Profitability Basics | Tory Burch Foundation
A CPA explains why revenue isn't always the strongest indicator of your company's health.
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You’re making lots of sales, but is it enough to really move your business forward? Time and again, I’ve worked with clients who have lots of cash moving into their business but who didn’t understand the profitability basics that would help them grow. Unfortunately, 82% of businesses go under due to cash flow issues, and I want to change that.
I am a big believer that entrepreneurship can help women close the wealth gap. Understanding the following principles will allow you to generate the profits that will help you achieve both your business goals and lifestyle goals.
THE BASICS OF MONEY MANAGEMENT
The first things a business owner can do for a strong financial foundation are separate their business and personal finances, use accounting software, make sure their financial reports are accurate and investing in a good bookkeeper.
Even with a good bookkeeper and accounting software, business owners still need to develop financial literacy. Knowing the inner financial workings of your business helps you identify areas for improvement, improves decision-making on how to support and grow.
Revenue vs. Profit
Profit is the true power of your business. Profit, which is the money that remains after all expenses (such as salaries, rent, inventory, marketing) have been subtracted from revenue, is what matters most in the end. Revenue is the total income your company makes through sales.
Business owners often make the mistake of assuming that high revenue equals high profits, but that’s not necessarily the case. A company could have an impressive revenue but still struggle to make ends meet because of high expenses.
AVOID THESE COMMON MONEY MISSTEPS.
I’ve seen so many business owners tripped up by the following money missteps.
Emotions get in the way.
Remember, money is a tool that you work with. It’s not uncommon for people, especially women, to experience fear and embarrassment when looking at their finances because so many of us don’t learn about these things growing up. Work to separate the emotions from the money management. You’ll have the opportunity to interpret data effectively to make profitable decisions.
You think you just need more sales.
Many business coaches will tell you that you need more sales, but in truth, you need to understand how many sales you need to generate to meet your targeted net profit margin. Standard margins vary by industry. For example, restaurants typically see 8 to 12% margins, whereas professional services can see margins as high as 80%. Do an internet search on your industry’s standard margins to get started. You need to understand how your money is being put to work so that when you do increase sales, you will be increasing your profit as well.
You’re not paying yourself regularly.
You went into business to make money, and if you can’t pay yourself from your business regularly, then your business is failing you. You must include your salary in your budget and make paying yourself from your business a priority.
You think your bookkeeper or accountant is taking care of you.
Your bookkeeper is there to input data according to the rules of GAAP (generally accepted accounting principles). They are not there to offer financial advice or interpret the data for you.
Accountants, on the other hand, are trained to give advice. There are two types of accountants: tax accountants and senior accountants. Your tax accountant files your business and personal taxes for you. Entrepreneurs hire a CFO or senior accountant separately to help them navigate their finances throughout the year. Still, you need to be prepared with an understanding of your profit margins and revenue to be able to have a productive conversation with your senior accountant or CFO.
KNOW YOUR FINANCIAL REPORTS
When you understand these three statements, you can make operational decisions alone or with the help of your CFO. Ask your bookkeeper to pull these reports from your accounting software or show you how to do it yourself.
Profit and loss statement
This report is typically the one you’ll use the most, as it allows you to see how your business is performing over time. By analyzing your income statement, you can determine where you’re making money and where you may need to cut costs.
Statement of cash flow
Cash flow, on the other hand, tracks money as it flows in and out of your business. Rather than looking solely at profit and loss, the statement of cash flow shows us exactly where a company’s money is coming from and going.
Balance sheet
This report provides a snapshot of your business’s financial health at a specific point in time. It shows your assets, liabilities, and equity, giving you a clear picture of what you own, what you owe, and what’s left over. Armed with this information, you’ll be able to make informed decisions about your business’s future, whether you’re looking to expand, invest, or simply stay afloat.
CONSIDER THESE CASH MANAGEMENT STRATEGIES.
Cash shortages in a business can be a critical issue, often stemming from insufficient profit margins or excessive debt. When a company’s profits are meager, it struggles to cover operational costs, let alone invest in growth or innovation. Low profits may be due to underpricing, poor sales, or high expenses.
To mitigate the risk of cash shortages, there are common cash management strategies a business can implement.
- Bulk ordering can lead to cost savings. Be careful—it requires a delicate balance to avoid excessive inventory. Look carefully at your sales history to lower that risk.
- Negotiate favorable payment terms with vendors to delay cash outflows without jeopardizing relationships or supply chain integrity.
- Stay on top of accounts receivable so that invoices are converted into cash quickly. Invoice promptly and follow up on payments is vital. Decide on a good system for tracking and reminding customers of outstanding invoices and stick to it. Timely collections can make a significant difference in the financial stability of a business.
MONITOR THESE 3 PROFIT DRIVERS.
Profit drivers are the factors that affect your profits. While there are several to consider, and they vary by industry, price, sales volume and expenses are the three principal profit drivers to play with when trying to increase profits. These all work together, so use your industry knowledge to decide where to start.
Price
Pricing your products or services is not just a financial decision, it’s a strategic one. Proper pricing affects not only profitability but also brand positioning, market entry, and customer perception. You must find that sweet spot where you can generate revenue and remain competitive in your market. Remember, setting your prices too high can turn off potential customers and send them running to your competitors, while setting them too low can make you appear cheap and undervalued.
Approach your prices by researching your target audience, analyzing your competitors’ pricing strategies, and factoring in your own costs (such as labor and materials) and profit margins. Factor in your competitors’ pricing but aim to distinguish your offering based on the unique value it delivers rather than engaging in a price war. You should review your pricing once a year at minimum.
Sales volume
Consider driving up sales volume through targeted marketing, improving customer experience, or expanding your product range.
However, it isn’t enough to sell more units of any product in your assortment or get more clients. Again, profit is more important than revenue. Make sure you understand your breakeven point and to determine the kind of volume you need to drive and how it affects your business. Your break-even point is the number of units you must sell for the revenue to equal business costs. That’s represented by the formula:
Breakeven point = fixed costs/ (unit selling price – variable costs)
Be intentional about increasing your sales volume by focusing on the products with the highest profit margins. If you have a product or service that produces higher profit margins than others, consider putting marketing behind it.
Expenses
While increasing revenue is important, controlling expenses is equally crucial to maximizing profits and reaching your business milestones. The ability to manage expenses well can make a significant impact on your bottom line, not just in the short-term but also in the long-term.
Conduct a thorough review of your expenses and reduce or eliminate those that fail to provide a return on investment. The key is to identify and prioritize the expenses that contribute to growth and eliminate or minimize those that are draining your resources. Again, you might consider negotiating lower prices with your vendors or making bulk purchases to capitalize on volume discounts.
Lastly, address operational inefficiencies. Streamline your processes to cut costs and improve customer satisfaction by shortening delivery times and increasing service quality. Those improvements can keep customers coming back, which is key. It is more expensive to acquire a new customer than it is to keep an existing one happy.
By focusing on these three critical areas, you’ll be on your way to driving revenue and profits in no time.
