I was having lunch with some bankers the other day and they were discussing customers’ responses when they applied for working capital lines of credit. When asked why profits were lower than in previous years, the most common answer the bankers received was, “It’s because of the economy causing lower sales revenue.”
That is only partly true.
In many cases, profits have fallen further than they should have because many business owners operate on the assumption that “profits happen.”
Profit that “happens” occurs only when you’re lucky enough to have total expenses lower than total sales. In contrast, managed profit, which can be projected, is a much higher figure and certain to occur as a result of planning.
To manage your profits you have to know where they can be lost and plug the leaks. Here are some of the major areas:
Low gross margins.
If you can lower your costs of goods, it will help you manage your profits to higher levels.
1. If material costs are high:
- Ask vendors for a discount based on volume, longevity as a customer, an agreement to use them exclusively or another reason.
- Look for alternate suppliers.
- Look for alternate materials.
2. If you are manufacturing or assembling what you sell and labor costs are high:
- Review the way you build or assemble things. Different sequences or steps may reduce labor.
- If you have short-run increases in orders, consider overtime versus adding staff that may be underutilized when the order is completed.
- Determine if there are functions you can outsource less expensively than performing in-house, and vice-versa.
3. If you are in a service industry and labor costs are high:
- Ensure that jobs are billed correctly to recover costs. If you pay a service person for 40 hours a week and they forget to bill a customer job or lose a charge ticket, you are leaking profits.
- For any jobs that involve un-billable travel, make sure that the way jobs are scheduled minimizes “steering wheel time.”
High general expenses:
- Ask the landlord for a rent reduction or abatement.
- Rent out any unused space if your needs have changed.
- Initiate energy conservation measures.
- Review your service contracts and renegotiate, replace the vendor, renew or eliminate them. This should cover all items from phone service and pest control to accountants and attorneys.
- Review advertising and marketing expenses for effectiveness. Do not necessarily cut these, but rather reassign the monies to more effective media.
- If you have service vehicles, track the fuel mileage. If it is unusually low, profits may be flowing into somebody else’s gas tank.
High Inventory Levels
- Sell outdated items at cost to obtain cash to reinvest.
- Liquidate items on the shelf for more than 90 days and use that cash to purchase faster-moving items.
- Use “just-in-time” buying for expensive items and, in a retail environment, make them special order, not stocked.
- Check that customers are correctly billed for items or labor used.
- Check that you’re getting all inventory you pay for.
- Check for signs of theft in over-the-counter sales.
High Interest Expenses
- Bill and collect from customers as soon as possible.
- Follow-up on all outstanding accounts receivable personally.
- Make sure loan uses match loan types. If you are using short-term loans, lines of credit or credit cards to finance long-term needs, you should attempt to refinance them.
- Check that service charges (like credit card processing) are competitive.
By managing your profit, you can boost it despite the economy. It will make you happy and it will impress your banker!