Articles

Getting the Numbers Right

Return on Investment
by Mark Deo

In today's economy many business people are looking at all kinds of ways to improve profitability. A wise man once told me that business is simple... make more than you spend!

But many translate this to mean they should cut as many expenses as possible — everything that is not an absolute survival necessity. WRONG! This is the worse strategy during an economic slowdown. My advice is to focus on getting a better return on your investment.

Here are some powerful, yet simple, ideas to help you improve your return on investment, increase volume, and sell more of what you have.

Increase sales per customer

It takes a lot of effort and expense to find new customers. In fact, if your advertising yields a response rate of just 2%, you're doing well. Once someone becomes your customer, though, you know them and can target them directly. Think about offering your existing customers more products or services. See what happens to profit if you increase volume by 5%.

Increase the number of customers

Increase capacity so you can handle more customers. If you have a big backlog of orders, are short of space or staff, or simply can't handle any more work, you may need to increase capacity. One of my favorite low-risk ways to do this is to subcontract, especially when I believe the increase in volume may not be on-going. Of course you must ensure that your subcontractors' work is satisfactory, that they can deliver on time and that they will not solicit your customer directly. Your costs maybe higher, but the increase you see in sales will more than compensate for it.

Increase Prices

Are you charging all you can for your products or services? If your products and services have competition, your prices cannot be significantly different than your competitor's. Price is generally inversely proportionate to volume. The more you charge, the less you'll sell. What would happen to your volume if you increased prices by 10%? Would volume decrease by more than 10%? Would the customers you lose be the ones that have the lowest profitability, give you a hardest time or cost the most to collect?

Change your sales mix

Are you spending a lot of effort on products or services that don't generate enough gross profit? Maybe you should stop selling them or raise prices for these specific services. See what happens if you increase the volume of the higher gross margin product line by 10% and decrease the lower gross margin product by 10%. The idea is to focus on product or service lines that generate the highest gross profit.

Reduce expenses

This is easier said than done! It's sometimes hard to know which expenses you should cut and by how much, and more importantly, what effect reducing expenses will have on sales. In fact that is the question you should ask when doing any type of analysis. What effect will not spending on this or that have on present and future sales? Quantify it! Spending $200 a month on meals will generate $X in new business or my employees with be $Y more productive. Here are some tips to help you along the way.

Cut the fat - Look at each expense item line by line. Do you need all the telephone lines and cellular phones? Is the travel that you're doing resulting in sales? Can you do with less office space? Are your employees productive? Do employees have enough work, or can you reduce staff and group responsibilities? Remember that if you cut staff, some employees will be laid off and moral may suffer, but if you go out of business, no one will have a job!

Don't cut into the bone - Some expenses are essential. If you cut them you will jeopardize current and future sales. A prime example is manpower for product development or strategic planning. These initiatives ensure your future growth and profitability. Another expense which is difficult to cut is advertising and promotion. Although trade shows and magazines ads are expensive, if no one knows about you, what chance do you have to sell to them? Rather than cutting advertising, target it more precisely so you have the maximum impact on sales.

Understand the Difference Between Profit and Cash

The Small Business Administration claims that most business failures are directly related to lack of cash flow. Many businesspeople will tell you that their profits may be skyrocketing but they are in a cash squeeze. How can this be? Profit and loss are calculated by deducting expenses from sales, whereas cash flow is calculated by deducting cash disbursements from cash receipts. So if you receive the cash from your customer at the time you deliver the goods or perform the service, then sales and receipts from customers will be the same. If you give credit to you customer, then sales happen at the point where you deliver the goods or perform the services, but receipts will not come in till you receive the cash from your customer at a later date.

Improve Collections

When you extend credit to customers you create a receivable which has a potentially negative effect on your cash flow. I advise my clients to measure their cash flow on a weekly basis. This can be done by preparing an aging of receivables. This involves calculating the amount of receivables owed based upon the time period owed. In other words, how much of your receivables is over 15, 30, 60 or 90 days past due. If your terms are net 30 days yet 50% of your receivables are over 30 days, then they are past due. This will create a severe strain on your cash resources. I recommend that no more that 10 to 15% of receivables be more than 30 days past due.

Offer an early payment incentive

For your high volume clients, a personal approach may work best. Take your client to lunch to discuss things. Be honest in looking for a solution that works for both of you. Develop some creative letters that can be sent when accounts are 15 days past due so they never get to 30 days, and establish a person in your company that will act as your collections clerk and make calls to clients on your behalf.

Make Change Happen!

I hope these ideas help you in improving both the cash flow and profitability of your organization.

This article has been written by Mark Deo and reprinted with permission from SBANetwork. For more information, please visit their website at www.markdeo.com/