How to Increase Profit Tomorrow
- You know what your current average dollar sale is
- You have involved your staff in your efforts to increase your average dollar sale
- You have identified and are beginning to implement strategies to boost your average dollar sale – even by a small amount
Make sure that your business is set up to reap the most profit from the efforts you have made attracting new, loyal customers.
The bulk of the strategies we have been focusing on have to do with external elements – like customers and marketing and sales processes. The last step in the process is internal to our operations and something we have quite a bit more control over.
What you decide to spend money on, how you price your products and services, and how much you pay to acquire your products and services are all choices that you make in running your business. Profit margins can be optimized so that each transaction that goes through your point of sale is contributing the highest possible dollar value to your bottom line.
Since you have invested so much time and money in the last four steps to bring in more customers who spend more money more often, it only makes sense that your profit margin should be as high as it can possibly be to reap the highest possible return on your investment.
In this E-Class we will cover:
- The impact profit margins have on the bottom line
- How to calculate your current profit margins
- The current status of margins in your company
- The factors that influence profit margins
- The three ways to increase profit margins
Profit margins are the final factor you can control (and increase) in the overall calculation of net profit.
Your profit margin is what you make after all of your fixed and variable costs have been subtracted from your total revenue. It is the difference between what the customer pays you, and what you have paid to acquire or offer the product or service, minus your operating costs.
Increasing your profit margin is the last opportunity you have to influence your net profit. The net profit you make is the product of your total revenue and your profit margin as a percentage.
$ REVENUE X % PROFIT MARGIN = $ Profit
For example, if my company brings in $100,000, and my average profit margin is 34%, my profit (or bottom line) would be $32,000.
If your average margin is too low, you will perpetually be spending your profit keeping your business running, and never make any money regardless of how many customers you have, how often they buy from you, and how much they spend.
So, you want to do everything you can to make your margin as high as possible. As I showed you in the last two steps, here is the impact that a 10% and 30% increase in your profit margin will have on your net profit.
|Starting Point||10% Increase||30% Increase|
|Conversion Rate||30%||Conversion Rate||30%||Conversion Rate||30%|
|Average Dollar Sale||$140||Average Dollar Sale||$154
|Average Dollar Sale||$182
The two factors that impact your profit margins are fixed and variable costs, and they need to be managed differently.
Fixed costs are the costs that remain the same, or are predictable for a long period of time. For most businesses, the cost of your products or services will be fixed. The amount you spend at the wholesaler or on employee salaries will remain the same from month to month, or be something you can accurately forecast.
Using fixed costs, you can calculate your profit margin as the difference between what your customer pays for the product or service, and what you paid for it. For example, if you buy toothpaste for $0.50 from your vendor, and your sell it for $4.25, your margin is $3.75. Alternately, if you offer a service like haircutting and you pay your stylist $40 per hour while your customer pays $100 for the treatment, your margin is $60.
Variable costs are those that change on a regular basis, and can be hard to predict and control. Usually these are your monthly expenses – the cost of running your business – but it can also include product and service costs if they fluctuate. For example, in restaurants the cost of food varies from season to season.
Variable costs include:
- marketing + advertising
- business development
- office supplies
- incidentals and unforeseen costs
What is the current average profit margin for your business?
The formula you would use to calculate your profit margin is:
$ price – $ cost (fixed + variable) = $ margin
$ margin / $ price = % margin
So, if an item costs $75, and your costs are $23, then your profit margin is $42, or 56%.
- Calculate profit margins on each item.
An easy way to do this is to use your service menu or inventory sheet, and record your cost, the price, and the difference between the two figures as a dollar amount and percentage.
If you carry hundreds or thousands of products, choose a representative sample and look at the margins on those items only. Or, if your inventory system tracks prices and your costs, you may be able to run a report that calculates your margins for you.
You’re looking for a general idea of what your margins are, as well as the ratio between high margin and low margin items. Every business that offers a range of products or services will have some high margin items, and some low margin items. You will need to ensure that you have a healthy balance, as you’ll learn in the upcoming sections.
- Calculate average profit margin for your business as a whole.
To calculate the average profit margin for your business, we’ll use some broader numbers to make calculation easier.
Take the total price of all the items you sold in a month or quarter, and subtract the total cost to acquire or provide them as well as your expenses for that month. This figure is your total profit for the month.
Then, divide your profit in dollars by your revenue in dollars, and you’ll get your profit margin as a percentage.
Your calculations would look like this:
$ revenue – ($ cost of items sold + $ month expenses) = $ profit
$ profit / $ revenue = % profit margin
Based on your calculations, what did you discover about profit margins in your business?
When you have finished calculating your profit margins, take a look at the figures you generated and make some notes about what you observe.
Sometimes, just working through the exercise of establishing exactly what your margins are can have a big impact on your business. You may have discovered something you didn’t know about your expenses, or found a product that was under priced.
Here are some questions you can ask yourself about your results:
- Is your profit margin what you thought it was? Higher? Lower?
- Do you think you can improve on your margins? (yes!)
- What percentage of your products and services are high margin? Low margin?
- What opportunities exist for you to boost your profit margins?
- Can you reduce variable costs – or make them more predictable?
- Can you reduce fixed costs to maximize your existing margins?
- Can you increase your prices? By how much?
- What strategy makes the most sense for the unique needs of your business?
Based on what you observed, there are a variety of changes you can make to increase the profit margins in your business.
There are three basic ways to increase profit margins: maximize margins, reduce costs or increase prices.
Depending on what you discovered about your profit margins when you calculated them, you may wish to implement one, two or all three of these strategies for boosting your profit margins.
- Maximize your existing margins.
- Increase high-margin items and decrease small margin items. Every business that offers a range of products or services will have a range of high and low margin items. If you have too many low-margin items, however, you will never be able to increase your bottom line because there is not enough profit to do so. High margin items generate the most income, so your staff should be focused on selling these items and bringing in the highest sales.
- Stop discounting. I’ll review in another e-class why discounting hurts your business, but in this case you should stop discounting because it’s eating away your margins. There are better ways to generate leads and repeat business without costing you money. If you have received a discount on products or services from your supplier, keep that discount to yourself instead of passing it on to the customer.
Reduce fixed and variable costs.
- Be aware of and manage spending. Establish clear protocol for sign-off on purchases over a specific dollar value, and keep a close eye on the people who are authorized to spend company money.
- Recession proof your spending habits. Remember that cost management will help your business survive through high and low periods in the economy. It’s easy to get carried away and spend freely when the company is doing well, but good money management habits will keep your business alive through struggles.
- Renegotiate or refinance. Can you refinance your loans, or negotiate a better interest rate? Consolidating debts and restructuring your business finances to reduce fees and other hidden costs can be a valuable exercise for your company. Interest rates and bank fees are big culprits of profit theft.
- Renegotiate with suppliers and vendors. Just like you would do with the bank, make sure your product and service costs are competitive. Renegotiate with your vendors and suppliers on a six-month or yearly basis, and always deal with decision makers who have the authority to give you better rates.
- Review staffing needs, wages and commissions. Of course you want to treat your staff well and reward good performance, but keep an eye on this category of spending to ensure it’s kept at an appropriate level. If you offer a rewards program, make sure you can afford to deliver staff rewards as promised. Renegotiate commissions every year, and make sure your staffing levels are appropriate to the needs of your business.
- Cut invisible costs. There are expenses in every business that go unnoticed and can be eliminated from the budget. Take a close look at all of your expenses, and identify any extras or amenities you can live without. Some examples are:
> Magazine subscriptions
> Brand-name office supplies
> Daily snacks and refreshments
> Brand name coffee or tea
> High end marketing materials
- Don’t be afraid to boost prices by 10%. Many business owners are afraid they will lose customers if they increase their prices, but this is rarely true. Most customers won’t notice a hike in prices, so you’ll lose very few.
- Make sure your prices are higher than your cost. Obviously, you might think, but make sure you consider not only the cost of providing the product or service to your customers, but the cost to you if you do not sell all the items that you ordered. Build room in your prices to accommodate fluctuations in sales volume.
- Include all expenses in your pricing. Remember that all your expenses need to be factored into your pricing structure. Include both the cost of providing your product or service, as well as the cost of running and maintaining your business. You could have huge margins, but if you don’t factor in operating expenses, you may have priced yourself out of business.
- Price for perception. Price will impact how customers perceive your business and your product or service, so consider this when you are establishing your pricing strategy. Consider what customers would think would be ‘fair’, as well as what your competitor’s price is, the image you are trying to create, and the perceived value of your product or service.
Monitor your costs and profit margins carefully to ensure that your business is running as efficiently as possible.
As you can see, there are many factors that impact your profit margins and it’s easy to let them spin out of control and eat your bottom line. Keep a strict budget and establish clear protocols for spending and expenses.
Remember that unless you have healthy margins, no matter how much time, money and effort you spend attracting and converting customers, you’re not reaching your business’ true wealth potential.
Next week I want to walk you through a case study about a client of mine who enjoyed amazing results after working through the five-steps. I’ll show you how she managed to use the strategies in this program to triple her lead generation and spend less time doing it.
Thanks for tuning in!