In the last blog posts, we talked about ways to improve your top-line revenues through marketing and sales. In this one, we will discuss the next level…BOTTOM-LINE profits. Dreaming of huge revenues is wonderful – but only if you have profits at the end and the ability to take some money home!
Profits are broken down into two distinct areas – gross profits and bottom-line (net) profits.
GROSS PROFITS – Gross profits are calculated by subtracting the Costs of Sales from Revenues. Most businesses have a cost of goods sold (COGS). For example, if I buy widgets at wholesale for $5 and my salesman sold you a widget for $10, I didn’t make $10. At the most, I only made $5 to cover the rest of my overhead. Why “at most”? Perhaps my salesman gets a $1 commission for each widget she sells, then I really only made $4. There may be other costs associated DIRECTLY with the volume of widgets sold that I should also consider putting into the “cost of sales” rather than overhead. Basically, any costs that you would not have to incur if you did not make a specific sale should go into COGS. If the cost is one you would mostly incur anyway even if your sales were to drop, then that is considered Overhead Cost.
So, how do you increase your gross profits as a percentage of your sales?
- Increase your prices – When was your last price increase anyway? Do you reevaluate the prices you charge your customers on a regular basis? People respond acceptably to small price increases over time, but tend to look at the competition when large increases happen no matter how long it has been.
- Decrease the expenses in your costs of goods sold – Walmart is famous for its “Roll-Back” pricing strategy. This is only made possible because they are constantly re-evaluating their vendors and finding small “nickles and dimes” that can be saved. Do not make the mistake of treating your vendors in a way different than you would want to be treated. However, the best vendors want to participate as your partner is keeping you competitive. Have you asked them to help you with that lately?
The Gross Profits that you earn will have to be sufficient to cover the Overhead Costs you have PLUS provide a proper return for the owner (Remember to treat any “work” you do for the company as a part of the Overhead/COGS costs. Proper return for the owner should be planned for in excess of that pay.)
BOTTOM-LINE PROFITS – Bottom-line profits are calculated by subtracting Overhead Costs from your gross profits (discussed above). Your overhead costs are generally fixed costs that don’t vary directly with your sales volume (e.g. rent, utilities, salaries, etc.) Every overhead line item on your financial statement should be reviewed to see where you can cut costs! In addition, budgeting or benchmarking to other similar companies can really come in handy to keep you from making decisions by the feel of the moment. Think about it- when should you go to the grocery store? When you’ve just eaten or on your way home before dinner? Even the best of us can be swayed into spending lapses of judgment. A written budget that holds our own feet to the fire is a great defense.
In summary, to maximize your bottom-line profits:
1. Be sure to know the difference in what expenses should be classified as COGS and which should be classified as Overhead.
2. Maximize your gross profit percentage by raising prices and/or negotiating with vendors.
3. Know the “standard” numbers in your industry to see if you are on-track. We can provide benchmark information if you want to see what other people in your industry are doing.
I know that this stuff isn’t the most exciting stuff to engage in, but if you do have a clear understanding of how your business works and what the numbers mean, your decisions as a business owner become much smarter.
In the next post, we will discuss ways to improve your cash flow! Until then, don’t hesitate to contact me, Michael Andersen, at Essentia Business Advisers for more information on how we can help you and your business!