Driving Profit and Cash Flow in Your Business
The success of a business can be measured in a number of ways, but the bottom line, literally and figuratively, is profit. While longevity, public perception, and product or service quality are a few things that factor in, the financial health of a business will always be a critical metric in determining its value – and driving profit is an important part of this.
Not only is strong net profit an indication that a business has been run effectively up to this point, it also informs how owners may be able to continue to thrive and invest in growth. But how do we use the drivers of profit to improve a business? Understanding how to leverage them by making small improvements can help in driving profit, and significantly improve your business’ bottom line.
What Drives Profit?
In order to increase your business’ net profit, we must first look at the driving forces behind it. Among other factors, there are four key drivers to consider – and they have varying levels of impact on net profit.
- Price: The price of your business’ goods or services has the greatest effect on profit, as any increase to the price for which you sell something goes straight to net profit (assuming it costs you the same to produce).
- Sales Volume: Increasing your sales volume generally increases variable costs (e.g. cost of goods sold), so the gain in revenue may be more significant than any rise in net profit
- Variable costs: The direct cost of acquiring or producing the good / service. Having greater buyer power to secure lower prices or being able to produce / deliver something more efficient without comprising quality will increase the gross profit margin and in turn your net profit.
- Overheads: Decreasing your overheads will increase your margins but not overall revenue, as such this has the least impact on net profit.
As you can see, not every profit driver is created equally. Therefore, it stands to reason that small tweaks to the more significant factors are likely to have a greater impact on your net profit. Below is an example of how critical some small improvements can be.
Small Tweaks, Big Improvements
In the following example, we’ll look at Luke’s Lawnmowing Service, and how making small increases to his profit drivers can have a significant impact on the business’ overall profitability (figures are annual).
|Rate of retention||90%||1%||91%|
|[Total existing customers]||180||2||182|
|[Newly acquired customers]||25||4||29|
|Retained customer base||205||6||211|
|Annual mows per customer||6||3||9|
|Total mowing jobs per year||1,230||668||1,898|
|Average price per mowing job||$50||10%||$55|
|Annual Customer Revenue||$61,500||$42,883||$104,383|
|Overheads (fixed costs)||$6,000||-2%||$5,880|
|Net business Profit||$15,525||$18,261||$33,786|
As you can see, Luke’s Lawnmowing Service has a fairly low profit margin at the moment. While he has 200 regular customers, all having their lawns mowed once every two months, and charges $50 each time – his current margin of 35% and overheads of $6,000 p.a. means Luke’s net business profit is only $15,525 p.a. Considering the fact that serving that many customers would likely constitute a Monday-Friday, 9am-5pm type of schedule, that is a pretty disappointing outcome.
While increasing the net profit of Luke’s Lawnmowing Service might seem an uphill battle, just a few tweaks here and there can make a significant impact. Luke could more than double his net profit just by doing the following: increase customer retention by 1%; acquire just six more customers; add three more mows per year, per customer; raise the price of each job by $5; and cut overheads by 2%. From $15,525 to $33,786 – what a difference those small improvements can make!
Other Factors in Driving Profit
There are also other drivers of profit, three of which you’ll find on your balance sheet. These are:
- Accounts Receivable: How much you’re owed for goods or services you’ve provided; and how long you’ve been owed for. Lowering this number increases cash flow for your business.
- Accounts Payable: How much you owe for goods or services you’ve used; and how long you have owed that money. Increasing these days improves available cash.
- Inventory Days: Average number of days you hold stock before selling it. Lowering the number of inventory days reduces the amount of money you have tied up in inventory (and therefore have in cash instead)
Much like the profit drivers outlined in the example, the three listed above can also make a big difference to your bottom line if they are improved even slightly (it’s all about the small wins!)
Next Steps & How We Can Help
If you’re interested in seeing how a few small tweaks could transform your net profit, our handy Business Growth Model is available on our Free Resources Page. With this tool, you can input the relevant data from your own business, gauge where you’re at right now, and project where you could be soon.
The Business Improvement team at McKinley Plowman has established a reputation over many years for creating awesome outcomes for clients by streamlining their business processes, optimising their cash flow, driving profit and guiding smart business decisions. Our integrated approach, including tax, accounting, bookkeeping and much more, means we work together to help you get the best out of your business. To find out what we can do for you, get in touch today via our website or call us on 08 9301 2200 for a free, no-obligation consultation.
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