I just don’t get it. We’ve worked our butts off the past nine months growing our revenue, but we aren’t making any more money. Our P&L shows some solid revenue increases, so we’re making money, but the bottom line profit has barely moved. It’s so discouraging. How is it that all this effort didn’t pay off? As the owner, I should be able to figure this out, right? What am I missing? I realize I’m not a financial whiz, but I know my business like the back of my hand. So why can’t we seem to keep more money with all the hard work?
Many business owners are faced with the constant reality of “my business is not generating enough profit” for it to be healthy, sustainable, and positioned to grow. It is really the fundamental challenge all business face at some point in their life cycle.
So how does a business make more money?
The reality is there are many ways for a company to be profitable. So, let’s focus on three solutions that may not be the most obvious or “textbook” ways to improve your company’s profitability.
1.Make Sure Your Employees Know How the Company Makes Money
You won’t find this in any Accounting or Finance textbook, but this is the fundamental catalyst to improving your company’s profitability. Here’s why:
a. You must first know how your business makes money before you can explain it to your employees.
Many business owners are very good at the trade, service or product that the company provides its customers. Often there is an assumption that providing good service at a reasonable price ensures the company will be profitable. In reality, many small-medium sized businesses are not generating enough profit to weather ups-and-downs of the economy or to fuel growth.
But do you really know how your business is making money? Can you explain it to your employees in a way they can understand and remember?
Develop a concise explanation of how your business makes money. Here are a few examples:
- A professional services firm makes profit when the revenue generated from the billable hours exceed the cost of the person doing the work. The firm makes more money when the work is delegated down to the organizational level that costs the least and is still able to deliver a quality work product.
- A restaurant makes a profit when customers purchase enough food and drinks to cover food costs, kitchen staff, wait staff and overhead costs. The restaurant knows that to make profit on a table is when the ticket exceeds $50.
- An oral surgeon’s office makes profit when the amount the patient or insurance pays is more than what it costs to deliver the medical service. The team is willing to provide consultation services, including using advanced 3-D x-ray equipment, at cost so that patients choose more complex procedures that are very profitable.
b. You will create a team of people who are all thinking about how to make the company more profitable
I’ve seen amazing results when employees are let in on the “secret” of how the company makes money. Many business owners are shy – maybe even ashamed – about the idea of making money when interacting with employees.
Instead, you need to be proud when talking about being a profitable company. It means that your company continues to be viable and your employees get to keep their jobs for a long time! Celebrate that, and let your team celebrate with you.
Arming them with the knowledge of how the company makes profit (keeps money) positions the entire team to make better decisions and encourages a flood of ideas on how to keep more. When an employee orders supplies, they will order the one that costs less. They will find ways to accomplish the same tasks that
take less time.
Sure, some of your employee’s ideas won’t be workable or achieve greater profit, but these ideas will fuel new ways of looking at everything about the business. They will stir your mind as well, often allowing you to refine the original idea into something that is effective.
Try rewarding individuals who came up with money-saving or revenue-generating ideas – even if the reward is simply recognition in front of their peers – and you will find a new energy and engagement from your staff.
2.Make Sure the Business’ Products and Services are Generating Healthy Gross Margins
Business owners tend to focus on Revenue (the top line). This is, of course, a critical metric for your organization, because it’s a measurement of the market responding to your products or services.
But to be a sustainable business, the revenue you bring in must generate sufficient Gross Profit /Gross Margin. In accounting terms, you must have healthy Gross Margins on what you sell. This means that the gap between the price you sell a product for (e.g. Sales or Revenue) and what a product costs (e.g. Cost of Goods Sold, or COGS) must be large enough to generate enough Gross Profit to cover all the indirect costs of the business.
We recommend setting a goal of making 50% Gross Margins across your entire product or service line. This means the price charged for a product is twice what it costs you (the product cost $10 so the price charged to customers is $20). It’s common to have a range of Gross Margins across your product line; for example, a more basic product may not generate as high of Gross Margins as a premium product. As long as the mix of products sold delivers an overall 50% Gross Margin level, you should be set up for success.
Once you know the Gross Margins on your products or services, share these concepts with your team and let them know what products generate the most profit and which generate little profit. Encourage everyone to identify ways to sell more of the profitable products and help identify ways to improve the profitability of low margin products. I guarantee they will surprise you with some insightful ideas.
Learn more about calculating Gross Profit, Gross Margins, and COGS by watching our webinar Make Your Business Worth More – Understanding the Basics of Business Valuation
3.Categorize Your Customer Base and Focus On Your Best Customers
A small business appreciates every customer that makes a purchase. But to improve profitability, you need to start distinguishing customers into at least three categories:
- Best Customers – Customers who value your products or services; are loyal or could become loyal to your company.
- Basic Customers – Customers who buy your products but are not especially loyal; the bulk of your customers are typically in this category.
- Bad Customers – Customers who demand price discounts while expecting extra service; they primarily purchase low-margin products.
By categorizing your customers into these three categories, you will be forced to better understand who your best customers are, and what common characteristics they have. Even if you don’t know which group every customer falls into, defining these three types of customers helps you understand your customer base in a new way. With this information, you can discover ways to keep good customers and attract more customers who are like them.
Defining these three groups helps you create a strategy for the organization on how to handle bad customers. It helps you set standards on how employees handle these types of customers to reduce their negative impact on the organization, and how to avoid attracting more of these types of customers.
Engage your employees to identify the groups of customers and how to categorize them. Since they are on the front lines, they often have insights that really help clarify the groups. They will also generate ideas on how to attract “best” customer and avoid “bad” customers.
You can read more about the importance of knowing your best customers here.
Yes, there can be a myriad of reasons your business is not as profitable as you need it to be – overhead costs are too high, staff is being paid too much for work performed, underperforming employees are not terminated, revenue is not sufficient, there’s too much competition in the market.
However, by focusing on the three areas identified above, you will be on your way to improving your profitability in short order. And once your profitability is on the rise, your business will see more success than ever before. You’ll stop asking yourself “Why doesn’t my business make enough money?” and start asking “What should I spend this year’s profits on?”