Last week I looked at seven ways your business could leak profits, and how to avoid those mistakes, courtesy of an article by Kelly Clifford.
In this post I’ll look at five more ways to leak profits. My mantra is that it is not the volume of sales that’s important in determining the profitability of your business, but the volume of Gross profits. Each of the five ways below has an impact on your gross profits.
So often I see businesses being told that they have to build their customer base, and sell more. Now that certainly can be true, but it is not always true. For many small businesses increased profitability can be obtained more easily, and more quickly, by plugging the profit leaks in their business.
Do you know which of your clients are profitable, and which are not? You’ve no doubt heard of the 8020 rule; 80% of your sales and profits will come from 20% of your clients. In my experience this is broadly true.
There are a couple of factors which affect the profitability of clients.
Many of these costs are hidden in your overheads when they should be attributed to the cost of sales to that client.
And that leads me to the next leak.
When looking at clients’ financial statements so often I find direct costs, i.e. those that are directly attributable to a product or sale, allocated to overheads. They include such things as freight and delivery, packaging and direct labour.
Freight in particular is frequently found in overheads. Yet it is a Cost of Sale.
I find the same with Wages and Salaries. It might be convenient for your accountant to include them in Overheads (Administration). After all, their main concern is determining your tax liabilities. Your concern should be management of your business.
Sure, the salaries of your admin staff are an overhead, but the salaries or wages, and their on-costs such as Superannuation, of those people who make or repair things are a direct cost attributable to the item manufactured or repaired. Unless you do so, you don’t really know your Gross Profit margin, and can’t make the right pricing decision.
Poor pricing decisions leaves money on the table.
And then there are the “nuts and bolts”. In trade-based businesses there are things like nuts and bolts (literally) that may be used in a job, and things like hand cleansers, wipes and a whole lot of other incidental costs.
It is difficult to record them against a particular job, so again they tend to end up in Overheads, spread across all jobs. Far better to do as some businesses do, and allocate a small percentage to “Incidentals” on the invoice.
You might have had this happen to you; my accountant would sometimes say “That was three hours, but let’s call it two and a half!” He would “write-off” a proportion of the time spent on my accounts. Gratefully received, to be sure, but it his decision. I used to wonder how many people he did this for, and what was the cost to his practice. No doubt it made him feel good.
More pernicious is ignorance. One client had a business that serviced small engines. The engines would come in by truck or service or overhaul, the engine would be unloaded, taken into the workshop, worked on, loaded back on a truck for delivery to the client.
While the time spent by mechanic working on the engine was recorded against that job the unloading and loading time was not. The owner told me that it didn’t matter as it only amounted to about fifteen minutes a job. If that happened twice a day, five days a week, the unallocated cost amounts to 2 ½ hours a week. At a charge-out rate of, say $100 an hour, that is $250 a week not covered. Over a year that adds up. It should be recovered against the job. But not doing so is a loss of profits.
Then consider this, just as a bad debt is not recovered by a sale for the same amount (the sale must give a profit to the same level as the bad debt), to recover that $250 a week requires sales which will provide that as profit.
The 80-20 rule also applies to products & services. The majority of your sales, and your profits, will come from the minority of your products and services. There is a catch here you should be aware of – the products you sell the most of aren’t necessarily the ones that make the most profit.
Here’s the point; so many businesses I’ve worked with don’t know the profitability of their individual products, or, not infrequently, of their product lines. They may know their theoretical profits, but not their actual profits.
That can be due to some of those issues above – misallocation of costs or not charging for all the work done. But in some cases they just don’t actually calculate their Cost of Sales by product line.
In one case, when we worked with a client to allocate their Cost of Sales to the applicable product lines, we found their Cost of Sales was greater than the price charged. The more they sold, the more profits they leaked.
We all know our reaction to poor customer service – “I won’t go back there again!”
According to a research report by Ruby Newell-Legner, a typical business hears from 4% of its dissatisfied customers. 96% won’t complain and 91% of those will never return.
Good customers are far more profitable than new customers. They buy more often, they spend more and they provide referrals. And it costs many times more to acquire new customers (think of your promotional costs) than to retain a customer. Yes, advertising may be about selling more, but it is mainly about acquiring new customers.
As marketing guru Dan Kennedy says, the whole point of a “Sale” is not to make a profit; it is to acquire a customer. But having acquired a new customer, you need to keep her.
If you are leaking customers, you will be leaking profits!
When clients approach me for coaching, so often, they are not getting the clients they need, the right clients. Eight times out of ten this comes down to not knowing what is working, and what is not working, and how to work out just where they are leaking profits, and plug those leaks.
For more than 28 years I’ve been helping small business owners plug the profit leaks in their business and restoring their cash flows by assisting them understand:
• The strengths, weaknesses opportunities and threats of their business
• Determine where they want to be – clear, achievable goals, and
• How they are going to get there – their strategies to achieve their goals
This is sometimes known as the NOW – WHERE – HOW model.
If you would like to discuss with me how you might do that, book a Strategy Consult here.
© Copyright 2017 Adam Gordon, The Profits Leak Detective
Some profit losses are pretty obvious - so you fix them.
BUT, what if you don't know profits are leaking, cash out the door?
Possible leaks could be anywhere.
Are there some clues or symptoms that are tell-tales?