Edition 265 – Profitable Analysis
Sadly, most people have no idea what parts of their business generate a profit and what parts generate a loss. Whilst monthly, quarterly or annual financial statements might report a Profit or Loss, all that tells you is the totality of the business performance for the period. It doesn’t actually show you how the profit is actually generated..
The significant downside all of this is that unless you know where you make profit in your business (and where you don’t), you’re not actually maximising the profit potential or valuation of your business. That, my friends, could be worth millions to you and your family over the time that you own and operate a family business. Millions!
To better understand how much profit you’re generating in business, here’s what you need to do:
- Identify the key revenue elements of your business. For some, it’s individual projects. For others, it’s a particular revenue stream. For others still, it might be revenue per client.
- Identify the “direct costs” associated with generating this revenue stream. For some businesses, this involves labour and/or materials. For others, it’s a specific cost attached to generating the revenue, such as a key supplier.
- Ignore all your overheads – these aren’t important for the purposes of this calculation.
- Subcontract the answer to 2 from the answer to 1 – and you have a number we call “Gross Profit”.
In my opinion, measuring Gross Profit should be the key financial driver you’re monitoring in your business. It’s the guts of turning a profit in your business because, unless you can make money purely on the sale of your product or service, your business is a goner!
Most software programmes these days have elements or bolt-ons that will enable you to analyse this data. If it doesn’t, the humble Excel spreadsheet will perform the function just as well. However, the process should not be software or IT driven. It should be as a result of Human Intelligence. What I mean by this is:
- Identify the element of your software or bolt-on that can measure profitability per job or per sale.
- Set up the system correctly so that you know where to send the various data elements.
- Ensure you enter all revenues and all costs into your system, accurately and in a timely fashion. By timely, read “daily”.
- Review the numbers daily or, at the least, weekly.
In an exercise I conducted with a client using this methodology, we were able to identify they were making a significant loss on work they conducted for a particular client. By sacking their client, this family business dropped their revenue by 23%. However, they went from a $50K loss to a $70K profit in the process. Sounds counterintuitive, but it’s true.
There are two final ingredients to this process:
- Set aside the time to look at this daily and weekly. If you won’t make the time to undertake the analysis, you’re not that serious about generating a profit.
- Seek expert advice and guidance. Some people understand this off the bat and have little trouble interpreting the numbers. Most don’t. However, with expert advice, you’ll have someone from the outside looking in asking the questions that you yourself haven’t considered.
Revenue for revenue’s sake is a recipe for disaster.
It’s all about the quality of the revenue and what level of profit you can turn on that revenue.