Does being profitable have to be this difficult?
Running a business is not just about increasing sales. It requires being profitable and business efficiency as well. If you want your business to succeed truly, you need to make sure its processes and people deliver the best results at maximum profit.
Channel Partners, a business training, and consultancy agency, has developed an industry-shaping channel tool called the Execution Excellence Model based on the principle of return on working capital. It focuses on not only growing sales but on making your business more profitable and efficient, by identifying five key areas and business metrics for evaluation: gross margin, cost structure, inventory days, days sales outstanding, and days payable outstanding.
Being Profitable – Gross Margin
When you make a sale, the money you are left with after deducting the actual cost of the product is your gross margin. If you sold $250 worth of books, which cost $200 to make in material, labour and factory overhead, your gross margin is 25 percent.
Businesses aim to get the highest possible gross margin, by either raising the price or lowering the cost to manufacture. Setting a price higher than the competition repels customers, equalling lower number of units sold and a dip in revenue and profit. Unless you have a monopoly or something new to offer, people will be swayed by the competition.
Walmart has become one of the world’s biggest companies by going in an opposite direction. By setting “always low prices” and focusing on the sale of large volumes, they have dominated the American retail sector. Look for ways in your business to improve the average gross margin on each transaction that you make.
Being Profitable – Cost Structure
The fixed and variable costs that your business incurs in running operations make up your cost structure. Fixed costs are those that remain the same regardless of the volume of operations or products/services produced. They include rent, employee salaries, maintenance, etc. Variable costs, on the other hand, are those expenses that vary with the volume of goods or services. They are costs depending on the number of people served in places like restaurants, events, or a spa.
Cost structure is used in management accounting, and can be further sub-defined into smaller categories like product, service, product line, customer, division, or geographic region. You can increase profit by stripping out inefficiencies in the way you allocate your people to the market and run your business.
Being Profitable – Inventory Days
Inventory days define the average number of days your goods remain in inventory before being sold. The shorter your inventory turns, the better. However, too low a number might be the warning of a loss in sales due to unfulfillment of demand.
Figure out ways to make your inventory returns shorter and shorter. Long inventory days are an indication of poor sales and excess inventory; whereas a shorter number means strong sales or unmet potential of sales. Be careful not to go to an extreme in either case.
Being Profitable – Days Sales Outstanding
The average number of days a business takes to collect the money of a sale after the transaction is known as your Days Sales Outstanding (DSO). Because liquid money is so important in running a business, it is vital for a company to collect outstanding receivables as quickly as possible.
The longer the duration of your DSO, the more time you lose investing that money and generating further sales. Your cash flow also gets disrupted which puts you in a tight spot when paying suppliers, workers and utility agencies.
Make a point of collecting money faster. Put processes in place that make sure clients are being called and followed up on. You can start by making a schedule of reminders. Since you can’t physically take your money out of their bank accounts, you have to settle with reminding them often and quickly.
Decrease the number of days between reminders as the time to repay gets longer. Supplement your letters with phone calls, faxes, and even a visit if it’s taking too long. At every interaction, make sure your client is aware of your company’s policies and payment terms.
Being Profitable – Days Payable Outstanding
Days Payable Outstanding (DPO) are the average number of days it takes you to pay back your invoices from trade creditors, such as suppliers. The longer you delay it, the more risk you put your credit rating at. Improve your credit with those companies and suppliers you owe money to by setting reminders for yourself.