Have you ever taken the time to look at the profit of your business and where it is actually coming from?
It is important to look at the products or services that your business is providing and see exactly where the profits are coming from for those items. Each product or service has a unique cost structure. This is not just in the sense of the cost of goods sold but the overall cost of the products from start to finish. When looking at your profit, you need to look at the entire process, each step involved in the process and how that can affect your profit.
What elements do you need to consider?
When it comes to determining your profit, you need to look at more than just the price you sell the product for. You need to look at the whole process;
- Cost of goods; the first thing you need to consider is the price that you paid for the products. This is your bottom line and where you need to work up from to determine your selling price
- Delivery of product; this includes both the delivery to you as the owner and also the delivery costs involved with shipping the product to your wholesalers or retail customers.
- Overheads; you also need to consider the overhead costs involved with your product. Do you need to store the product? Does this attract fees? Have you calculated the insurance costs on your product?
- Admin and employee costs; you also need to factor in the costs that you attract from your employees and the administration side of the business. The time that it takes to package your products, invoice your clients and communicate with businesses around them stocking your products.
These all take time; and time is money.
- Wholesale cost; Once you have looked at these areas you then need to look at the price you are selling wholesale. Are you offering different wholesale prices based on the quantity ordered?
Higher gross profit doesn’t necessarily mean the better option
There is the common misconception that when selling your products, the higher gross profit option is going to be the best one for your business. But this is not always the case. This is why it is important to look at more than just the gross profit because you may find that there are better options for your business.
For example, a company sold the same product into two market segments:
- Major chains;
- Boutiques;
The gross profit on sales to boutiques was much higher so it would be easy to think that this was good business. However, when the costs of handling many small sales orders, the costs associated with sending small orders all over the country and the costs of time put into debt collection were all taken into account, it was found that the business would make more profit if it did not sell to boutiques at all.
This example shows that the higher-margin market segment may not deliver the best bottom-line outcome. If you’re not identifying which market segment provides the best bottom line, how can you focus your marketing to grow the good segments and your management to fix the not so good segments?
In another example, a company sold into several major customer chains, but never analysed the gross profit by customer. When this analysis was undertaken, it was found that five out of six customers returned the same gross margin while the sixth customer returned 9% less than the other five. Once this pricing anomaly was fixed, profit increased by over $50,000 per year.
If you’re not analysing margin contribution by market segment, errors in costing or pricing will remain hidden.
Segmentation and Analysis
It is important to set up the structure of your account in a way that will enable you to measure profit results for different segments of the business and analyse them. Segments may be;
- Products;
- Customers;
- Geographical locations;
- Other factors suitable for your business.
Once you have segmented your business into different areas, you are then able to analyse them, make changes where necessary and know exactly where your profits are coming from. This helps to give you a true sense of your business and understand it completely. Profit doesn’t come from just the sale price, it comes from the moment you first start designing a product, that is where you need to start your calculations.
If you segment your business and really know where your profit is coming from your bottom line will improve. Why? Because you will focus your marketing on the best profit contributors and your management on the worst profit contributors.
We are here to help you make sense of your figures and business strategies to ensure you have a full understanding of your financials, enabling you to make fully informed decisions within your business.
Reach out today to find out how we can help you on your journey to financial freedom.
