When we ask clients what sits at the top of their business agenda, improving profitability is one of the first things they name. That is no surprise. Profitability is the lifeblood of any business, and understanding what drives it is one of the most useful things an owner can do. In this article we look at the two main drivers of profit, and the close link between profitability and cash flow.
Profit is shaped by two things: how you sell, and how you control your costs. Within selling, there are three connected factors at play: price, volume and customers. They do not work in isolation, each one pulls on the others. And once those three are working, there is a fourth move worth making: turning the revenue they generate into income you can count on.
Price
Demand sets the scene, but price is where you have the most control. It shapes how much you sell and the kind of customers you attract, so it is the natural place to start.
The selling price is the most visible part of profitability, and the key is to make sure your price and your sales volume together leave the business profitable. That is why prices are worth reviewing regularly, not setting once and forgetting.
Pricing is a balancing act across your whole range. It is common to carry a loss-leader or two, products that earn little themselves but pull in sales that more lucrative lines can carry. Your competitors and the position you want in the market should guide you. Discounts can lift volume, but they eat into margin, so record every discount and review them often.
Two numbers are worth watching closely, profit margin and mark-up, but they are easily confused. Profit margin is the profit you keep as a percentage of the sale price. Mark-up is the percentage you add on top of your costs to set that price. They are not the same thing, so keep both in step with your pricing strategy and you can adjust with confidence as you go.
A few habits that help:
• Review your gross and net margins against previous periods
• Understand which customers are profitable, and how they behave
• Keep discounting to a minimum where you can
• Set a mark-up policy, and review it
• Analyse your sales regularly, using indicators such as cost of goods sold margin, gross margin, stock turnover and mark-up to flag anything unusual
Volume
There are two ways to grow volume. The first is selling more to the customers you already have. The second is winning new ones. It is almost always easier, and cheaper, to do the first. So start there before you spend to bring new people in.
To sell more to existing customers, you need a proper marketing approach and a real focus on up-selling, which is often the most overlooked opportunity in the business. Clear sales targets and a firm grip on your break-even point are what drive performance here. Understanding break-even lets you set targets that are both realistic and profitable.
To grow your volume:
• Understand your customers’ buying patterns
• Put a marketing strategy in place to lift sales
• Introduce loyalty schemes that encourage referrals
• Train your team to up-sell your higher-margin products
• Use break-even calculations to set achievable targets
• Look for opportunities to move into new markets
Customers
Great customer service is the foundation of keeping customers and winning new ones. Understanding what your customers need and prefer is a simple but powerful step, and a good CRM system gives you genuine insight into how they behave.
Ways to improve the customer experience:
• Understand what your customers need, and use it to improve their experience
• Measure your service levels rather than guessing at them
• Reward loyal customers for their support
• Watch your online reviews and ratings, and act on the patterns they reveal
• Stay in regular contact so you remain front of mind
Recurring revenue
Get price, volume and customers working and you have a healthier business. Turn the result into revenue you can count on, and you have a more valuable one.
Most businesses live on one-off sales: win the work, deliver it, then start again from zero next month. Recurring revenue breaks that cycle. Retainers, subscriptions, service plans, maintenance contracts and memberships all turn a single sale into a stream of income you can predict and plan around. It smooths the peaks and troughs, makes cash flow far easier to forecast, and lowers the cost of every future sale, because you are not forever replacing customers who have drifted away.
It also does something the other three cannot. Predictable, repeating income is worth more to a buyer than the same value of one-off work, so a business with strong recurring revenue tends to command a higher valuation.
A few ways to build it:
• Find the part of what you do that clients need again and again, and package it as an ongoing service rather than a one-off
• Make a retainer or subscription the default option, not the exception
• Make staying easy and leaving a decision, with simple renewals and clear, ongoing value
• Track the share of your revenue that is recurring, and grow it month on month
The bigger picture
Improving profitability is a journey, and this article only scratches the surface of what is possible. The point worth holding onto is that price, volume, customers and recurring revenue move together, and small, deliberate changes across all four add up.
This is where a fractional CFO can really help you. They bring you the financial leadership of a top-tier CFO, part-time, for a fraction of the cost of a full-time hire. The CFO Centre is the world’s number one fractional CFO provider, with 350+ CFOs in the UK and 750+ across 18 countries worldwide. Helping clients improve their profits is a large part of what we do.
If you would like to talk it through, we are here to help.