How can I make more money in my business?
A business that doesn’t make profit and generate cash flow is a hobby
The second of The 7 Big Questions of Small Business, on the lips of most small business owners is: How can I make more profit and generate more cash flow? Personally I believe the question about making money is even more important than the growth question, because I have seen many business go bankrupt, even though they were growing. Business Growth only makes sense if you end up with more money in your bank account as a result.
So these are the most important rules about making and keeping money in your business (click on the links for more about each rule below):
- Profit is not the Purpose of business, but without profit there is no business
- Someone’s got to be the most expensive, it might as well be you!
- 20% Of your customers generate 80% of your profit and vice versa… Know who they are.
- Collect collect collect
- Profit and cash are not the same
- Know your breakeven, and hit it 4 times every month
- Being in control of your business through the numbers
John Mackey is the founder of a large international chain of organic supermarkets called Wholefoods Markets. It’s been highly profitable ever since John founded it in the early eighties and has never not paid a dividend to it’s shareholders. Amazon just bought the company for untold billions of dollars and John Mackey is one of the world’s richest people. John clearly knows something about building great businesses and about making money.
John Mackey also wrote a book however, called Conscious Capitalism (link below) and in it (and various interviews I’ve read and watched with John Mackey), he says something that made the penny drop for me. He says this: Thinking that the Purpose of business is to make money is as silly as thinking that the Purpose of people is to eat food. We need to eat food, we eat food all our lives, and good food is better than bad food and without food we die, but eating food is not the reason we exist. We eat food so we can make good on our Purpose in life. John says it’s the same with business and money. The business must make money and profit and generate cash flow, and plenty of it, but only so that it can make good on it’s greater Purpose.
So let’s be clear about that, making money is the means to an end, and without profit and cash flow, the business can not perform it’s function.
What do we do with profit, how do we measure it, how much profit is enough, what’s the difference between profit and cash flow and which of the two is the most important?
All about Profit here:
- Future proofing your business with profit
- Profit or cash, what will it be? Podcast
- The meaning of profit (Ask Will Online)
- Profit, what is it good for… say it again! (medium.com)
- Analyse your business here
Everyone can sell cheap. It takes no special skill or approach to sell cheap. It takes incredible skill and focus to be the cheapest and make profit and only very few businesses can do so consistently, the only three big ones I know off that can consistently be the cheapest and build sustainable businesses that stand the test of time, are Aldi, Ikea and Walmart. I’m sure there are others but they’re far and few between.
If you make low pricing your main differentiator and competitive advantage you better be the most disciplined and focused business out there, because there will always be someone knocking on the door undercutting you, and you’ll constantly struggle to make enough money to survive, let alone build a Great Business. Competing on price is simply a dog’s game.
Instead, I suggest: Ask yourself what you need to do to be the most expensive. Raise your prices and see what it takes to sell with higher prices. What else can you compete on? Building a Great business is so much easier if you can do it with high margins than with low ones.
More about competing on price here:
- The first steps to sound financial management of your business
- How to make more money in business
- 1001 Business Bedtime Stories: Amanda and financial management
- The problem with value and pricing (Smallville)
You might have heard of the Pareto Principle or the 80/20 rule. The rule can be applied in many situations, but there is no more appropriate topic to apply it to than that of business and it’s customers. I can just about guarantee you that if you were to run a report today listing all your customers on a continuum with maximum profit and cash flow at one end of the scale down to least profit and cash(or even loss) at the other end, expressed in dollars, you will find that there is a small bunch of customers at either end. There is a small group of customers from whom you make by far most of your profit, and equally there is a small group of customers who cost you money.
The problem is that most small businesses aren’t able to run a report like that, easily. I can tell you it’s worth spending some time pulling a report like this together, for that matter, it’s worth getting the software installed that allows you to run a report like this easily, because you will be shocked. You will be shocked how much of the effort in your business gets wasted on customers who do nothing for your business but keep you busy, who don’t make you any money Equally you’ll realise how urgent it is to give more attention to those customers that make you all your money, because God forbid they might leave!
More about the 80/20 rule and customers here:
- The problem with business funding
- The importance of funding and Profit (Times of London)
- Financial management resources for small business
I’ve seen many businesses make profit and grow and yet struggle and even go bankrupt. The problem in those businesses is cash flow. More about cash flow and profit and their tenuous relationship further down. Here I just want to talk about completing the work or delivering the product, invoicing and collecting. It may seem obvious, but making profit is pointless if it doesn’t hit your bank account, but you’d be surprised how often I talk to business owners who complain about never having enough money to pay the bills while having tens or hundreds of thousands dollars of outstanding debts.
In my own days as a builder, a recurring problem was not finishing the jobs 100%. Sometimes for months, we’d leave a few small defects outstanding, that meant we couldn’t collect the final invoice. In other businesses I see that people finish the work but wait until the end of the month or sometimes even longer before they invoice the client and finally, most small businesses do not have a simple and consistent collection system. Those three factors mean that your business is functioning as a bank for your customers. Your money is in their bank account and it’s no use to you there. It means you constantly have to rob Peter to pay Paul and you can’t take advantage of early payment discounts from your suppliers and when your business is in growth mode, the problem compounds exponentially.
It’s actually even the case that you’re not doing your customers a favour by not completing, invoicing or collecting. Your customers want nothing more than having their work done quickly and cleanly and when the work is completed well, your clients actually feel they are in your debt and they want to remove that feeling as soon as possible. With every day that passes that feeling of indebtedness changes and if they don’t receive your invoice until a week or a month later, they’re actually not so keen to pay you anymore.
More about invoicing and collecting here:
- 5 Ways to improve your cash flow in INC magazine
- 1001 Business Bedtime Stories; Vivienne and cash-flow
- How to get paid in your business
As I mentioned above, many businesses fall over even though they make profit and they grow. I also mentioned the compounding problem of growth. I’ll explain the compounding problem in a super simplified example here:
Let’s say you start in month 1 with a bank account balance of $1,000 and you sell $1,000 worth of stuff this month and after expenses you have $100 left over. that should mean you are $100 better off at the end of the month than you were at the beginning.
But if you’ve only collect $500 of that $1.000 in month 1, and the balance follows the month after, you’ll be $400 worse off at the end of month 1 than you were at the beginning. The balance at the start of month 2 is now $600. Now if in the next month you grow 20% and sell $1200 and you make the same profit percentage (10%) you will have made a total $220 profit by the end of month 2.
We’ll assume that you collect at the same level (50%, in the month and the rest follows the month after). So the starting balance at month 2 is $600 plus the remainder of the collections from month 1 makes $1,100. Minus expenses of month 2 ($1,080) leaves a balance of $20, plus collections for the month of $600, so your balance at the end of month 2 is $620. In other words, after 2 months of profitable and growing trading you’ve gone backward by $380. And that’s if everyone pays within payment terms. If only 5% of your customers are late payers, you will go backwards even further at the end of month 2 and so on.
Obviously this is a highly simplified worked example, but it demonstrates the principle precisely. For this reason, in a growing business you must give at least equal attention to cash and profit all the time. You could argue that cash is actually more important than profit for two reasons: Firstly, you can continue to run a business as long as you have cash to pay the bills. There are many examples of big businesses that ran for many years without making profit, but who didn’t run out of cash (Amazon is one such example). And secondly, profit can actually increase your cash stress because profit leads to having to pay tax and tax simply takes cash out of your business.
More about profit and cash here:
- Profits are a liability; what do you want for Christmas?
- Fun with financial management, Small Business Masterminds webinar
- Why cash is more important than profit
- The one thing all great business owners have in common
- Cash and profit on Linkedin
One of the most important things I do with new clients when I start working with them is to find their breakeven. Breakeven is the number of dollars you have to sell every month (or every day or week or year) to pay all the bills every month. What does it cost to open the doors and turn on the lights, in other words. I find that the simplest way to establish the breakeven is this:
Step 1: Look at last years Profit and Loss statement and find the total of all the overheads, the fixed costs of the business, rent, insurances, electricity, marketing costs, subscriptions, etc. Add to this the monthly repayments of loans and lease payments you have to make. Now divide that number by 12. This is the amount of gross profit the business has to generate every month, 12 months of the year.
Next step: By looking at the P&L for last year (or any other representative period), you’ll be able to see what percentage of revenue your Gross profit is. for argument sake, let’s say that your monthly overheads are $20,000. and that in the past year, your Gross profit has been 30% of revenue. Now we can do the sum to find out how much revenue you need to make, to “Break even”. The sum is: Overheads divided by Gross profit = Revenue. Or in this example: $20,000 / 0.3 = $66,666.00. In other words. Based on last years figures with a margin for error and inflation of 5% added, you have to sell $70,000 of your business’s products or services every month.
But that’s not the end of the story. To survive and actually break even you have to hit this number four times every month:
- You have sell $70,000 every month.
- You have to produce $70,000 worth of goods or services every month.
- You have to invoice $70,000 every month.
- And you have to collect $70,000 into your bank account every month.
If you miss out by even $1000 on any one of those four in any month, you’ll have to make up for that $1000 in the month after.
By introducing this simple discipline, your business and life will never look the same again. BTW: keep in mind that I’ve been ignoring profit in this topic. Obviously you must make profit as well. But first you must instill the discipline of hitting your breakeven 4 times every month at least.
More about breakeven here:
- There’s one number we all forget about
- Breakeven worked example
- Do the numbers really matter?
- Predict the future by monitoring this key number
Lastly I always teach my clients how to put and keep their fingers on the pulse of the key aspects of the health of their business, every week and every month. The Numbers, the KPI’s. The break even number I talked about above is obviously one of those key numbers, but there are more. Bank balance is a key number, so is gross profit and aged debtors. Then there are various financial ratios, such as the gross profit percentage and ratios like “The debtor days ratio” and the “Liquidity ratio”. More detail about ratios etc below.
Besides financial numbers and ratios, there are many other numbers and ratios in a business to keep an eye on. For example the number of enquiries in the past month, or the conversion rate (for every 10 enquiries, how many contracts were signed), average job value, or average sale. Warranty returns, customer satisfaction, you name it.
A client of mine who has a furniture removals business knows that he needs to keep a keen eye on his removalist’s wages as a percentage of total sales. If he spends more than 60% of sales on the wages of his boys, he knows he’s not managed the work schedule well enough.
Your business will have its own specific numbers and ratios that can tell you a lot about the health of your business. I often talk about the mailboat report with my clients: Imagine you are banished to a deserted island in the Pacific, without mobile phone or email, and the only information you could get about your business would be a single sheet of paper that would be delivered by the mailboat every week. What numbers would have to be on that single sheet of paper to tell you precisely what you needed to know about the health of your business, so you could send immediate instructions back with the mailboat?
More about numbers here:
- How to grow your business with your finger on the pulse, podcast
- Driving your business forward by getting under the bonnet
- The Ten Priorities: financial Management
- The 5 P’s for your business in 2017 (and beyond)
- Financial management for fun and profit Small Business Masterminds webinar
- Business is all about the numbers
- What numbers really drive your business (Rick Polito)
- Why your business needs a dashboard (Valerie Khoo)