10 Tips for Improving Your Company’s Profitability
If you want to improve the profitability of your business next year, you are not alone. Accounting Today recently surveyed 1,000 small business owners and leaders.
The survey asked respondents to list their top financial challenge during the past year. They reported their number one challenge was cash flow (cited by 32% of those surveyed). At a close second, 31% cited low profitability as a challenge.
Below we describe ten tactics you can use to improve the profitability of your business. If you are also worried about cash flow, visit our post in improving cash flow.
1. Invest in Growth
It does take money to make money. You cannot skimp your way to growth. Marketing, materials, supplies, new staff all require expenditures. December is a great time to take stock of your business and plan next year’s activities.
Think about which clients bring in the most profits (by the job or by industry). Typically, 20% of a company’s clients generate 80% of the firm’s revenue. Develop plans to find more like your top 20%.
2. Keep a close tab on profits, profitability, and expenses
Calculate your profit margin, which is different from profits. To calculate your profit margin, determine your gross profits (the difference between revenue and cost.) To determine your profit margin, divide your gross profit by revenue.
For an example, we’ll use a hypothetical cleaning business. In 2018, this business made $2,000,000 in revenue and incurred costs of $1,700,000. The firm’s gross profits were $300,000 ($2,000,000 – $1,700,000). The company’s profit margin was 15% ($300,000/$2,000,000).
Check how your profit margin stacks up with your industry norms. As a rule of thumb, a good profit margin is 15% to 20% in many industries.
After you know your profit margin, you can calculate how much you can spend for every dollar you earn.
To increase profits, you can look to decrease expenses or increase your pricing.
3. Make sure you charge enough
Many businesses, especially new business, undercharge for their services. They underestimate the time it takes to run the administrative and marketing parts of the businesses. You must factor all that time into your pricing.
Do research on your industry. If you do not currently align your pricing with your peers, think about raising them, especially for new clients. In a service business, people buy from people they know and trust. If a potential client trusts you, they will pay the going rate for your service.
4. Assess the value of each job or client
Once you understand your profit margin, you can better asses the value of each job. You will have a clear idea of what you need to make on each job to reach a break-even point.
Use job costing to identify your least and most profitable jobs or clients. You may discover that some smaller jobs are not worth it unless the small job leads to larger jobs.
Think about the life-time-value (LTV) of a client. Do you get a client and keep them for years? If yes, making a little less on the first job is OK as long as the client provides a profitable LTV.
If you consistently lose money on a specific type of job, eliminate that work or change your pricing.
5. Build a revenue stream or change your pricing structure
Look for ways to build a revenue stream. Can you provide a regular monthly service and charge a retainer fee or an annual subscription? Many large software companies are moving to a subscription model, for example, Microsoft and Adobe. Could you provide your service on a monthly basis?
Can you restructure your pricing? If you are losing money on smaller jobs, could you move from fixed price to time + materials?
6. Bundle products and services into packages or sell additional services/products
You might be able to increase your profits by bundling products and/or services. Bundling is a great way to sell more. For example, a fitness gym could sell a series of classes. See if you can sell new services. For example, a company that designs exhibit booths could train booth staff or a nutritionist could sell supplements.
7. Retain customers
It is far easier to keep a customer than to spend money to find a new one. Make sure you retain your best customers. Ask for regular feedback. Watch for signs that a customer is not happy. Correct any problems as soon as you see trouble.
If your main contact moves to a different company, make sure you get to know his or her replacement. If you can keep customers for years, you get the very best return on your initial customer-acquisition cost.
8. Keep an eagle eye on A/R and A/P
Make sure you stay up-to-date on your accounts receivable (A/R). If a client is late paying, someone in your accounting department should call and ask about the invoice status. Sometimes even electronic invoices get misplaced.
On the accounts payable (A/P) side, look at the terms offered by your vendors. If they offer discounts for early payment, take advantage of that when you can. If vendors don’t offer discounts, pay bills just as close as possible to the due date.
9. Establish KPIs to measure your business’s performance
Create a set of key performance indicators (KPIs) to monitor the health of your business.
For example, you could create a target profit margin. Each month or quarter, you could create a profit margin report by customer.
You can run a variety of useful financial reports directly from most accounting software programs. You can look at areas such as aging accounts receivable (average time a customer takes to pay an invoice) or current ratio (the ability of a business to pay its bills).
10. Outsource services rather than hiring staff
When you hire new staff, you greatly increase your overhead. Employees require salaries, benefits, office space, computers, insurance, etc. If you can hire well-qualified sub-contractors, you will save you money.
Make sure any sub-contractor you hire meets the requirements of being a 1099 independent contractor.
You can also outsource non-essential functions, such as marketing or bookkeeping to an outside expert or firm.
If you need any help, developing strategies to improve your company’s profitability, please contact us.