A simple way to ensure business profitability and healthy cash flow is to focus on what drives both.
- What drives revenue needs to be understood.
- How saleable is the product or service and what’s the market?
- What marketing is working and how much is it costing to acquire a customer?
- Is it profitable revenue?
- How does the true cost of delivering the product or service compare with the price?
- Are customers returning and if not, why not?
One of the biggest missed opportunities we see in business reports is lumping all revenue into one account and not breaking it down into categories. Breaking down, not only the revenue, but also the costs associated with each revenue source, enables you to see clearly where you’re making and losing money.
Pricing of products and services is vital to profit.
To ensure profit, it’s vital to know the true cost of the product or service and keep an eye on it, to avoid ‘margin squeeze’, i.e., allowing costs to rise without increasing prices and absorbing extra cost. Market forces have an impact on pricing, but it’s not viable to continually absorb cost increases without price increases. It’s not always necessary to increase everything. Example: One client recently told us they hadn’t increased prices for years. We did some analysis to find out what their best selling products were. On each of these, we agreed to a small increase with no resistance from customers. A small regular price increase is much easier to achieve that irregular big ones. Most customers expect a CPI increase and if it’s written into contracts, it’s much easier to achieve.
Costing of products and services is vital knowledge to work out gross profit.
Gross profit is the difference between revenue and costs and is an important benchmark. Cost of products may include: the product, importing, freight, packaging, labour, warehouse, raw materials, and so on. Cost of jobs may include: labour, materials, out of pocket expenses, etc. If gross profit is below expectations, it may be necessary to assess how products and services are costed and acquired. Example: We had one client in a wholesale business whose packaging was a large portion of costs. When we questioned their ability to negotiate a better price with the supplier, they said it wasn’t possible. We did some shopping around and found a supplier who offered a 10% reduction. The regular supplier soon agreed to a similar reduction.
Labour is another example of cost management on jobs.
It’s often the case where chargeable labour spends time doing non-chargeable work, such as admin. If you take the number of people, and calculate the total hours spent on admin multiplied by their hourly charge out rate, it’s often the case that the cost of employing someone else to do it is less than the missed income. Overheads can get out of hand where there is no budgetary control. Owners don’t always have time to keep an eye on what everyone is spending, or shop around for the best deal. A budget can be a saver, and will keep your banker happy. One overhead that can get out of hand is wages. Often in a growing business, staff are employed to meet demand, without proper job descriptions. An organisational chart can be useful for a growing business. Begin by listing all tasks in the business, then list who currently does them. Any overlaps and gaps should become obvious and job descriptions can be realigned to suit. Giving someone the task of shopping around for better deals can be a saver.
Debt collection is an area that has blown out recently.
Dunn & Bradstreet recently reported that average collection days were 55.6 days. Compare this to your 7-day terms to see what impact this is having on cash flow. Start with Terms of Trade so your customers understand the expectation. Invoice as soon as the product/service has been delivered or get a deposit or progress payments. Then follow up smartly. Email follow-ups for small amounts and phone calls for large amounts. Keep good records of reasons/excuses for late payment and agree to outstanding amounts being paid off in instalments over a period.
Stock and Jobs can be a huge drain on cash flow.
Think of stock as dollars piled up on the stock room floor and jobs in progress as dollars on the workroom floor. It really pays to reduce the time stock sits in store and jobs wait to be finished and invoiced. Good records and planning are vital to management of both. There are some cost-effective online systems available that can save thousands of dollars in working capital requirement to fund stock and jobs. Examples are Unleashed Inventory Software and WorkflowMax Job Management Software, both of which link to Xero Online Accounting Software. Slowing down payment to suppliers is often the last resort where there are cash flow problems. Often, we see suppliers being paid too quickly or worse being overpaid. A close eye on this area can provide much needed cash.
