“How to Increase Profit Margin” and Other Common Questions Answered by YOCFO
4 Simple Solutions to Profit Margin, Cash Flow, and Other Common Business Challenges
Growing your business is an exciting and rewarding experience. Often, business owners find themselves caught up in various challenges within their business, preventing them from realizing the growth they had anticipated. A crucial component to growth in your business is having control over your cash flow.
Having an outsourced CFO can relieve the burden these business owners feel and allow them the time to focus on expanding their networks and growing their businesses. YOCFO’s CFOs take a unique approach to working with their clients, focusing very little on historic performance and more on the potential your business has for growth, specifically on strategies supporting an owner’s objectives.
One of the most common questions we get from CEOs is “how do I increase profit margin?” In this blog we will look at several common situations and offer practical solutions to quickly fix or understand the issue at hand.
1.) Adjust Your Accounts Receivable Collection Period
Increasing profits can be a result of your business’ growth and you may have also seen an increase of costs along with that growth. The only way to continue this growth is to make sure you have sufficient operating capital to absorb those additional costs before the profit can be realized. Let’s consider a few examples.
Example: If you are growing and incur $400,000 of new labor costs this year, or $35,000 a month, you incur $105,000 of additional non-budgeted expenses during the first 3 months. Because you might not have any revenue coming in due to your AR being 90 days, your current cash levels will suffer, even if your profit is higher at the end of the year.
Fixing this is relatively simple and important to ensuring your business’ cash levels are healthy. YOCFO will look at your cash conversion to determine if it is in your best interest to expand or hire ahead of collecting revenues, and if not, we will suggest pursuing a line of credit to fulfill your cash needs. It is also smart to think about the speed at which you are growing, and to project what your cash levels should look like in order to grow at the speed you would like to achieve.
2.) Raise Your Prices (Responsibly)
A major component that determines the fiscal performance of your business is your ability to position your most successful services or products in the marketplace and manage your variable return/gross profit.
Example: Businesses often price too low, making their gross margins significantly smaller than they could be. In solving this, you may look at adjusting your pricing so that you are low enough to prevent significant customer loss, but high enough to fulfill your financial needs for business growth. We help our clients tackle this problem by comparing their pricing to competitors within their industry, providing a platform for their business to grow.
3.) Increase Business Liquidity
Being efficient with your money and building up your cash reserves is difficult, but necessary in any healthy business. With careful planning and mindful spending, you can begin immediately. Mike Michalowicz, author of Profit First, emphasizes taking profit off the table day one of your business to help you retain cash for expansion. It is an excellent book and we recommend you read it. Here are some of YOCFO’s typical tactics to address this issue of cash pressure.
Example 1: A common way to increase your cash and liquidity position is to speed up your AR collections. As mentioned previously, speeding up your AR will allow you to have more cash on hand faster, making it possible to continue to reinvest in the costs needed to grow. A simple way you can adjust your AR for more cash collections is to offer discounted prices if the invoices are paid early. This way your customers are incentivized to pay off their accounts payable to you, and you receive cash faster than you would have normally.
Example 2: Extending your full AP period longer can also provide you with more cash. Although this is not always the best tactic, it can be beneficial to you as you try and fund growth within your business. If a vendor gives you 30 days to pay, why pay in 15 days?
4.) Invest In Your Company
The question is, whether this investment can move the profit margin up by cutting costs, producing more, or saving time. In analyzing the profitability of a company, the total profit margin provides the answer, however, product margin analysis would reveal the “winners” and “losers” in the line of products the company is producing.
Example 1: A common investment is hiring a business manager. This person can streamline internal engagement management, HR, and bookkeeping, which may allow for cost savings, employee retention, and better reporting, however, mechanisms should be put in place for the measurement of those results.
Example 2: A new piece of machinery that can reduce cost to manufacture, including labor, waste, and repair.
In conclusion, running a successful business is not just about net profit. Managing cash flow, staying ahead of competition, and thoroughly understanding the industry a business is in are paramount in today’s cutthroat business environment. These are just a few examples we note today, but each ownership has unique variables affecting their path of growth.