Every business can improve its profitability - its "bottom line". Sometimes a single factor can significantly increase the profitability of a business, but for most businesses increasing profitability is a matter of creating a framework for implementing a number of small improvements gradually, ideally built into day-to-day processes and operations.
There's no one solution that will work for every business, but there are three key areas that every business can consider when aiming to increase profitability. These are:
- reducing costs
- increasing turnover and increasing productivity
- increasing efficiency
You can also look at more major changes to your business, such as expanding into new market sectors or developing new products or services.
Examine your options
Look around your business to see where you can be more efficient. A number of small measures can have a surprising impact on your profitability.
Your current position
Analyse your present capabilities, strengths and weaknesses. Using key performance indicators (KPIs) will quickly show how well you are managing your profitability.
KPIs to examine when considering your profitability include:
- past, present and future sales
- working capital
For example, falling sales, deteriorating working capital and rising costs are all typical indicators that your profitability is suffering. Use our interactive tool to assess how well your business is performing.
More effective purchasing can increase your gross profit margins.
Find ways to cut waste and uncover hidden costs. Find out what your sales are actually costing you - you may find that some customers are not as profitable as you thought.
Find ways to get more productivity from your staff. Staff are most business' largest cost - raising their effectiveness can boost profitability.
Review your sales operations. Ensure that you are targeting the most profitable customers with the right product offering.
Consider your offer - can you sell other complementary products to profitable customers?
Plan for profit
In most cases, a combination of these measures will give a useful boost to profitability. It's a very good idea to build these measures into your business plan.
Manage your costs
Close management of your costs can drive your profitability. Most businesses can find some wastage to reduce, but be careful not to cut costs at the expense of the quality of your products and services.
Key cost areas
Your key cost areas to consider are:
- Suppliers - assess whether you are getting the best deal from suppliers. Can you drive better deals by consolidating your supplier base? Can you buy on a "just in time" basis to make more effective use of your working capital?
- Finance - review your finance facilities - are they at the most competitive terms available? Are you using any loans and overdrafts effectively?
- Premises - examine whether you are getting the most out of your space. Are there more efficient ways to use your premises? Could you sublet some unused space?
- Production - assess whether you can cut waste and lower the costs of your materials. Check whether you can adapt your production processes so they are more streamlined, using fewer working hours or resources to cut labour costs.
Uncover real costs
Consider using activity-based costing to find the real cost of specific business activities. Activity-based costing shows you how much it costs you to carry out a specific business function by attributing proportions of all your costs - such as salaries, premises or raw materials - to specific activities.
While it may take some time in the initial analysis, using activity-based costing can often show up costs (and therefore potential efficiencies) that you would not normally uncover using more traditional costing methods.
Review your offer
Look carefully at what you offer, who you sell it to and at what price and see if you can make improvements.
It's a good idea to review your pricing regularly. Changes in your marketplace may mean that you can raise your prices without risking sales. However, it's essential to test any price rises before you make them permanent.
Find your best customers
It's not just your price list that affects your profitability - the type of customers you're selling to can also make a big difference.
Consider the Pareto principle (often known as the 80/20 rule) and how it applies to your business. In simple terms, the Pareto principle says that around 80 per cent of your profit is gained from 20 per cent of your products or services. The same percentage of profit is often also gained from the same percentage of customers.
Focusing on your most profitable customers - even if it means letting the less profitable ones go - may boost your profitability, so long as it is handled carefully.
Can you sell more to your best customers?
You may also be able to sell more to your most profitable customers. You can consider:
- up-selling - selling them premium products that make a greater contribution to your profit
- cross selling - analysing what they buy and offering complementary products
- diversifying - identifying a need and developing new products and services to meet them
Buy more effectively
One of the most obvious routes to increasing your profitability is to buy more effectively. It makes sense to review your supplier base regularly and see if you can buy the same raw materials more cheaply or efficiently. However, you need to ensure that you don't damage your product or service by reducing quality for the sake of cutting costs.
Get the best deal
Identify your key areas of expenditure. Analyse your expenditure to show where the largest share of your money is spent.
Once you know where your money is going, shop around. Try bargaining with your suppliers - ask if you can have price reductions or discounts for early payment. Consider using your status as a valued customer to agree long-term contracts or realistic annual minimum spends with regular suppliers to obtain a better price. You could also buy as part of a consortium with other similar businesses. If you can't strike a better deal, consider switching to other suppliers.
Review how many suppliers you use. Buying from too many can be inefficient - it takes up more time and dilutes your buying power. However, try not to place all your business with one or two suppliers - it leaves you very vulnerable if things go wrong.
Review common areas of waste and see how you can reduce them. Are there ways to cut your power costs, eg is all equipment turned off when it's not being used? Are you getting the best deals from your power suppliers? Are you paying for services that you're not using, eg unused phone lines or photocopiers?
Consider whether you're getting the best from your property. Your premises are one of your largest expenses, so it's a good idea to get the most from your investment or rental agreement. Can you use your space more effectively by rearranging it? Could you sublet unused areas? Could you negotiate a lower rental if you agree to a longer contract?
Concentrate your sales efforts
There are two key strategies for boosting profitability through your sales efforts - selling more to existing profitable customers and finding similar customers like these to sell to.
Work with your best customers
You should have a clear idea of who your best customers are, what they buy and when they buy it.
You can usually put your customers and the products or services they buy into one of four categories:
- high sales and high profit
- high sales and low profit
- low sales and high profit
- low sales and low profit
It makes sense to encourage customers that provide high sales and high profit. However, you can also significantly boost your profitability by nurturing customers that provide high profit on low sales. If customers are providing low profit from high sales, you should consider your pricing to see if you can generate more revenue from them.
And if customers are generating low sales and profits, you should consider if it's worth your while continuing to do business with them.
Find new "best" customers
Consider expanding your customer base by finding new customers who share a similar profile to your existing profitable customers.
If you are sure you have covered your existing market as much as you can, consider moving into new markets.
Expand your market
Moving into new market areas can transform a business and, handled correctly, can significantly increase your profitability. However, bear in mind that developing new products and services and selling in new markets can be risky - and mistakes can prove very expensive.
Do your research
Before you start, carefully research the potential opportunity. Can you tailor or adapt existing products or services for new markets? This can provide new revenue at minimal cost and is ideal for boosting profit. For example, if you manufacture tools for the garden market, are there any potential applications for the tools in the construction industry?
You need to clearly understand who your potential new customers are, why, when and how they will buy the product or service and how much they will pay for it.
Starting from scratch
If you're developing a new product or service for a new market, you'll need to carefully consider whether it's viable for you to do so. Key questions include:
- Do you have the skills and expertise in-house or will you have to buy them in?
- Have you got the commitment and resources available to make the new project work?
- Can you minimise the risk?
- Can you be sure there's a demand for the new product or service at a price you can make a profit on?
Rather than going it alone, it may be less risky to develop a partnership or joint venture with a complementary business. While the potential rewards may be lower, the risks are also significantly reduced.
Getting the most out of existing resources can benefit your profitability. All businesses can work to minimise wastage costs and downtime and still ensure the cost of providing their product or service remains competitive.
Measure your operational efficiency on an ongoing basis. Put systems and processes in place that allow you to monitor and adapt as necessary in order to get the most from your resources.
For example, you should regularly monitor how many employee hours it takes to perform specific tasks or provide services. If the time rises, it indicates inefficiency - the quicker you eliminate this, the more your profitability will benefit.
The commitment to managing productivity must come from the top to be successful. Communicate your productivity targets and how you are going to measure them so staff feel they have something to aim at. You can also consider introducing staff incentives to keep to targets - but define them carefully so quality is not adversely affected by increased speed of production.
You should define the key performance indicators (KPIs) that are most suitable for your business. They should reflect your goals, be measurable and comparable and allow for corrective action if things go wrong.
Streamline your processes
Step back on a regular basis and question whether there are more efficient ways to reach your goals. For example, you may always produce a particular type of product at a specific time in the month. But would it ease your cashflow if you produced, shipped and invoiced it earlier, or later, in the month?
It's useful to get an idea about how comparable businesses approach similar issues. This is known as benchmarking. Benchmarking can be on a basic, like-for-like level - such as comparing energy costs between similar businesses - or it can be more detailed, such as sharing data and analysing production and stockholding patterns with other businesses you trust.
The additional perspective that benchmarking offers can provide new ideas and momentum to make your business more efficient.
Ensure continuous improvement
Making profitability a priority isn't just a matter of concentrating on it for a short time and then letting it look after itself. You must maintain a consistent focus on profitability across all areas of your business.
Routinely manage your profitability
You need to review your profitability regularly, assessing all the key areas - how you buy, your sales and marketing processes and plans, production and delivery arrangements. It's a good idea to build these reviews into your everyday business processes wherever possible. For example, consider motivating sales teams to focus on profitability of sales, rather than pure turnover. You could also reward production staff for suggesting more efficient ways of doing things.
Periodically, you will need to step back and reassess the profitability of your business.
Watch the market
Stay aware of trends in your market - they will have an impact on your profitability. If you fail to recognise these developments, you may miss opportunities. If you watch trends carefully, you stand a much better chance of capitalising on them.
There are two key processes you can use to manage your profit strategy - benchmarking and SWOT (strengths, weaknesses, opportunities and threats) analysis.
Benchmarking shows you how you are performing against comparable businesses. If you benchmark regularly, you will get a more impartial idea of where improvements can be made.
Regularly carrying out SWOT analyses will help you manage your strengths, weaknesses, opportunities and threats as they change. This gives you the best chance to respond to changes before your competitors do, thereby protecting and growing your profit.
Here's how I increased profitability by expanding my market
Paul McCormick GCA Ltd
Paul's top tips:
"Drive down costs and be ruthless about getting paid on time."
"Share ideas with other businesses through networking."
"Be prepared to lose a few clients in order to focus resources on your most profitable customers."
What I did
Take financial control
"When I joined GCA four years ago, the company had plenty of work and customer feedback was excellent, but there was little financial control. Poor cashflow meant that we were running an overdraft, borrowing unnecessarily and had made a loss for the previous four years.
"Financial management is definitely the place to start when you're seeking to increase profits - there's no point doing anything else until you've got costs and cashflow under control. We devised a plan to reduce our borrowing, eliminate our overdraft and implement rigorous financial management procedures. We also changed several of our suppliers, for example saving tens of thousancds on insurance."
Research the market
"Once we had finances sorted, we set about researching the engineering market with a view to growing the business - at the time, we positioned ourselves as structural engineers only. The objective was to add services that utilised our existing skills pool, while offering customers a one-stop-shop that would allow us to take on larger projects, as well as attract new customers.
"Through a mix of competitive analysis, customer consultation and instinct, we decided to focus on transport and highways. Structural engineering is extremely competitive with margins of just 3 to 4 per cent, whereas niche services like highways engineering pay between R100 and R400 more per hour - even though exactly the same person does the work, using exactly the same skills! We put together a marketing plan to launch the new services, produced new sales materials to support them and advertised them online using Google AdWords, which has proved highly successful."
Strive for continuous improvement
"The initial momentum can soon wear off, so it's been important to have systems in place that encourage us to regularly review our profitability. We include profit and loss accounts in our monthly management meetings and cascade the findings down to all staff, encouraging feedback and ideas. We've also expanded in-house training provision to keep a stream of talent flowing through the company as we grow.
"The figures speak for themselves - our profits were up 55 per cent last year and are now two to three times the industry average, with the new services already accounting for 30 per cent of profit overall."
What I'd do differently
Do more research
"In the early days, I don't think I fully appreciated the benefits of thorough research. The more information you have, the better your decision-making will be."
Consider share options
"Our growth plan has proved so successful that we inevitably get other companies trying to poach our staff. In retrospect, we should have looked into more ways to lock in key staff, such as share options. That's something we're currently exploring."
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