Most companies do not have large, single areas in their businesses where money (potential profits) pours out every month- I call those “large profit holes.” Big problems are so alarming and have such an obvious impact on a business’s survival that these types of problems are usually addressed and fixed quickly. That’s great.
But on the flipside of this, most companies I’ve dealt with have many small profit holes that money trickles from every single month. Taken individually, none of these holes have a tremendous impact on the business. But collectively, they amount to a small fortune! In many companies, these little holes cost them more money than the companies earn in profits each year! That’s important; Let me say it again: These little profit holes needlessly cost business owners more money than the business profits every single year! For every dollar these companies profit, at least a dollar is figuratively being thrown in the trash!
If you want to dramatically increase your profits, identifying and plugging the many little profit holes in your company will help you greatly. If your business is currently not profitable, or worse, then this is a great place to begin to turn that around.
Wouldn’t it be nice if you had only one place to look to find every single profit hole in your company? Well, I have great news for you- that place does exist! It is your company’s income statement (profit and loss statement, also called your P&L). If you can pull up your company’s P&L detail report, you’ll see where every single penny comes in and goes out of your business. If you don’t have the ability to do that, you need change that immediately by scheduling an appointment with your accountant. Having sound financial statements are critical to running any business.
The very top line of your income statement is “Income” (from sales). The bottom line is “Profit” or “Loss.” Everything in between is where you’ll find the profit holes! I’ll give you an action step later that will return you to your own income statement, but for now, I’ll outline some typical sections in your P&L where you just may find many profit holes. I’ll also give you a series of questions for you to ask (and have answered) to determine which of these areas contain profit holes in your own company. Most importantly, though, these questions are provided to you as a guide to show you how to dig-deep with your own questioning of each line on your income statement.
Let’s start with the top of your income statement: “Income,” which comes from sales.
Here’s a few important questions that you should ask yourself: What would happen if you increased your pricing by just a little bit? Would you lose clients? Would a loss in clients necessarily hurt your profits, or would the price increase make a tremendous, favorable impact on your profitability?
Some people don’t easily recognize how even a slight increase in pricing can have a significant impact on your profitability. Please consider this:
Pricing for Profitability
In 2012, you sold widgets for $1.00 each. The total net cost to you (all overhead considered) was $ .95
SALE PRICE: $1.00
YOUR NET COST: $ .95
NET PROFIT: $ .05
NET PROFIT MARGIN: 5%
If annual sales were $1,000,000, then your net profit would be $50,000 (5%).
In 2013, you decided to sell these same widgets for $1.03. The total net cost to you (all overhead considered) is still $ .95
SALE PRICE: $1.03
YOUR NET COST: $ .95
NET PROFIT: $ .08
NET PROFIT MARGIN: 8%
Assuming you lost no customers due to your price increase, then sales will be 3% higher in 2013 over 2012 (all other things remaining the same). That means, annual sales that were $1,000,000 automatically go up 3% to $1,030,000. Your 2013 profit margin went up to 8%, so your 2013 profit would be $82,400. An increase in net profit of $32,400!
Let’s presume that in 2013 you lost 20% of your customers due to your $ .03 increase in pricing…
$1,000,000 x 80% = $800,000 x 1.03 (that adds your 3% price increase) = $824,000 in annual sales.
$824,000 x 8% net profit margin = an annual profit of $65,920.
SO HERE’S THE QUESTION…
“Would you rather earn $50,000 by producing $1,000,000 in work, or would you rather earn $65,920 on $824,000 in work?”
I know the answer to the question is obvious. It’s far better to do less work for more profit than to do more work for less profit. So what stops people from increasing their prices? In a word: Fear.
As business owners, sometimes we actually negotiate against ourselves and set our pricing too low. Then we get stuck thinking that our customers will not be willing to pay us more; even as our own costs of doing business go up!
Listen, you may be right. Maybe your customers will ditch you for someone else if you raise your prices. But you owe it to yourself and to your company to at least have the courage to test that theory before you sell yourself on it.
Here’s your first action step: Meet with your executive team and review all of the pricing you currently have in place. Again, by printing out the detail report of your P&L, you’ll be able to see the unit price of everything.
Challenge yourself to find opportunities to increase pricing; even if it takes you a little bit outside of your comfort zone. From experience, I can tell you that more times than not, I’ve seen business owners make slight increases in their pricing and not lose a single customer because of it. Of course I can’t guarantee that for you, but I do encourage you to test the market from time to time instead of constantly negotiating the best deal you can for your customers.
To be clear, I’m not advocating taking advantage of your customers. But I am asking that you reconsider what it means to have a win/win relationship with your customers. Right now, you may have put yourself on the losing end of what should be a win/win relationship.
Now we’ll go down to the lower portion of the income statement; “Expenses.” NOTE: THE FOLLOWING AREAS I’LL COVER MAY OR MAY NOT BE RELEVANT TO YOUR BUSINESS. THE POINT OF THE QUESTIONS THAT FOLLOW IS TO SHOW YOU HOW TO QUESTION EACH OF THE EXPENSE LINES ON YOUR OWN COMPANY’S INCOME STATEMENT. THE POINT IS TO “MODEL” HOW TO DO IT, SO PLEASE DON’T WORRY IF THESE EXAMPLES AREN’T RELEVANT TO YOUR OWN BUSINESS.
Let’s start with the line item that typically is the most expensive for a company; personnel costs (labor).
Personnel costs (or labor costs) are all of your costs associated with employing people. Here is a sampling of the questions you and your senior leaders may want to answer together relative to personnel costs:
- What are our total personnel costs (dollar volume)?
- How much do we invoice (sell) per employee (total sales revenue divided by the number of total full-time equivalent employees)?
- How can we increase that number?
- What is our labor ratio? (total labor costs divided by total sales)
- How can we reduce that number?
- How much overtime are we currently paying?
- Can we reduce overtime through smarter staffing and/or scheduling?
- Go through your employee roster and one-by-one, ask (and candidly answer), “Is this person earning too much for what they bring in the way of company benefit / profits,” or, “Are we overpaying this person?”
- Is our benefits package competitive, or is it too aggressive or too conservative based on comparable positions in our industry?
- What are the different health insurance options available to us?
- Who are our strongest players?
- Who are our weakest?
- What can we do about that?
- Could we produce the same quality and level of service for our customers if we had one less person on our payroll?
- Are our salespeople making us money or are they costing us money?
- Where else do we have “fat” in our labor and labor costs?
If applicable to your business, “Brokered Work” is another line on your income statement. Brokered work is a product or service that you sell, but don’t produce in-house. Another way to state that is; it’s the work that you re-sell. Here are the questions that need to be answered:
- How much are we marking up brokered work (what’s our profit margin)?
- Can we increase that margin and still be competitive?
- When is the last time we researched new sources to produce the work we broker?
- Are we competitively bidding brokered work to different vendors?
- Are we brokering so much that we should consider bringing manufacturing of those products or services in-house?
- Are the orders we’re brokering really worth the effort, or should we scale back, broker less, and focus more on our core products / services?
Equipment / Equipment Repair are the costs associated with the purchase, lease, and repairs of your production equipment (if applicable to your business). If you have production equipment, here are some questions that need to be answered:
- Do we have the right equipment for what we do, or are we using older, less productive equipment that is cheaper but is causing our production labor costs to be out of whack?
- Are our team members properly trained and are they using the equipment in the most effective manner?
- Are there any features on our equipment that would help us a lot but we don’t use them because we don’t know how?
- What are the costs vs. benefits (relative to labor costs) if we buy faster equipment?
- Have we bought state-of-the-art technology when we don’t need all the bells and whistles? Could we buy a comparable piece of equipment without the features we don’t need and therefore, save money?
- Should we consider buying used equipment instead of new?
- Should we consider buying new equipment instead of used?
- Are there any pieces of equipment that we’re holding onto that are now obsolete for what we do? Can we sell it or trade it in?
- Do we consistently bid our equipment purchases to multiple vendors, or have we limited ourselves by being overly loyal to just one vendor?
- Would service agreements save us money in the long run?
- Are service agreements costing us more than if we just paid for each repair as it became necessary?
- Are we paying excessively for after-hours service contracts when we don’t really need them?
- Should we be taking advantage of after-hour service rather than having the equipment down and losing production time?
- Should we train one of our own employees to be able to service our equipment?
- Are there areas in our business that we could automate with new equipment that would provide a return on investment greater than doing these jobs manually?
- Would we be better off outsourcing functions rather than paying huge fixed costs for equipment that’s rarely used?
Production Supplies are the supplies needed to produce your products. If you purchase and use production supplies, then please ask yourself the following:
- Are we competitively bidding these purchases or just sending blanket purchase orders over to vendors we’ve used for a long time?
- Where do we have excessive production supply waste?
- Do we lose supplies due to damage?
- Are we keeping good inventory on-hand, or are we running out at the last minute or paying rush-service fees to get supplies delivered same-day? How much production time are we losing due to poor supply inventory management?
- Are we tying up cash and valuable work space by ordering too many supplies at a time?
- Are we taking advantage of volume purchases and fast-pay discounts?
- Are we buying inferior supplies in an effort to save money but end up costing us more money due to projects having to be re-run or returned by our customers?
- Can we find less expensive products that would accomplish the same thing as our existing, higher-end supplies?
- Do we have too many people making the purchases to the point where we’ve lost control over purchasing?
- Are we still using vendors that consistently deliver late and send us wrong orders?
- Are we considering the necessity of specialty supplies when quoting customer projects?
- Do we have proper supply inventory tracking, or is there a chance some of our stuff is “walking out of here?”
- Can we buy our supplies from online sources, such as e-bay?
Sales and Marketing Expenses are the costs associated with selling or marketing your products or services; including advertising. Please ask yourself the following questions:
- After analyzing our advertising costs, are we certain we’re getting an appropriate return on our investment?
- Do we track the results of our advertising?
- Is our advertising message fresh and relevant, or are we simply using old artwork over and over?
- Are we negotiating to reduce our marketing and advertising expenses, or simply paying sticker price?
- Are our salespeople getting great results and earning us money, or are we throwing money away on paying salespeople that aren’t getting results?
- Do we have a thoughtful sales and marketing plan?
- Are we marketing to the right demographic, or are we simply sprinkling marketing money around in the same places we always have?
- Do we belong to associations that we don’t even attend or that don’t get us results?
- Are we providing our sales people the correct sales training they need in order to get better results?
- Should we hire another sales rep?
- Should we consider using an independent rep?
- How do our sales and marketing efforts compare to our best competitor’s?
Automobile expenses are the costs associated with either company owned vehicles or personal vehicles that are used for company business and require reimbursement to the owner. If you have company vehicles or if you reimburse your employees for using their own vehicles, then please ask yourself the following questions:
- When is the last time we looked into other vehicle options for our company vehicles? Are we simply buying the same vehicles we’ve always bought, or are we making sure we’re not over or under-buying?
- Do we consider fuel efficiency when choosing our vehicles?
- Are we properly maintaining our fleet? Should we consider outsourcing fleet maintenance?
- Do we provide our drivers GPS or are they still printing out from Mapquest or using a map (causing wasted time)?
- Are we properly controlling the use of our company gas card?
- Are we paying employees mileage reimbursement when it would be less expensive to just buy another company vehicle?
- Are we paying for company vehicles when it would be less expensive to pay reimbursement to our employees for using their own vehicles?
- Do we have the proper amount of insurance on our vehicles? Is our deductible where it should be?
- Do we understand the potential liabilities from the use of personal vehicles?
- Have we invested in driver safety training to protect our drivers and reduce our insurance costs?
- Are all of our company vehicles safe (including good tires)?
- Are we taking advantage of our company vehicles for marketing benefits (decals, vehicle-wraps, signs, etc.)?
- Are our company vehicles kept clean inside and out?
- Do we perform preventive maintenance, or do we just wait until something breaks?
- Have we made sure all our drivers have a valid driver’s license?
- Are our company vehicles being used for personal reasons by our employees?
- Do we have written policies regarding the use of company vehicles?
- Do we drug and alcohol test our drivers?
- Are we following all local, state, and federal laws regarding our vehicles?
- Should we look into GPS vehicle tracking to have better accountability of our vehicles’ whereabouts throughout the day or night?
Okay, those are several questions from just six lines that you may find on your own income statement. There are literally scores of other lines that will require you to review in detail as we’ve done here.
Here’s your action step: Schedule a meeting with your executive team with the objective of identifying and filling the many little profit holes that money pours from each month at your company. I suggest you set a revenue savings goal as well. For example, if your total annual expenses (from last year’s income statement) are $3,000,000, then you could set a goal of reducing expenses by 3.5%. 3.5% of $3,000,000 equals $105,000! That’s not just $105,000 in reduced expenses; remember that every single dollar in reduced expenses (all other things remaining the same) equals a dollar for dollar increase in your net profit! And those savings carry over from year-to-year, further compounding the return on your investment of time.
Just think how much of your product or service you would have to deliver to increase your profits so significantly!
If the six areas of your income statement that we addressed today are not relevant to your particular company, just look at your own income statement and do the same thing we did here. Ask as many thoughtful questions as you can about each purchase indicated on your income statement to make sure you’re being as smart as you can be with your money.
The next time your executive team convenes, go line by line through your own income statement and ask as many thoughtful questions as you can about each line as I did in the examples provided.
As you answer those questions, action steps will be developed and assigned to the different members of your executive team. As you know, results don’t come from great planning alone; they come from executing your plans, measuring the results, and adjusting your plans when necessary.
This will take a considerable amount of time, effort, focus, and discipline, but you can do it. And the outcome could be a significant increase in your annual profits and in your company value.
I wish you all my best!
Review / Action Steps
- Consider raising your prices: Meet with your executive team to reconsider your current pricing. Is there a chance you may be leaving money on the table? When is the last time you raised your pricing? What are your competitor’s charging? If you determine that you should raise some of your pricing or all of your pricing, go ahead and do it! And remember, every penny of that increase will directly impact your net profit margin significantly. Even slight price-increases can have a significantly favorable impact on your net profits and profit margin.
- Meet with your executive team to analyze and question every single line on your company P&L to see where you may be able to make smarter purchasing decisions and therefore, increase profitability through reducing costs or increasing efficiencies. This will take a significant amount of time. Please don’t rush it! Take your time, be creative, and be open to doing things differently than you have in the past. Remember, if you want different results, you have to change your thinking and your processes. This is well worth the effort!
Everyone knows the value of money and of positive cash flow. But as business owners, we sometimes tend to negotiate against ourselves when it comes to pricing. Likewise, we occasionally neglect to reconsider all the areas where we spend our money. We assume that we’re doing the right things with our money, but without a periodic self-audit, it’s only a matter of time until your company has many small profit holes that cost you a fortune each year.
By using your executive team to assist you in identifying and then planning, executing, measuring, and adjusting your pricing and cost reduction measures, a couple things happen. First, you’ll increase your profits by increasing your sales margin and by reducing costs. The second thing that happens is that your executive team members will become more profit-conscious. This initiative will really open everyone’s eyes to how modest adjustments can have such a significant impact on your company’s profits and profit margin.
You and your team work too hard for your money to allow any of it to be squandered away. By taking action now, you can immediately begin to grow your bottom line.
© Copyright 2013 by Jon Denney