A few months ago, we talked about inflation-proofing your business in the face of nearly 8%. In the past week or so the annualized rate was identified as being above 9%! While the tips we gave on making your business more resistant to the detrimental effects of inflation apply more than ever, the issue of business profitability bears more scrutiny.
Are You Even Profitable Now?
The first thing to consider is if your business is actually profitable to begin with. Many people make the mistake of assuming that their business is doing well just because they have a steady stream of revenue. But the simple fact is…revenue does NOT equal profits!
To identify your profit margin, you use a simple equation:
Profit Margin = (Total Sales – Total Expenses) / Total Sales
To put it in basic terms, take your total sales, subtract your total expenses, then divide that number by the total sales number again. This will give you a number that is your percentage of profit margin. So if your total sales for the month are $10,000 and your total expenses are $6,500, your profit margin is 35%.
What is a “good profit margin?” That is going to vary by business, but a healthy profit margin for a small business if 7 to 10%. Keep in mind that that number can vary wildly by industry, so it’s important for you to determine what other businesses in your segment and your geographical area are doing. You probably can’t just ask your competitors, but some research should give you a general idea.
Why Does Your Profit Margin Matter?
Figuring out what your profit margin currently is will help you in a few basic ways as you navigate the business world. First, it helps you to price your offerings appropriately. If you aren’t making a healthy profit margin, the core problem could be that you are undervaluing your goods and services.
Second, it can alert you to some of the costs of doing business that have gotten out of hand. If your overhead or cost of goods sold has gone up dramatically, it’s going to affect your margin quickly and you need to be able to respond in some way.
Also, if you want to grow your business you need to know how much you can put back into it. Maybe you want to open a new location or feel the need to add more employees. Knowing what kind of profit margin you currently have can help to determine when you are able to do that.
Last, if you are looking for investors or a potential buyer for your business, a healthy profit margin is something they will want to know. Don’t go into a conversation about money without being armed with the basic facts.
How Can I Maximize My Profits?
After you’ve determined what your profit margin here are a few things you can do to help increase it:
- Cut Costs. How much are you paying for office, manufacturing, or warehouse space? What can you do to cut down those costs? Would moving to a smaller warehouse or an office without a “prestigious” address save a significant amount of money without incurring more costs somewhere else? How can you reduce your monthly utility and insurance bills? Examine your regular monthly expenses and see if there are expenses that are simply unnecessary and can be cut.
- Increase Revenue. Yeah, that’s simple to say, but there are 3 basic ways to do this. First, charge more for what you already sell. This goes back to undervaluing your goods and services. If you aren’t charging enough, you might sell a lot, but your margins are still taking a beating. Second, sell more goods and services to the same customers. This may take the form of upselling or cross-selling to those customers whenever you have the opportunity. For a retail or restaurant that will mean whenever someone is physically there, but it also could mean sending out marketing emails with purchase incentives or announcements about new products and services. For an office environment, it means reaching out to current and past clients to see how you can help them now, as well as having handy cross-sell lists whenever a sales person is on the phone with a valued client. Last, expand your customer base. Find ways to reach out to the customers of your competitors and get them to talk to you, or expand your reach to a larger geographical area if you can.
- Make Cuts. If a services or product isn’t helping your profit margin, maybe it’s time to just stop offering it. It really doesn’t matter if it’s something you are passionate about or not. For example, in a retail environment, every product has to “pay rent” for the shelf space it sits upon. If you are in love with the product, but no one wants to buy it, it really isn’t doing you or your business any good…discount it, get it out the door, and replace it with something that will help your bottom line!
- Customer Incentives. This could be a subpoint under a subpoint in the “Increase Revenue” section, but there’s enough to say that I thought it deserved it’s own point. Your loyal customers are far more valuable than the typical “man off the street” who walks into (or calls) your business one time…make sure they know that! It’s hard to find a big business today that doesn’t have some kind of “Frequent Buyer Program.” People love to get discounts or dollars off for spending a certain amount…and it gives you the ability to track individual customers, see what they buy, and market specific products or service to them in a more aggressive way. You may also consider giving them some kind of incentive to give referrals and Google reviews. Word of mouth between friends is one of the most powerful ways to get new clients and when people can’t find someone who knows someone, they often turn to the world’s largest search engine.
- Engage Employees. For a lot of you, employees are like family, so you don’t want to have to cut back…laying someone off because your profit margins aren’t good enough is not going to be a good day for either side! A better way to handle it is to give them a reason to help the business grow the margins. Be as transparent as you can with them about how the business is doing (understandably you can’t tell every employee every business secret) and explain how they can help the company do better. Then give them a reason to do so! “If you want to keep your job, you’ll do this!” isn’t the most effective way to communicate this, though…that may just give them a reason to jump ship and go to a competitor. A better way to approach it might be to say, “If we can increase this quarter’s profit margins by ‘x’ amount, there will be a bonus for everyone.”
- Recurring Revenue. One of the best things I’ve done in the past is a coffee subscription through that big online retailer. I know I’m going to drink a certain amount of the magical brown elixir every morning, so instead of putting it on the grocery list, I set it up to auto-deliver my favorite brew every month. For me, I don’t have to worry about if I have my wake-up juice…for the retailer, they are certain about the $35-40 a month that they will collect from me. What do you have in your business that you can set up for recurring payments? A local retailer might offer a similar subscription service, either to be delivered or available for pickup every month. A restaurant might have a “club” that charges a customer’s card every month for a set amount to be spent…and then you incentivize that “club” by giving them a discount on purchases (see #4 above!). If you sell bigger-ticket items, maybe you give customers the option to spread payments over 6 months or a year. It gives them a lower monthly outlay while giving you guaranteed income for that time. (But try to make sure you have a way to auto-charge their card each month so you don’t have to bug them for payment on something they’ve already received.)