Almost every business owner I know wants their business to make more money. It can allow them to reinvest, expand their product offerings and increase future sales or it can allow them to put more money in their own pockets. Further, more profitability and greater cash flow generally increase your ability to borrow money to grow as well as increase the value of the company should you look to sell or bring on an equity partner.
So, what’s the best way to increase your profitability?
You could focus on increasing sales and revenue, but that does not guarantee increased profits and profit margins. Why? First, your efforts to increase revenue will typically cost money and profits in the short term. If your investments in marketing or additional salespeople don’t have positive returns on investment, your profits and margin will go down. Second, even when those efforts succeed, you could sell more of low or unprofitable products and services. Third, you could increase expenses other than sales and marketing and find your company with less profit.
You can also reduce expenses. If there are expenses that can be reduced or eliminated without breaking your systems and/or impacting customer satisfaction, you should always be looking at those opportunities. However, if you’re trying to grow your revenue too, reducing expenses in the wrong places or in the wrong way could hurt your ability to onboard new customers and keep them happy along with your existing customers. In the long run, this path could lead to higher profits in the short term and lower profits in the long term as old and new customers leave.
My recommendation is an approach that focuses on profitable top line growth with carefully chosen expense reductions. What do I mean by “profitable top line growth”? It’s new revenue that brings in more revenue than the expense incurred to generate the revenue and provide the service or product. Whether you are a product or service business, I strongly urge the use of a Cost of Goods Sold section on your income statement resulting in a gross profit margin or the percentage of your revenue that’s available to cover overhead costs and yield a profit for the owners.
I’ve found that some businesses either don’t pay attention to their gross profit or, if they do, only look at it companywide and not by product or service. Focusing on your gross profit margin in total and by product or service, understanding how it’s changed over time and finding ways to improve it in the future are keys to increasing your company’s profit. There are three ways to increase your gross profit margin. 1. Increase your price while holding your costs steady. While this sounds simple, market forces do no always allow businesses to increase their prices. 2. Find out which of your products have the highest profit margins and focus your sales efforts on those products. 3. Reduce your costs of goods sold. While certain costs may be hard to reduce, there are often unseen opportunities that just takes some effort. Tactics include switching vendors, re-negotiating with existing vendors, eliminating costs that are no longer needed.
In sum, efforts to increase your profit and profitability should look at all three areas: increasing revenue, reducing expenses and improving your gross margin. While increasing revenue is always a key strategy to grow a company, doing that in conjunction with improving your gross profit margin and holding overhead expenses in check is the best route to improving your bottom line. If you’d like to discuss how you can improve your company’s profits, reach out to me at llevy@CFOoptionsinc.com.