Most business owners think they know where their profits are made but in reality, they don’t know this. I have helped some clients figure this out. Some clients have the system to track projects but haven’t used that part of the system until I have pulled this information out for them and came to helpful conclusions.
The answer is in breaking down your business into logic parts. Here are some suggested ways to break it down:
- Types of products or services,
- Types of customers or specific customers,
- Projects
- Geographical areas
Once you figure out the most logic way to break out your business, figure out the sales for each part and the expenses that relate directly to those sales. These expenses include direct materials, direct labour and if you are a manufacturer, the overhead costs that directly relate to manufacturing and distributing those products. When you subtract direct expenses from sales, you get gross margin. Divide this gross margin into sales and you get gross margin percentage. Compare this gross margin percentage to your industry’s average to see if you are above or below that average. This is a good start, but you are not finished yet.
Just because the gross margin percentage is higher for one part of your business than another part, doesn’t mean it is the most profitable. You should compare gross margin dollars because one part of your business may generate more margin dollars than another. One business I helped is part of a co-op organization that provides buying power and unique programs. One of these programs offered very high gross margin percentages compared to other similar products that can be sold to customers. When I analyzed the profitability of these programs, I found that this business made less gross margin dollars on the new program than if they sold the products the old way. In some cases, there are some good reasons to still sell the new program, but this business was fully aware of the implications on profit when they do.
I have talked a lot about gross margin dollars and gross margin percentages for each part of the business. However, to really understand the profitability of each part of the business, it is important to look at profitability of your business down to EBIT (Earnings before interest and taxes) where possible. The different parts of your business may incur different levels of marketing, sales, administration and operating expenses than other parts. For example, some customers or some product lines might require more “hand-holding” than others.
Once you understand what parts of your business are making profit and which ones are not, then it is time to make some decisions on the parts that aren’t making enough or any profit. Are there things that can be done to make it profitable? If not, does it make sense to sell that part of the business or drop it?
Make sure you are a business owner that knows where they are making profits and where they are not. Act now to have this figured out for you so you can make the informed decisions you need to make.
Find out more by contacting Kevin and setting up a no-obligation meeting – kevin@kevinballantyne.com or (226) 791-0374