It’s not what you make, it’s what you keep. This may be the most important truism in business.
Simply put, there’s a big difference between how much money a business collects, or its revenue, and how much money it earns after all expenses are paid, or its profit. Not understanding this difference is one of the chief causes of failure among small businesses, especially new ones.
It’s nice to collect a lot of money from your customers, but the mistake comes in not realizing that, for most businesses, expenses must be paid out of this revenue. Whatever money is left over after you have paid all of the expenses incurred to manufacture and deliver a product or service is your profit.
Improving your profit starts with understanding the concept of profit margin, which is simply the difference between profits and sales.
For example, if your business collects $1,000 for the delivery of a finished widget, but it cost you $500 in materials, labor and overhead to manufacture that widget, your profit margin would be 50 percent (500/1,000 = .5, or 50 percent).
The higher your profit margin, the more money your business earns. In the example above, if you could reduce your material, labor and overhead expenses to $400, your profit margin would grow to 60 percent and your profit to $600.
There are two primary ways to grow your profit margin: Reduce costs or increase revenue.
Reduce Your Costs
Look at every possible way to cut your costs. Try these ideas:
- Negotiate with suppliers
If you manufacture a product, raw materials may be your biggest expense. Talk to your suppliers about ways you can save on raw material costs. For example, maybe you can lower your price by buying materials in bulk. Also, many suppliers offer discounts for paying invoices early.
- Watch miscellaneous expenses
Little costs add up over time. Be careful not to overspend on items like office supplies, overnight shipping and, with the high price of gasoline, extra trips in your car.
- Replace face-to-face meetings with virtual ones
High energy prices have resulted in soaring travel costs for businesses. However, the quality of virtual meetings has increased drastically in recent years. Consider whether a trip to meet with a vendor, client or prospect can be replaced with a Webcast, teleconference, videoconference or even a phone call.
- Barter
Many small businesses are able to trade their products or services to other businesses in exchange for things they need, like office supplies or raw materials, thus saving valuable cash and boosting profits. For example, you could cut marketing costs by trading your product or service with a magazine or newspaper in exchange for a display ad.
Increase Revenue
Consider these strategies to increase revenue:
- Raise prices
This is the most obvious way to increase revenue, but raising prices can result in lost customers if not done carefully. The best way to raise prices is to offer additional value along with the higher price – in particular, value that costs you little or nothing. For example, offering free gift wrapping might cost you very little but add a lot of value to your products.
- Earn more money on excess cash
If you keep excess cash (above and beyond what you need to meet your business’ daily operating expenses) in a non-interest bearing checking account, talk to your bank about other account types that let you earn interest on these funds.
- Offer ancillaries
Are there add-ons or additional features to your existing products or services that you can offer your customers for an additional price?
- Launch new markets
Are there new products or services you could offer that would appeal to your existing customers, new customer segments or niches? Ideally, these should be complementary to your existing products or services. For example, if you manufacture cleaning solutions and sell them to janitorial companies, maybe you could offer your customers cleaning supplies as well, or begin offering your cleaning solutions to retailers or homeowners.
Get More Ideas
Need more ideas about how you can improve your profit margin? Get help from the small-business consultants at
ProTalk. They’re just a phone or keystroke away. And they’re available at no additional cost to AFS Members.
(Posted September 2008)
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