By Jonathan Amponsah CTA FCCA, The Tax Guys
Without profit you will have no business and miss out on all you were hoping to achieve when you started. Many small business owners don’t understand sufficiently how to make the profit that their hard work merits. Let’s look at some of the biggest profit mistakes to avoid.
Bank Balance Accounting
With cash in the bank you may make the mistake of assuming cash equals profit when you may really be making a loss. This could be because you haven’t paid your suppliers or other creditors, you are not paying yourself a reasonable salary, payroll expenses have not been reflected in the accounts etc.
Discuss these with your accountant along with other factors specific to your business.
When you get your accounts, take the direct costs of sales or direct expenses out from the revenue. Then divide that number by the revenue. That is your gross profit margin. Say your revenue is £1,000 and your materials, direct labour or direct expenses cost you £700. The difference of £300 divided by £1,000 revenue gives you a margin of 30% i.e. for every £1 of sale, you’re making 30p gross profit. If profitability at this gross margin level is low, you’re unlikely to be making net profit because there won’t be enough to cover your overheads.
Other Vital Numbers
In addition to your gross profit margin you need to understand, profit per staff, profit per client/ project, net profit margin, breakeven number, your monthly costs; all important numbers to focus on. Without knowing them it’s unlikely you will improve on your results.
Wrong Price Calculation
Assuming your profit margins of 30%, a common mistake is this. You have a new customer. You take your costs, say £1,000. You apply 30% to the costs. You then quote £1,300 for the job. However, if you take your £1,000 costs from the £1300 revenue (price) you get £300. Now divide that by £1,300. You now get 23%. You’ve just lost 7% profit margin!
Fear of Losing Customers
Many entrepreneurs avoid price increases for fear of losing customers. Say you have 20 customers. Your charge £1,300 per customer (£26,000 revenue. If you put prices up by 10%, your new revenue will be £28,600. If you lose 10% of your customers (2 customers x 1,300 = £2,600), your revenue will revert to £26,000 but with two fewer customers and less resources needed to service the remaining 18 customers. Depending on how you communicate the increase, you may be pleasantly surprised that less than 10% of your customers leave.
A small %
A study by McKinsey & Co revealed that increasing pricing has a bigger influence over profits than reducing costs or increasing sales volumes.
Most entrepreneurs do not consider: Assessing the power of a mere 1% increase in price, 1% increase in sales, 1% decrease in variable costs and 1% decrease in fixed costs.
Ask your accountant to run these numbers and show you the impact on your profits.
Dr W Robert Deming once said “85% of the reasons for failure are deficiencies in systems and processes rather than employees”
The tip here is to review the seven wastes (Transportation, Inventory, Motion, Waiting, Overproduction, Over-processing, and Defects – Google ‘MUDA’ for more on this) that exist in all businesses and have a plan to reduce these in conjunction with staff training and engagement.
If a customer challenges the price you’ve quoted do you rush to discount? Let’s go back to the example of making a 30% margin on sales of £1000. Assume you offer a 10% discount. Your revenue drops to £900 but your costs are unchanged. Your margins drop to 22% (£900 less £700 divided by £900) The 10% discount now means a 26.6% drop in your margins (the original 30% less the current 22% divided by the original 30%).
It gets worse if we look at the impact on the bottom line (net profit margin), assuming you keep all your overheads the same. Were you intending to have a 26.6% drop in your margins by offering a 10% discount?
Be aware of the profit effect of price discounts and use it to negotiate a better win-win deal.
Secure your profit
In his book Profit First, Mike Michalowicz suggests opening another bank account and transferring your net profit before you make any payments. Transfer it immediately to your “profit bank account”. This will force you to make do with the remaining 90%.
Don’t throw your hard-earned money away. Avoid mistakes such as the ones discussed here and enjoy the benefits of a more profitable business.
ABOUT THE AUTHOR
Jonathan Amponsah CTA FCCA is an award-winning chartered accountant and tax adviser who advises entrepreneurs on business and profit improvement. Jonathan is the founder and CEO of The Tax Guys. www.thetaxguys.co.uk