If you’re in the hot-seat, do you rely on intuition…
THE 7 KEY LEVERS TO MAXIMISE SALES, PROFIT & CASH FLOW IN YOUR BUSINESS
Most business owners spend time looking at the results of their efforts in the Profit & Loss Report andoccasionally the Balance Sheet.
However if you focus your attention on the ‘Top 7 ‘Levers’ that maximise sales, profit & cash flow is what creates better results in business.
You don’t need to do a degree in accounting or finance! They are simple and operational ideas that are easy to understand and many are able to be implemented immediately.
You will see in this $1m turnover business an example of the results that can be achieved by implementing these ideas. A $100,311 improvement in cash flow and a $60,383 improvement in profit is well worth giving some attention to!
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KEY LEVER 1: REVENUE GROWTH
Business owners focus a lot of attention on Revenue.
“Let’s make more sales and the profit will look after itself!”
Heard that before? Making sales is obviously important … but what is just as important … is what those sales cost you to make and also … what they cost you to fund.
As soon as you sell something, and often well beforehand, there are costs involved e.g. goods for sale, freight, labour, overheads etc. It’s critical to know these costs, because if they exceed your price, then obviously you are making a loss and heading for cash-flow problems.
This driver is the most important of all the seven, because business growth is often the killer of small businesses. What! Go back a second! It’s because there are many other numbers as well as Revenue that relate to profitability.
If the other numbers aren’t well managed, revenue growth will just exacerbate cash-flow issues. If it’s not a good situation … it won’t get better with more sales … but it can get much worse. Revenue Growth is a cause for celebration, but it’s also cause for attention to other ‘Key Drivers’ because more sales can cause cash-flow problems.
The age-old question accountants get asked by their business clients is:
“How come I’ve made more profit but I don’t have any more cash?”
The answer to this lies in the ‘Cash Flow Cycle’ diagram following. The ‘Cash Flow Cycle’ is often not well understood by small business owners … until the business starts to grow and they begin to experience a cash flow squeeze. Let’s explain how it works. In the image below you can see a timeline of 365 days.
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It shows: Before you can sell anything you have to buy something i.e. stock or it could be labour.
Depending on your sales cycle i.e. how long the stock sits in store, you may hold onto stock for 60 days.
Depending on the terms you get from suppliers you may have to pay for that stock after 30 days – which means you have 30 days negative cash-flow.
That is you’ve had to pay for it 30 days before you sold it.
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Depending on your accounts receivable management you could wait 60 days to get paid – which adds another 60 days negative cash-flow.
This adds up to 90 days negative cash-flow!
This is your money! You have paid for the stock on day 30. You have sold the goods on day 60 … and then given credit to your customer who has taken 60 days to pay for it.
Effectively another party is using your money to fund their business. What this illustration shows is that the money due to you, has been somewhere other than your bank account for 90 days.
That is, it is in the bank account of your supplier and of your customer.
This can cause a BIG problem when growth occurs. You now have to buy more stock and find more working capital … and the issue just gets bigger!
If a business isn’t working to minimise these things, that is the number of days stock that is held … and then the number of days a customer is taking to pay … then the problem just gets worse when sales grow.
Sometimes businesses get so focused on increasing sales that the issues of stock movement and accounts receivable just get ignored, or it’s viewed as not considered worth investing in.
This is the reason growth can often kill a profitable business!
A lot happens to cash on its journey from the sale to your bank account. If you are planning to grow your business, obviously it helps to understand this phenomenon and put in place measures to manage it.
Ways to manage revenue growth and see where the profit and losses are:
- More sales could mean more capital required. Understand the impact ofrevenue on the other numbers. More sales may mean more working capital is required.
- Account for different products/services separately. Don’t lump all revenue intoone account in your accounting system. Split it up by product/service groups, divisions, branches etc. Also split the costs related to each so you can see which ones are profitable and which aren’t.
- Find what categories make you money. Once you know which categories areprofitable and which aren’t, you can work on maximizing the profits and learning from mistakes where losses are occurring.
- Measure profitability by jobs. Keep track of labour, materials etc. on jobs so thatyou can compare to revenue and see which jobs are profitable and which aren’t.
- Get more customers through lead generation, your website, marketing/regular promotions.
- Get existing customers to spend more by increasing the average transaction value.
- Get customers to buy more often – increase the frequency.
- Get customers to stay longer – increase customer retention.
KEY LEVER 2: PRICE CHANGE
This means the percentage increase or decrease of the price, at which you sell your products or services.
In a highly competitive marketplace it’s tempting to sell for the cheapest price possible. This is fine, but let’s state the obvious … if you’re not covering your real costs with the price you’re charging … then you’re not going to make a profit!
A common trap is that many businesses fail to increase prices regularly by small amounts e.g. by the Consumer Price Index (CPI), or where there are increases in transport costs like fuel.
Failing to do this will cause margin squeeze. This means, your gross profit suffers, due to increased costs associated with delivering the goods or services.
Customers get a shock if you are forced to make a sudden large increase, whereas regular small increases are much easier for customers to stomach.
Major fast food chains are experts at this. A company rep noticed that the cost of his breakfast was $8.90, when on a previous occasion it was $8.50. That’s a 4.7% price increase.
It was barely noticeable and that person didn’t see it as significant enough to take his business elsewhere for the sake of an extra 40 cents.
This increase is probably quite justified with increased costs to deliver, present, market and sell the product. It’s a good lesson for the rest of us and one way they can maintain profitability and hence viability!
There’s no reason why most other businesses don’t do the same. And it’s not necessary to announce it to the world as you see some business owners do with signs such as: “We apologise for the inconvenience but because of increases to our costs and staff wages we have to put up our prices … blah, blah, blah”
Don’t fear losing customers by putting up prices. The reality is that you may not lose as many as you think. We say adopt quarterly small increase method, small, regular and incremental price increases. If you do lose a small number of clients, they may be the most cost conscious anyway and it may not be such a bad thing. Our modelling has shown that increased price and reduced overall revenue could, in some circumstances, actually have a positive impact on your bottom line.
Seven ways to achieve a Price Increase and when to do it:
- Best customer service: Provide the best possible customer service and valuecompared to your competitors – not all customers buy on price alone.
- Promote your POD: Promote the perception of quality and make it your ‘Point ofDifference’, make sure your customers know you are different and better. Make the ‘invisible’ ‘visible’.
- USP: Emphasise your ‘Unique Selling Proposition’……is there something that you do that others don’t? Don’t assume they know just because you do.
- Small regular price increases: Do small regular price increases e.g. CPI at end ofyear and write it into contracts. These are much easier to achieve than big irregular increases.
- Track Margins to increase: Connect price increases with supply increases – keeptrack of your margins to see when to do this.
- Know your customers: Ask how they value your product or service. Happycustomers should be happy to pay for good quality products and services and appreciate that you have to run a sustainable business.
- Sack “C” class customers: This may be a scary one but there may come a timewhen you need to ‘sack’ some customers. Price focussed, demanding, slow paying customers can take up a huge amount of time and be less profitable than you think. The time you spend on them could be more profitably spent on good customers. If you feel brave and the time is right, it may be time to categorise your customers and focus on the better ones.
KEY LEVER 3: COST OF GOODS SOLD %
Percentages tell you much more about your business than numbers ever could.
One business man, who recently sold a sand haulage business told us how the simple concept of focusing on percentages changed his whole future and was in a large part responsible for his success:
“I used to read the numbers my accountant gave me,” said the owner, of a $2.8 million dollar business, “and it drove me crazy. I knew we were improving, but I wasn’t sure how well we were managing costs, relative to the growing sales.
“Fortunately I had a good CFO. He suggested he add percentages against all the costs and income on the Profit & Loss, so I’d know if we were up or down at a glance.
“It was like someone turned the light on!
“I knew instantly how well one set of figures compared against the previous one without even looking at the numbers.”
“Cost of Goods Sold”, commonly abbreviated to COGS%, simply means the costs you incur to get the product or service to the customer, before taking into account your day-to-day operational costs or overheads.
(They are also called “Direct or Variable Costs.”)
This is a really important number as it has a huge impact on your Gross Profit … and an even bigger one on your Net Profit.
Many business owners focus a lot of attention on Revenue, but a small reduction in COGS% can have as much impact on Gross Profit as a large increase in Revenue. Understanding what makes up your COGS, and some negotiation or investigation with suppliers for better prices, can make a big difference.
If you are a service based business, pay attention to work practices and job management, as these can have the same effect on your Gross Profit. This provides an opportunity to investigate differences and tighten up processes. An example of this is knowing:
How many labour hours you are selling … compared to those you are paying for!
Too many “un-billable” hours could be costing thousands of dollars when you multiply them by your charge out rate.
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Most basic accounting systems have a rudimentary job costing system, but if your business does “jobs” and contracts out labour, then we suggest you get dedicated job-management software that links with your accounting system.
It seems obvious why you would want to decrease costs in business, but many will not appreciate how big an impact this can have on the bottom line.
Every dollar you save on your COGS … goes straight to the bottom line!
There are generally two types of costs in business, being Direct Costs or COGS (Cost of Goods Sold) and Indirect Costs or Overheads. COGS are sometimes referred to as COS or Cost of Sales.
The difference between COGS and Overheads is that COGS only occur when you sell something, whereas Overheads occur whether you make a sale or not. For example Rent is an overhead, as this has to be paid whether you make a sale or not, whereas purchase of stock or paying service providers, directly relates to when you sell something.
It is important to differentiate between COGS and Overheads, because every business needs to know what its gross profit is. Gross Profit is calculated by subtracting the COGS from the Income figure.
It’s a vital indicator of business performance for both managers and lenders. Gross Profit is also an important benchmark against which to measure your business… to others in its industry.
So what types of costs are classified as COGS?
- Purchase of stock to sell
- Movement in stock held i.e. what was held at the beginning of an accounting period versus what was held at the end of the period.
- Freight costs to get goods into and out of stock.
- Labour costs relating to production of a service or product.
- Importing costs e.g. duties etc.
- Discounts given
- Stock adjustments/wastage
- Purchase returns and allowances
- Raw materials
- Manufacturing costs
- Packaging
- Other costs to get goods or services ready for sale.
COGS are often the most sensitive of the ‘Key Levers’ in relation to both profit and cash flow results.
It’s possible, in some circumstances, to create a larger increase in profit, by reducing COGS by a small percentage, rather than increasing sales by a large one.
This is because when sales grow, generally other numbers grow too, such as COGS and Overheads.
Also an increase in sales, creates a need for more ‘working capital’ to fund your suppliers, additional inventory and ‘Work In Progress’ … but a reduction in COGS does not!
The reduction goes straight to your bottom line!
If you’re in a service business don’t think that COGS doesn’t relate to you because you don’t sell products. A factor in COGS for a service business is ‘Work in Progress’ (WIP). Many service businesses have no real methodology for handling WIP or Jobs.
I once asked a contractor: “How often do you do your invoicing to customers?”…..and the answer: “When I run out of money!”
Ensure jobs get invoiced out as quickly as possible. By doing so you’ll speed up payment. There are systems available that easily speed up WIP and jobs, and the resulting improvement in profit and cash flow can be significant.
Budgeting for COGS will help you monitor profitability. COGS can very easily ‘creep up’ without you realising it. These increased costs need to be passed onto customers regularly, or they erode profit margins.
Keeping track of such costs may seem like a pain, but the resulting control over margins and profitability, far outweighs the cost of maintaining such control.
Here are eight ways to reduce your COGS:
- Reduce wastage: Reduce materials used on jobs by managing wastage and writeoffs. Review ordering methods and introduce systems such as job cost sheets to track goods used on jobs.
- Increase productive time: Maximise efficiency of contractors and staff e.g. checkany ‘non chargeable’ time spent. Incentivise the staff by sharing the savings. It may be that some work can be outsourced, even overseas. Try www.upwork.com for skilled inexpensive techs, artists, designers and business services worldwide. This could free up a more costly person to focus on more chargeable work.
- Review and negotiate with suppliers: It’s easy to get into a ‘rut’ and deal with thesame old suppliers and do things in the same old way. Technology has opened up all kinds of opportunities to improve efficiency.
- Innovate: Look for innovative ways to change the way you perform processes.Research your industry to find out what new ideas are available. Create a ‘one-small-improvement-a-week’ policy.
- Industry benchmarks: Check to see what the top performers are achieving.Benchmarks for your industry/business could be available online.
- Exchange rates: Lock in good exchange rates with forward cover on foreigncurrencies.
- Manage your margins: Regularly looking at the percentage of Cost of Goods sothat you know when is the right time to renegotiate or look for alternatives.
- Use ‘Purchase Orders’: Don’t just allow anyone in the business to spend yourmoney. One form i.e. a purchase order could save you thousands of dollars. The person ordering goods or services may not know something you know about a change or potential obsolescence.
KEY LEVER 4: OVERHEADS %
Many business owners focus attention on the Overheads in a Profit and Loss (P&L) Statement, but they may not compare them relatively, (by percentage) to the Revenue. This has an impact on the profit.
If you just look at the Overheads dollar figure … it could be that you’re making more Revenue but not increasing your Net Profit.
It’s much easier to focus on one number being the Overheads% say, rather than getting too bogged down in all the numbers you see on a P & L. If you don’t have a budget it can be very difficult to know if overheads are reasonable anyway.
A business without a budget is like trying to find a new destination without a roadmap!
Yet very few businesses have a budget, which makes it difficult to know how the business performs month by month. So do you need a budget? Ask yourself … are you planning to reach a goal in business … then you definitely need a budget.
It’s obvious why you would want to decrease your overheads, but it’s sometimes overlooked how big an impact this can have on the bottom line.
Here are Nine Ways to reduce Overheads:
- Simply shop around: It’s so easy to ignore potential savings because you don’thave time. The time spent saving on overheads could far outweigh the value of time spent on other things in business. Have a three quotes policy when purchasing any goods or services.
- Create competition: Shop moresuppliers for your business. Don’t underestimate your value to suppliers as a customer. Look at what business you’ve done with them over a period and use that knowledge to seek better terms and pricing. If you are a good customer they should want to keep you.
- Reduce fixed costs: Rather thanlocking into fixed costs, try to utilise non fixed solutions like outsourcing or sub contract labour. That way you aren’t paying costs during downtime.
- Don’t pay high skill rates for low skilled work: Get the right peopleinto the right jobs with clear job descriptions that meet the overall objectives of the business. Regularly review staffing levels in line with business development.
- Use new technology: Such as VOIP, Skype, Zoom etc. Could a website orecommerce save staff time in your business?
- Have a budget and stick to it: Report on variances between actual and budgeteach month and investigate. (Shown here is the CFO On-Call One Page Snapshot report showing all the important numbers on one page.)
- Review overheads regularly. Have an ‘in depth’ review of overheads several timeseach year. It’s amazing how savings can be eroded and increases creep back in again.
- Use ‘Purchase Orders’. Don’t allow staff to spend money unchecked. You couldsave thousands of dollars by stopping spending that could be done smarter or cheaper before the damage gets done.
- Break-even Analysis. Understand your overheads so you know how much youneed to sell to cover them.
Remember every dollar saved on overheads goes straight to the bottom line!
KEY LEVER 5: ACCOUNTS RECEIVABLE DAYS
Also called Debtor Days, this is the number of days on average your customers are taking to pay invoices, as opposed to the terms you offer them. Think cash-flow with this key lever. Managing this number can have a huge impact on cash flow.
If for example your Accounts Receivable is currently 70 days and you can get it down to say 50, you could put tens of thousands of dollars back into your bank account.
The way to improve this number is to focus attention on your Accounts Receivable (AR) and debt collection procedures. It’s fine to look at the report out of your accounting system, which lists all the customers and how much they owe you. If your business is growing rapidly you need to know how much AR Days are changing compared to Revenue growth.
If it’s not comparable … you will experience a cash flow squeeze … and could run out of working capital.
Chasing payment is often one of the least enjoyed jobs in business. Think of it as your money sitting in other people’s bank accounts and collecting it quickly can make a huge difference to your cash flow.
Here are nine ways to speed up customer payments:
- Create a terms of business document: Ensure you have clear and documentedterms and your customers understand what they are at the point of sale.
- Credit Checks: Check who you are doing business with. Are they a potential baddebt?Run credit checks and assess how they operate if a business customer. If the account is a large one it doesn’t mean to say the client is solvent. Big companies go bad too and hurt more little ones when they do.
- Improve customer relations: Have good customer relations to ensure your invoiceis a priority.
- Invoice immediately: Ensure the payment due date is included so there can be no confusion or excuse. Why wait until the end of the month to invoice and give customers as much as 30 days more to pay?
- Manage credit better: Get a creditmanagement system in place. Report regularly on outstanding customer amounts so that you know who to chase and how hard. Measure who owes what and for how long.
- Follow up appropriately: Small amounts by email and larger amounts with atelephone call. Have one person in your business that is responsible for doing this. A part-time accounts receivables clerk could pay for themselves because they collect more and improve the cash flow. Calculate how much.
- Make it easy: Make it as easy as possible to get paid. Credit card merchant feescould cost a lot less than waiting for a bank transfer for 90 days. Have clear systems and processes in place.
- Progress Payments: Seek progress payments or deposits if it’s a job that takes awhile.
- Get tough: Don’t write off collectible debts too easily. This happens far too often. There are good debt collectors around.
KEY LEVER 6: ACCOUNTS PAYABLE DAYS
This is the number of days, on average, you are taking to pay your suppliers. This number is just as important as Accounts Receivable Days, as it can also have a big impact on your working capital situation.
Have you noticed how it’s so easy for you or a staff member to oil the “squeaky wheel” and pay the supplier who hassles you most for money (sometimes before it’s due)? It’s also easy to ignore potential better terms to be had from suppliers because you get so focused on revenue.
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Some small changes to procedures relating to Accounts Payables can pay big dividends in your bank account.
If your business is growing this could be critical cash for funding growth. We’re not suggesting stringing out suppliers beyond the agreed terms, but we are proposing negotiating better ‘agreed’ terms from suppliers. Paying suppliers too early and wasting credit available could be costing you precious cash flow.
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These are eight ways to get the most from your supplier credit terms:
- Systemise paying suppliers: Have a routine and stick to it, be disciplined.
- Do you pay early: Never pay early unless you are offered a discount.
- Credit cards: Use credit cards to maximise interest free days.
- Payment system: Have a system for payments on the due date to ensure you getthe benefit of every day’s credit. Don’t just pay everyone on the same day.
- COD’s not on: Don’t pay cash on delivery – ask if an account is available. Mostbusinesses will give an account to another business.
- Make ONE person responsible: Just one person pays suppliers to avoidoverpayments.
- Check every invoice: Validate supplier invoices against quotes or purchase ordersto ensure you aren’t overpaying for goods or services.
- Good relations: Develop good relations with suppliers to enhance negotiationeffectiveness. Know how much business you have done with them to assist with negotiations for better terms and pricing.
KEY LEVER 7: DAYS INVENTORY OR WORK IN PROGRESS
This is the number of days, on average, that goods for sale are sitting in your storeroom, from when they are delivered by suppliers, to when they are shipped out to customers. Where goods have to be paid for before they’ve been sold, it means you have had to spend valuable working capital for the stock sitting there waiting!
If you can manage this situation well, and reduce the number of Inventory Days, it has a big impact on your bank account and working capital situation. It’s very tempting when a salesperson calls and offers you a discount to buy more stock, but try not to be tempted because it could cost you more than the discount in the long run.
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Consider the amount of working capital that will be tied up in that stock, compared to the discount being offered. If you are borrowing funds, a bank overdraft for example, think of the amount of interest payable on those funds tied up in slow moving stock.
Are you in a service based business? Then “Work in Progress” (WIP) Days is very similar to Inventory Days, in that your ‘stock in trade,’ is the labour and materials you have to sell. Slow WIP days can be just as dangerous to cash-flow and working capital as Inventory Days. Anything you can do to tighten up your WIP and speed up the time work is ready to be invoiced, will pay dividends in your bank account and reduce your interest expense.
Here are eleven (11) ways to reduce the number of days stock sits on the shelf waiting to be sold:
- Stock system. Have a good system for managing stock
- Research lead times. Understand customer needs/lead times and forecast salesand requirements.
- Redirect to customers. Get suppliers to deliver direct to customers if possible –avoid holding stock.
- Buy for immediate use. Where possible purchase materials for jobs rather thanfor stock
- Because it’s cheap! Don’t ‘impulse’ buy when offered discounts.
- Track stock movement. Report regularly on what stock is doing and measure your inventory days to give a target to work at reducing.
- Assign responsibility with targets. Make someone responsible for managing itand incentivise them.
- Seasons. Take into account ‘seasonality’.
- Industry Benchmarks. Check your industry benchmarks to see how you compare.
- Neat ‘n Tidy does it. Have a tidy stockroom to avoid over-ordering
- Are you a stock hoarder? Get rid of obsolete stock so you can use the funds tobuy faster moving lines.
Here are ten (10) ways to reduce the time jobs are in progress costing you money:
- Job management system: Seek out a good quoting/estimating system andmeasure actual costs against each job to see which jobs were the most profitable.
- Follow up system: Have a system for following up quotes and tenders – thequicker you get started the quicker you finish. Review operations for efficiency and ask yourself “Am I getting deals over the line quickly?” Create a sense of urgency.
- Just one person: Have one person managing jobs who has a good understandingof status and progress to ensure jobs get finished.
- Manage labour: Manage resource allocation and track staff/contractor time spenton jobs. Schedule jobs and travel for efficiency.
- Cost for variations: Make allowances for variations to material prices on jobs toavoid hold ups.
- QC: Have good quality control to avoid rework and investigate write offs to avoidthem in future.
- Checklists are vital: How many people do you know who don’t use checklists andeven worse rely on memory. Use checklists and templates to maintain standards and improve customer satisfaction.
- Allow maintenance time: Keep equipment well maintained to avoid down time.
- KPIs: Have ‘Key Performance Indicators’ for jobs such as number of quotes versusjobs won and lost.
- Job management system: Use a job management system to keep informationeasy to access and provide information for improving job profitability.
How to calculate the 7 Key Levers:
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As a business owner, you may not need a full-time CFO. But you almost certainly DO need more expertise than you get from a bookkeeper and annual trip to your tax accountant.
A CFO On-Call advisor can become your Chief Financial Officer – but part-time. We can help with internal financial control and direction for your business decisions. That could be every now and then, once a week or once a month. It’s up to you.
You can have all the benefits of your own CFO, for a fraction of the cost of hiring someone full-time!
We will always be available, face to face or on-line, to help plan strategic direction with you, discuss new ideas… and be your right-hand financial guru… whenever you need help.
Best of all we bring ‘big company’ experience to your business.
Rob helps businesses boost their profits, wipe out their competition, nail their perfect customer and put their business in a position of dominance! He has been through it before in much bigger organisations and can help you with each step of the way to the success you’ve been dreaming about! Call 0457 555 787
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