Photo by Megan Rogers Photographie
Q. How do I maximize the profits in my business?
A. I love to ask small business owners the question, “How profitable should you be?” I often get quizzical looks followed by smiles. It is a liberating question. It takes the entrepreneur back to the early days of planning their business, when everything was exciting and possible, when profitability was the plan. It reminds us that profitability is a goal, not just a result.
The answer? It depends on the type of business, the location, and the economic environment. Most net profitability percentages average between 5-10% of sales. Think of it like a report card:
What do I do when I meet the small business owner who is driving 20% of sales to their bottom-line? I shake their hand because it is not easy to do.
Focus First on Your Business Model to Improve Your Grade
1. Start in the middle. Look at the middle line of your P&L, your gross profit. Your gross profit is the amount of money you make on each sale.
Sales - Direct or Variable Costs = Gross Profit
· Are you perfecting pricing? Perfecting pricing requires aligning the market and customer perceptions with your business model.
· Are you discounting too frequently? Small business owners discount too frequently out of a misconception that discounting equals value.
· Are you managing your costs? For the retail business, this means understanding your true cost of goods sold. For the service business, this means getting good at estimating time and managing labor.
If you are averaging a gross profit margin of 45% as a percentage of sales, but the industry averages 60%, it doesn’t matter how hard you work, your business model is broken and profitability will be allusive.
2. Turn, turn, turn. If you have dialed in gross profit, the key to increasing profitability is either increasing sales transactions or reducing inventories, or a combination of both.
For the retail business, this means focusing on inventory turns, defined as cost of goods sold divided by inventory. For the service business, this means turning direct labor hours. Just like profitability and gross profit margin, turns can be benchmarked to the industry. If you’re turning at a lower rate than the industry, the question is why?
Low Turns are caused by
· Low Sales
· Poor Purchasing / Poor Estimating Time
· Obsolete Inventory / Overstaffed
If your business model is humming with good margins and turns, looking at your fixed expenses is the next step. It is possible you are misallocating resources and this is negatively impacting profitability. The key is to keep asking the question, “How profitable should I be?”
President, Flow Capital LLC
Professor Entrepreneurship, Washburn School of Business