5 Ways to Improve Profitability

CHINOOK BUSINESS ADVISORY | JANUARY 2022

Every single business at one point or another wants to improve their profitability.

Whether this is after your kickstarter year when just trying to get the ball rolling, or 30 years down the line looking for new tips and tricks. Most often, business owners think “well, to gain profit, I need more business. In order to get more business I need more staff to do the work… but then I am spending more money without guaranteed growth. Maybe I’ll get stay where I’m at.” And it ends there until the fiscal year end and you’re wishing for more profits.

The intent is to increase revenue and decrease expenses with the hope to gain better cash-flow and increased profit. We can help break that internal conversation loop and get you on the right track.

Here are 5 Ways to Improve Profitability:

1. True Margin

Do you know your “true margin” and are you selling your products or services at the right price?

Many business operators don’t fully understand what their “actual” or “real margin” is based on cost of goods sold or services offered. They fail to consider a portion of the expenses and cost associated with running the business when setting a price or rate of services offered. Does your price or rate create enough of a margin after wages, employee costs, material costs, subcontractor costs etc. to allow for an acceptable margin, yet still be competitive?  Be sure to research your local competitors which will assist in understanding what customers are paying. This should be a determining factor for where your company should position itself in the market and your future profitability.

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2. Financing

How are you financed and/or supported by your bank?

Most small businesses are self-financed and have very little support from banking institutions. Do your research; there are financial institutions that work well for some industries and not for others. That said, most banks will provide a small “operating line of credit” (LOC) based on the individuals own personal creditworthiness. A very broad formula to determine the correct size of an LOC would be approximately10% of annual revenue. (Eg. $1,000,000 in annual revenue = $100,000 LOC) Having the appropriate financing will allow you to preserve cash during normal operations while allowing for receivables to be paid. Try to avoid personal credit card use and ensure that all monies or assets provided by the shareholders are documented at fair market value, thus reflecting a shareholder’s equity position within the company financials. These amounts can be repaid with minimal or no tax consequences later.  

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3. Personnel

Are all your employees/workers contributing and/or necessary?

In most businesses, all employees are necessary to affect the sale of services or products, whether they are front line workers, support staff, or administrative.  In small businesses, it is imperative that everyone contributes, and that the management structure be as flat as possible. The more folks out in the field or in front of customers, the better chance of sales success. In service businesses, eliminate as much of the “non-billable” time as possible. This is a direct cost to the bottom line, which is not recoverable and, where possible, make use of sub-contractors, with the appropriate mark-up, allowing for a clear line of profit.

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4. Accounts Receivable

Are you guilty of financing your customers without even knowing?

At the retail level this is not so much an issue, but many small trades and service companies invoice after the work is complete, then wait another 30 days to be paid (or more.) This results in the company having to carry the payroll, subcontractor, and material costs while waiting for payment on work that is completed. In most cases, we would suggest a decent percentage deposit at the time of booking (40%) and progress payments throughout leaving no more than 10% due upon completion. This will hold you accountable to the customer and provide you with the opportunity to react to change orders and changes in scope of work while the project is in process. It’s very difficult to go back to a client after the work is done and ask for more money.   

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5. Equipment, Rent, and Leases

Do you have flexibility with your current lease? Are those equipment purchases necessary?

It goes without saying that a small business must work within its ability to pay for equipment and facilities. In the retail environment, the best real estate wins! Or at least it used to … Now, with the monopolization of online retailers being in a high traffic/high rent, property is not always a remedy for success. Many urban area retailers are being pushed out by landlords trying to recover the cost of very high municipal taxes. Try to avoid or renegotiate rents or leases that cannot guarantee a high volume of sales. Most landlords would rather have some revenue coming in than the alternative of having an empty space. Understand that long-term leases may seem like a good thing at the time, but they also represent a long-term commitment that the business must endure through good and bad times. Try to negotiate some flexibility with the landlord. 

Service and trade businesses often invest in large dollar equipment purchases of leases without acknowledging the long-term implication of liability and cost. Ask yourself when assessing, is this necessary for the operation? Could you rent as needed? Could you subcontract? Once again, understand the cost associated with financing the purchase or lease, maintenance, insurance, operator wages, and resale.

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In Summary

Profitability is not a given and does not come easily. All businesses will face adversity through market conditions, pandemic, political change, and many other factors from time to time. Ultimately, being mindful of the 5 tips indicated will help ensure your business has a good chance at success and profitability.  If you want to talk to the expert that has used these skills to turn a $600K business to over $7.5m in about 18 months, set a meeting with Dana here to talk about what we can do for you.

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