“How much did I make?” “How much is left for profit?” These two questions are often all that many business owners every concern themselves with. They want to know how much, in dollars, they sold and how much of that is profit. To some, this seems like a good practice.
While certainly knowing how much your business sells and how profitable is important, there is a lot that happens between those two numbers. What happens there has a significant impact on your business and something that long term successful business owners understand. Not knowing what happens there, not understanding what impacts your profit there and even not truly understanding where your sales actually come from (it is not just the customer) is a serious part of your remaining in business.
Even the best of businesses do not always operate at the highest level of sales or profit. Things happen that can be controlled if you understand them and put into place efforts to manage them. Let’s start with the first controllable number after your gross sales.
Discounts: Businesses give discounts for many reasons. Sometimes it is to provide a quick start to a business. Other times it can be to expedite the collection of money due you in the form of accounts receivable or to gain a good market share in a new area or with a new product or service. All of these should be temporary measures and even when bound by long-standing custom or tradition, you are not obligated to continue the practice. In short, you control the type and amount of discounts you offer. If you offer them too frequently they become an expectation and all you have done is lower your prices.
Error: Error is mistakes you make in your process. These add costs to your business and directly impact your bottom line profit. Every dollar of error you experience means one dollar less of profit. Understanding your process and making adjustments to that process helps reduce your error. In some cases, you can completely eliminate error.
Waste: Waste is material or processes that add cost but provide no value. An example would be that you buy an 8 foot 2×4 and the job you purchase it for requires 6 feet. What happens to the remaining 2 feet that you paid for? If you can’t use it immediately it becomes waste. Waste also occurs as it relates to your Inventory. Excess inventory is a common problem for small businesses. Often times the lure of a Big Box discount store selling you mass quantities of “stuff” is hard to avoid. Yet when you buy in bulk what you don’t use immediately or very soon gathers dust, takes cash out of your business because you spent money on it and if left to wait until later use can be damaged, spoiled or otherwise becomes less useful or useless. That becomes waste. Watching your inventory and materials purchases by buying what you need and what you can quickly sell is important to reducing this level of waste and money drain on your business.
Once you understand those you have Cost of Goods Sold, commonly referred to as COGS.
COGS: This is what it costs your business in labor, materials, equipment, etc. to provide your product or service. This is not your rent, office wages, insurance, etc. Managing your COGS involves understanding exactly what it takes to provide your product or service. This is everything from the actual time involved to the hourly rate you pay your workforce that actually does this work. If you can write out your process, every single step, you can look closely at where you can improve this cost, reduce this cost and improve your business profitability.
When you’ve managed all of these parts of your business, and subtract your discounts, error, waste and COGS from your sales you have what is called Gross Profit or Gross Margin. You aren’t done managing the money in your business here. What follows is your employed labor that you must pay regardless of whether or not you have work, and your business expenses such as insurance, rent, utilities, etc. Once these numbers are subtracted from your Gross profit you have the good number – you have your net profit.
Many business owners simply take this money as theirs but even this must be managed. Some for reinvestment, some to pay taxes, some to save for bad times. What is left is yours.
Paying attention to your business numbers is more than how much you make and what is left. Understanding that and knowing how to manage it will help ensure you remain in business. Not doing this could spell trouble or disaster.
Want to know more? Ask me, I’m here to help.
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