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Increase your profit – Understanding your Margins

I am working a lot with companies that have been around for 5-10 years or longer and have revenues in the $2-$10 million range but their profits are getting smaller or stalled out.

There are lots of things to help these companies but two of the common things to look at are

  1. Understand margins of different service lines (what we will focus on in this article)
  2. Understand fixed costs and how scale can help stay above breakeven and increase profits. I wrote a blog post on this a few years ago and you can see it here.

The main problem is when companies start out, they take on all of the work they can get and have an overemphasis on top line revenue growth.  It’s not a horrible strategy as it is easy to track and it feels good to see revenue grow but to take their companies to the next level they need to do more.

Update your chart of accounts to have your Revenue and COGS service lines match

When you are setting up Quickbooks or when sending financials to your CPA to do your taxes you set it up they way that it makes sense to you.  Now that your company has grown it may be time to look at how your Revenue and Cost of Goods Sold accounts are organized.  The goal is that each service line or value stream will have its own account for both Revenue and COGS.  When you have both numbers you can calculate a margin for each service line to see which ones are trending up and down and which areas of your business generate the most profit so you could decide to put less resources into the least profitable service lines.

Garbage in / Garbage out

The reason you probably haven’t setup your accounts like this is it is hard.  A worker may work on multiple service lines so it is hard to segment their payroll costs into the correct service line.  Your revenue may be bundled together or in your CRM or point of sale system but it is not easy to get that level of detail in quickbooks.  Since you don’t have the good data or way to obtain it then there are a few options.

1 time analysis

If the data is going to be hard and costly to get into your accounting software on an ongoing basis it may make sense to do a detailed analysis over a shorter period of time or build a tool that can be updated on an as needed basis.  For al of the problems mentioned in the garbage in section you can come up ways to get the data if you know you will not have to always get it.  You can have staff use time sheets for a week and clock in and out of activigies.  You can do the work to unbundle pricing or to analyze your POS / CRM data to break out revenue.  The 1 time analysis should be enough to give you some insight into areas of the business that can be improved.  If the analysis helps your business you may decide to repeat the analysis a few ties a year and if it doesn’t help increase your profits or direct your strategy you may decide to not do the analysis again.  IF the analysis is super helpful you may need to do a cost benefit analysis of upgrading your accounting systems so that you can get the data on a real time basis from your accounting software.

What is the data telling me?

When I look at the data I am looking for trends for gross margin %, # of customers, price / customer, etc – what is getting better and what is getting worse?  Are there areas that have small profits or worse than you thought?  You may uncover the areas to investigate more and look at things at a customer or staff level to see if there are customers or staff you may need to fire.  Does the revenue correspond with the effort – maybe you spend all of your marketing money trying to get certain customers but in reality they do not make up their share of revenue / profit.  Firing 2 or 3 clients that are a pain to work with, do not pay on time, make your staff unhappy and have low margins can instantly free up your business for easy growth and higher profits.

Wow that impact was bigger than I thought

A lot of times I will send highlights / observations to clients of concerning data and they usually have a good explanation of what happened but may not have realized how decisions they made have impacted the bottom line.  Some examples are an owner who switched their role from revenue producing / customer facing to more business development / working on the business.  This is a great long term strategy and the focus of Michael E. Gerber’s emyth but short term the business was not at scale yet and both revenue and profit took a major hit.  Another client had changed their invoice frequency and it looked like they were losing customers but in reality they were just invoicing less frequently.  This had cash flow impacts and was not helping their business so after discussing it they changed their invoice process again.  These little changes can have an impact on the profits.

Start looking for ways to improve

Once you understand the trends and have some good data to track you can start trying to improve to increase your profits.  I have written some blog posts on Look at scale (mentioned above), KPIs /goals, and get rid of bad customers.  I find that both the sales and the operations teams, (which may be the same person for smaller companies but for companies in the $2-$10M is not) usually have good insights on what the competition is doing from a pricing standpoint and what the process bottlenecks are.  Once you uncover the issues you can start looking for ways to improve 😊

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