By Sue Hirst – Director, CFO On-Call
Have you ever wondered why your business isn’t as profitable as you would like and keeps running out of cash?
Despite your great efforts at making plenty of sales… it just doesn’t seem to end up on the bottom line!
The problem is the big gap between sales and profit. The gap is filled with costs and overheads.
Costs are the ‘direct costs’ of producing your product or service e.g. purchase of stock, packaging, freight etc. If you’re in a service or jobs business, it’s the labour and materials to produce the job.
Overheads are the general day to day things like rent, wages, stationery etc.
The place to begin ensuring a profit, is with Costs. Until you know exactly what it costs to produce an item or a job, it’s very difficult to work out what you should charge to cover them. It’s tempting to just follow competitors and charge the same, the problem with that is how do you know they are making a profit? They may get the business for a while, but will they still be in business next month or next year?
If you really can’t avoid competing on price, one option to be competitive might be to produce the item/service at the best possible cost. Look long and hard for ways to produce in the most efficient and cost effective way. How can you minimise cost without compromising customer experience too much?
Another option is to let customers know why your product/service is better than competitors and therefore why they should be happy to pay a commensurate price for the quality. Make the invisible, visible… If there’s something you do that ensures a better quality item/job let customers know about it!
Once you’re confident you’ve got control and a fair amount of certainty about costs you’re in a great position to work out what margin you want to achieve and set your price to achieve that.
Once you’ve set your price it doesn’t end there! You need to constantly review information about gross profit to keep your price at the right level to achieve the right level of profit. Constant monitoring of costs is necessary to ensure you maintain the margin you need to ensure a profit.
If you’re delivering a service or job it’s desirable to have a budget or quote of what you think the job entails before you start (this is usually driven by customers, and should be undertaken for the benefit of the business too). Once you’ve done one you also need to enter the actual transactions against the budget/quote (preferably in a simple system providing a budget versus actual report), so that you can see where things went right/wrong and learn for the future how to improve profit.
The next step in the gap is Overheads. Some businesses end up with so many overheads, it can be a real headache to keep track of them all. A great place to start managing them is with a Budget. It really pays dividends to spend some time thinking about what overheads you need to incur to run your business, rather than just spending money willy nilly without any plan.
Once you’ve put together a budget you can enter it into your accounting system and run a report every month to compare actuals against the budget, to see where things are on/off track and fix it quickly to avoid further losses.
Another great tool to help you manage overheads is ‘Purchase Orders’. This is a simple form that everyone has to complete before they spend any of the business’s money. You can set a limit of say everything over $100 requires a Purchase Order, signed by the business owner prior to ordering/spending. It may seem time consuming, but if it saves you thousands of dollars it’s a well worthwhile exercise.
The above are fairly simple concepts and some tools to help you with them are:
- A monthly budget entered into your accounting system
- Pricing and costing analysis
- Reporting on actual versus budget each month
- Purchase Orders
- Quotes on jobs
- Report on job quote versus actual