track, it generates the illusion of success and it’s easy to talk about. But it’s not a good measure of success…unless your goal is to work more and make less per hour!

Here’s a quick exercise to help make the point. Let’s keep the math simple and look at a business that has a flat $1 Million in revenue and a profit of 5% – so the business owner is taking home $50,000 on that $1 Million worth of work.

However…let’s imagine that this business owner opts to try something different and they cut their revenue by $100,000 and now they are only making $900,000 for the year…but their profitability is 10% – which means they are taking home $90,000 and doing 10% less work than they were before!

In fact in this example, the business owner could do ½ the revenue / work and still earn the same $50,000 (10% of $500,000) – it’s an extreme example, but it’s not crazy.

Maybe you’re making more than $1 M in revenue, or less…or maybe your business or industry can’t support 10%, 20%…30% profit, the numbers change based on your situation, but the overall principle is the same – higher profitability is always going to be a better indicator of success than revenue growth.

How to Drive Higher Profits

Driving higher profitability is simple…although definitely not easy. There are only a couple of levers you can pull that will translate into higher profits, here’s the high level view:

  1. 1.       Raise your prices – if everything else stays the same, any time you raise your prices that extra money you’re charging will flow directly to your profitability…your bottom line.  Raise the price of a product by 10% and every penny of that becomes more profit for you. Note – by raising prices, you may sell less, but the odds are good that you’ll still be ahead in terms of bottom line (see example above).
  2. 2.       Cut cost of delivery – Almost all businesses have some sort of variable costs. If you’re making widgets, your variable cost includes the raw materials, some labor costs, etc. If you’re delivering a service, then your primary variable delivery cost is going to be labor. Can you find a cheaper way to deliver your product or service? If so, those savings will flow through as more profits.
  3. 3.       Cut your overhead costs – Your final option to drive higher profits is to cut your fixed costs…your monthly overhead. This includes stuff like your rent or mortgage, any staff that aren’t directly involved in delivering your service, office supplies, etc.

That pretty much sums up your options – again it’s simple but not easy.

Strategically I’d suggest you try these 3 ideas…and sooner rather than later:

Drop your worst clients – Almost every business has a bottom tier of clients who are difficult to deal with, pay late, complain and constantly push for the best deals.  These are the clients that are killing your profitability and if you could lose the bottom 10% you will be better off in a lot of ways, including profitability.

Do a cost audit – Do a line by line view of your expenses…compare them to previous years and see if there’s any big line items that jump out at you as not being critical or necessary.  What can you cut?

Raise your prices – I know it’s obvious, but I also know most business owners need to do this more.  If you haven’t raised your prices in a year or two, then you likely need to bump them up – unless you are consistently losing business due to your price, then you have room to grow…and even then you could look into increasing the value of what you offer.

What can you do to improve your profitability? Is it something you’re consistently focused on? We’d love to hear your thoughts – share them in the comments below.

Shawn Kinkade  Kansas City Business Coach

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