Finance has shown me many things over time, but perhaps one of the more powerful concepts is “profit versus turnover”. For the golfers out there, I liken this to “driving for show VERSUS putting for dough“.
Underlying profitability and the associated free cash available for debt servicing are focal points for a Banker with any finance proposal – as this shows whether there is the expected ability to repay the loan within the proposed terms. The simple “revenue line” however, whilst interesting for trend and margin analysis, by itself – does little to prove debt servicing ability.
This also applies for Business Owners and their “personal return” from the business – as it’s the same net margin line which they get to keep. Both the Business Owner and Banker are looking at the net margin or surplus to prove viability.
So with this in mind, now find 5 business owners who know and trust you and ask;
“How is business performing?” – noting that you are looking for a real answer supported by numbers, and not just a one word response.
I can virtually guarantee that 4/5 of them will respond with a response which includes turnover, and if you are lucky, a reference to margins. Over many years of testing this question with a variety of audiences, less than 1/5 will talk to underlying profitably.
The simple reasons behind this sort of outcome include;
- what gets measured gets mentioned
- closing a sale is exciting and memorable, doing the bookwork is not
- sales tend to be highly visible and in the moment, collections, margins and profit calculation are not
- a general lack of profit reporting and monitoring of the true margins on sales
- a “get the sale” and the “rest will be ok” approach
- the many excellent technical skills (ie. law skills, painting skills, engineering skills, building skills etc) used in driving the sales, are unfortunately not as evident in the disciplines required to run of business
Few clients don’t want to know their bottom line, but many either don’t fully appreciate its importance or have the appropriate systems in place to capture and report it.
So why is it important?
The benefit of understanding your bottom line performance means that you can operate your business far more effectively – driving better profits, which invariably means more choices and better hours for the owner along with the creation of real enterprise (business) value.
Business owners work hard, devote a lot of hours and generally don’t get the return they desire. By understanding what your margins are (gross and net) and having regular profit reporting in place, then as a business owner you are equipped to make far better business decisions.
For example, by knowing this information you are able to;
– more accurately quote for work or bill your time
– identify which current “sale” activities are not worth pursing as they have low or no return
– allow the breakdown of sales to see where you are making or losing money (ie. the initial sale was profitable, but the type of shipping or payment terms given weren’t)
– appropriately assess the performance of people within your business, whilst building personal accountability and enabling greater empowerment
– more readily identify fraud or stock losses
– pick up legitimate errors early enough to do something about it
– undertake more effective tax planning
– permit more beneficial wealth creation or financial planning
Some of the solutions used to improve the performance of business in this area,
- Ensure a clear understanding within the business (owner and team) of the difference between profit v revenue.
- Implement simple business reporting disciplines so that at least monthly, you have sales (revenue), gross and net margin reporting, along with a breakdown on key cost areas and resultant cashflow. Good bookkeeping is great, but I tend to find an experienced bookkeeper is better.
- Establish core benchmark values for each reporting area to make it easy to identify when something is “out of whack”, with these measured and reported monthly.
- Incorporate margin analysis into your quoting or billing calculations. This method varies depending on the style of the business and can be a fully costed mechanism for each transaction (high value/low volume sales) to more simplistic “rule of thumb” values for others (low value/high volume sales). The key is then to use the relevant mechanism in all quoting.
- Draw on the enhanced reporting to start picking apart expense categories – examine where your money is being spent, draw relativity back to “how” you make your money and identify points of potential waste. Look carefully at any items that are “auto deductions”, as many owners tend to have a low awareness level of these as they are not “physically” making the payment [auto payments should be reviewed annually for relevance and value].
- Assess your wage costs – not so much from the perspective of reducing the expense, but more from the perspective of ensuring that your “paid employee hours” are appropriately contributing to your revenue in the way they should. For many firms, I advocate identifying where these hours are being spent, drawing them back to either specific client billings, sales contracts, production jobs or work tasks (ie. 40 hours of paid work should align to 40 hours of related billing). This will identify levels of inefficiency which can be applied to increasing revenue.
By working on your financial “short game”; creating a bottom line and cash focus to your business operations, you will by default – perform better.
Knowing what you keep for every sales dollar, will naturally migrate you to the better margin sales. Understanding where your expenses are will see you deftly decide what expense is adding value, versus what is simply costing you. Lastly, being able to link your employee wage/salary expenses to their associated revenue creating activities, will improve your operational efficiency to levels that you have not previously experienced.