The vast majority of business owners in this country work hard, very hard. However, despite their best efforts, a lot of businesses never reach their full profit potential.
There’s no doubt, to create a successful business you need to do research and planning plus you need to take risks. There are very few shortcuts to success and no amount of enthusiasm, passion, talent or hard work can guarantee business success.
While there are a multitude of reasons why a business can fail, there are even more reasons why a business under-performs. The wrong product, incorrect pricing, a poor location and a lack of marketing can all drag down your bottom line profit. Bad timing and simply not minding your own business by maintaining quality financial records can also impact on your profit. Of course, some of these issues a business owner can control while others are out of your control including economic conditions, new technology or natural disasters.
Profit is how we keep the score in business and it is also a consequence of decisions made by management. The mission is to maximise your profit and when you sell your business, the valuation might also be a multiple of your profit so it’s important to continually grow your profits.
Fundamentally there are only four ways to grow your business and your profit:
- Increase the Number of (Ideal) Customers
- Get the Customers to Buy More Often
- Increase the Average Sale Value
- Improve Your Systems & Processes
It doesn’t matter if you run a physiotherapy, plumbing or painting business, the first step in growing your business is to identify these 3 key numbers:
- Your number of customers
- How many times each year those customers transact with you
- The average customer sale value or transaction amount
To illustrate the point, let’s assume you run a hairdressing salon and your metrics are as follow:
It’s basic mathematics to arrive at the turnover figure of $187,500. They say you can only manage what you measure so it’s important that you know these three numbers in your business. If the business has rent of $50,000 plus wages of $45,000 and other costs of say $15,000 (including rates, insurance, repairs and consumable products) then the business profit would be $77,500. Assuming your business was valued at 2 times your profit (before interest and tax) it would be worth $155,000.
Now, let’s look at the profit improvement potential in the business by increasing some of these key performance indicators.
The simplest example is increase your average sale price by 10% so it goes from $125 to $137.50. That might be as simple as putting your prices up or alternatively you start ‘up-selling’ so each customer buys some hair product on leaving the salon. Multiplying the numbers through, your turnover goes from $187,500 to $206,250. The $18,750 increase in revenue goes almost entirely to your bottom line profit.
Let’s now look at what happens if we can get an increase in more than one of your key performance indicators. If you could increase your number of customers by 10%, increase your prices by 10% and get your customers to come in for a haircut 7 times a year (instead of the current 6 times) what impact would that have on your business turnover and profit? As you’ll see below, the business turnover rises by an incredible 41% to $264,688. The compounding effect is massive!
With the extra number of haircuts, you might have to employ a part time hairdresser, so we will allow an extra $15,000 for wages and hair product you might consume delivering these services. The business profit increases by $46,021 (59.38%) from $77,500 to $123,521.
Not only that, because of the profit improvement, the value of the business has increased by $138,063 from $232,500 to $370,563.
A 10% increase in price combined with a 10% increase in the number of customers plus getting customers to come and buy one extra time per year is probably achievable for any hairdresser, but what can your business achieve? Can you identify the 3 key performance indicators in your business? Financial modelling will help to identify the profit improvement potential in your business and let you set some financial targets for the next financial year. Think about how you are going to attract more customers, get existing customers to spend more with you and buy from you more often.
As your accountant, we don’t want you leaving any potential profit on the table. Talk to us today on ways to improve the profitability of your business.