Business Essentials 2 - Improving profits and Cash flow
In our first article, ‘Getting to know your Business Fundamentals’, we explore the key measures to help you get a better grip on your numbers and leverage them to improve business performance. In the second article of our Business Fundamentals Series, we will explore methods to improve profits and cash flow to help you reach your organisational goals.
Despite what we’d all like to believe, gross sales or total revenue doesn’t always result in a profit. Understanding what impacts profit is key to ensuring strong sales equates to strong profits. Managing your gross profit (GP) margin is key, along with understanding how to increase revenue, decrease expenditure and manage cash flow & working capital.
Below, are the four core areas to focus on, and how they can add value to your business success.
1. GP Margin
Gross Profit, or GP Margin, is a financial metric used to assess your business's financial health and business model by revealing the proportion of money left over from revenues after accounting for the ‘Cost of Goods Sold (COGS)’ (Investopedia). It is calculated as:
GP margins for businesses may vary depending on industry and product. Determining what the benchmarks are for your industry will help you pinpoint the GP goal you need for business success.
The Australian Taxation Office (ATO), provides a range of industry benchmarks in detailed table format in the form of financial and activity statement ratios.
To increase your GP, you will either need to increase revenue or, decrease direct costs / Cost of Goods Sold (COGS).
Once your Gross Profit Margin goals have been established, you are now able to focus on maximising revenue to achieve your GP goal.
Maximising revenue is an important factor for any growing business and will help increase profits. Example strategies to consider include:
- Pricing - An increase in revenue by raising prices will directly improve profitability, provided you remain competitive, and your customers appreciate the value of the product or service you provide.
- Consider whether you have optimised your pricing structure to match the marginal benefit of your customers, and how you can increase this effectively whilst maintaining your sales targets.
- Increased sales - Have you considered all viable options to increase sales? Leveraging modern marketing and sales tactics such as eCommerce, social media, offering rewards programs, developing by-products from excess material, etc. can help you to reach new audiences and increase sales revenue.
Taking control of the how your business spends money is a key factor in driving profitability. It is crucial to know your expenditure and to look for opportunities to spend smarter on both direct and overhead costs.
Direct costs - A real win in profitability lies in ensuring that direct costs do not rise disproportionately with any increase in sales. Strategies include:
- Buying smart, shop around;
- making the most of your people and ensure they are operating efficiently and effectively in your business;
- variations in shift hours to save on overtime costs;
- staff productivity improvements;
- automation and outsourcing for increased efficiency and lower costs;
- eliminating roadblocks which may impede staff morale and performance;
- sourcing materials from alternate sources.
Overhead review – any wins here will add to the bottom line
If you have been busy trying to increase sales, it is easy to forget about overhead expenses. Minimising your running costs can have a significant impact on your bottom line. Examples of how you can achieve this include:
- Reviewing expenditures, and shopping around for better rates for electricity, insurance and banking.
- Reducing property expenses by talking to your landlord about rent, or evaluating whether you need as much space as you have.
- Finally, check the return on investment (ROI) of your marketing activities, honing in on strategies that generate the most sales and conversions.
3. Cashflow vs working capital
Managing working capital is critical to cash flow success, so it’s important to know exactly what it is, and why it is critical.
Put simply, working capital is your current assets minus your current liabilities. It is a measure of both your businesses efficiency and short-term financial health. Critical working capital items include:
- inventory and;
- Work in Progress (WIP).
By implementing effective working capital management strategies, you will improve your business's cash flow health. Strategies include:
- Managing debtors. Are your debtors paying you in a timely manner? Are you dealing with issues as and when they arise? In doing so, you will help to avoid excuses and delays in payments.
- Managing creditors. Are you paying your creditors at the best times? It is important to triage your payments to suppliers, ensuring that you make full use of your payment terms, whilst getting the most out of discounts and other incentives.
- Managing inventory. Are you holding so much inventory that your cash is tied up in obsolete or slow-selling stock?
How many days is your stock sitting on the shelf before it is used in production or sold to your customers?
These are inventory questions you must ask to optimise your inventory and cash flow. Be careful though, there is a sweet spot between having too much and not enough inventory. You need to find the right balance between having enough to meet customer needs, but not too much as to tie up excess cash. Strategic stock management is key.
Implementing Just In Time (JIT) inventory management or inventory tracking software may work wonders for you.
- Managing WIP. Continuous monitoring of aged WIP balances will help to ensure timely invoicing. The earlier you get that invoice out, the earlier you will get paid!
By considering the strategies discussed in this article you will improve your business cash flow.
But keep in mind - there is no magic formula. Each business is different and requires an action plan tailored to its unique characteristics and objectives. If you'd like to discuss how you can apply the strategies in this article to your business, contact a BDODrive Adviser today.