A profitable business is a saleable business. A profitable business is easier to manage and to operate. Everyone loves to do business with probable businesses because they all know the invoices will get paid. The best employees want to work for profitable companies because they know their paycheques will not bounce or get delayed.
Profit is the reason entrepreneurs get into business in the first instance; but how to keep a company profitable is sometimes a trial. Here is how, with the first of our 5 keys to profitability.
Attention to cash flow
Most business owners focus on price and margins forgetting an important element in running a successful business – cash flow. What does this mean and how does it work?
Let us consider for a moment that you are selling loose tea. You pay 1 dollar per kilo for the tea. You sell the tea for $1.50 per kilo giving you a margin of 33%. Monthly you can sell 100 kilos to 100 different customers. So every time you sell one kilo of tea you profit by 50 cents.
At $1.50 per kilo you can sell 100 kilos per month but experiments have shown that by dropping the price to $1.29 per kilo you sell 150 kilos per month to 150 different customers. That generates a margin of 22%. So every time you sell one kilo of tea you profit by 29 cents.
Most business owners will focus on sales and price believing that dropping the price will increase sales and the sun will shine. But will that reasoning help your profits?
In the first example the cash flow is $50 per month. In the second the cash flow is $43.50. So dropping the price and selling even more tea has damaged the bottom line. In terms of cash flow, increasing the sales with a lower price has not been a good decision.
But if you focus on the cash flow figure, you can also improve profits, as follows. Suppose that you are now selling tea for the sale price of $1.29 per kilo. But instead of selling one kilo at a time, now the buyer must buy a minimum of 2 kilos. As before, 150 customers come in and buy tea and the margin remains the same at 29 cents per kilo. But this time the contribution to the bottom line is $87. And you did not have to work any harder for that profit.
What this example tells us, is to focus on the dollar contribution and not margins or even the price. Dollars pay the rent, employees and taxes.
Written by Andrew Gregson, Senior Partner at Floodlight Business Solutions and author of Pricing Strategies for Small Business (2008). 1-888-959-0752 www.floodlight.ca. Floodlight Business Solutions, where we help you drive profits.