When you are too worried about not making enough money, or you keep stressing about how you’re going to pay the bills and your team this month, it’s difficult to focus on the best ways to serve your customers. Luckily, there’s a solution!
Pay attention to these three words because you’re going to be reading them everywhere in this article: Healthy. Profit. Margins.
Monitoring your profit margins helps you understand your business’ health and makes it easier to keep it afloat. Not many of us know how to efficiently determine our profit margins, but that’s what this episode is all about!
Angie Noll is the founder of Reconciled Solutions, a company that helps high-achieving small businesses advance toward profit acceleration, operational efficiency, and work-life sustainability. She’s here today to explain to us what healthy profit margins are, tips on how to improve them, and how to use them to make better decisions. So, keep on reading!
Are your profit margins healthy?
Amalie: Let’s just dive in. The first thing I want to start with is how do you evaluate if someone’s margins are healthy or not?
Angie: When we get a client at Reconciled Solutions, we usually start with the numbers. We’re starting with their QuickBooks online file. Our clients are small business owners, I would say they’re typically selling half a million dollars in revenues on up to $10 million a year in revenues. The first thing I look at when I am analyzing a file is their profit and loss. Although I do look at total income, I want to look at how the income is expressed in comparison to the cost. So I look at silos of income and what I’ve seen a lot of small businesses do is that they dump everything into income from services, or consulting income, or sales of products, and there’s no differentiation in their books.
So from the first point, we have to see differentiation in their books. So if you’re a lawyer, you’re going to have litigation, flat fee services, real estate closings, maybe it’s insurance or subrogation, but each one of those is a separate way that you go to market because this ties back to your market and how you position your brand. And then within that, the expenses for each are varying. So if you have a large piece of business as an attorney and it is based on flat fee, residential closings, you’re going to have different expenses for that than you would have for an insurance subrogation case. And so I want to see if the expenses are split between the different income streams because one might be a loss leader for your company. Another one’s going to be the bread and butter of your company. And the third is going to be like “this is the really juicy deal. This is where we make some really good margin.”
Amalie: It also probably helps them to see where they should invest marketing money too and make decisions on how you’re going to grow the business, where you’re going to spend your money, all those things.
Angie: So it’s not only just tied to the margin and the profitability of the company, but it’s also tied to how we make our marketing decisions. When we are setting out our marketing strategy, not only do we need to measure where we make the best margins, but where it’s easiest to get the business to where there’s opportunity? and how to fine-tune that? Where are we finding repeatable processes? We want to go for the low hanging fruit. So if you’re in a situation where you want to improve your gross margin, when you’re looking at your different silos of income, you need to think about “where do I have capacity to grow easily so that I’m not struggling to make that operational side and deliverable difficult for my firm?” That’s where you need to spend your energy because you’re delivering efficiently, accurately, and without pain.
Amalie: What should a business owner track to ensure that their margins are healthy?
Angie: You’re an expert in business, not necessarily an expert in your accounting system. But you need a good accounting system that is telling the story of your business.
So what I said earlier about setting up your accounting system so that it is tracking the different streams of revenue, and matching it up to those different expenses. Being able to see that the gross margin on this revenue stream is 50% and the gross margin on a different revenue stream is 10% is really critical. That’s all done through your QuickBooks file.
If you’re using staff or contractors, it doesn’t necessarily matter. But when you are using employees, I often see a lot of companies that report all their wages paid under just a category called wages. If you’re measuring your profitability, it’s critical that you’re separating out the owner’s wages from the rest of the staff.
If you’ve hired a contractor to deliver against a project, then that is considered a cost of good or, materials and contractors expense. And we want to be able to call that out separately, according to the revenue stream. Then if you have that lined up that way in your accounting file, the last thing is utilization of staff. And you can calculate your utilization of staff just by taking your total revenue and dividing it by the number of full-time equivalent employees that you have so that you can get idea based on a day to day basis, week to week basis, month to month, year to year.
Tips to improve your profit margins
Amalie: Let’s talk about raising prices. I think it’s really important because, in order for the business to continue growing, prices need to continue growing too.
Angie: Costs go up all the time, that means that we need to reflect that in our prices. There’s regular inflation, but then things get thrown at you like a global pandemic. That being said, I’m a big believer in regular and systematic price increases. If January is your time to reassess your contract, then everybody’s price goes up in January. I do think that the percentage of price increase or how you want to do that is subject to going back to your margin health on the different revenue streams, and where your company is focused on. If you’re getting tons of business in one area at a certain price point, and you’re not getting very much business in a different area that has a different price point, but it’s so hard for your company to deliver on that revenue stream, then you don’t need to do a standardized 5% price increase across the board. You can do it by revenue streams. You can do it by looking at where your opportunity lies and where you want to get more clients.
We had a client in my mastermind group yesterday, one of the business owners was offering something at a very low price point. I told him, “I think your price point is too low. You’re not showing value at that price point. People don’t think it’s worth it.” And it was worth it, it was full of juicy offerings and things that were going to be favorable for the client. So charging what you’re worth is very important. If you want to offer a discount because people are hitting hard times, that’s fine. But the initial price has to go out at a value proposition price, meaning you’re providing high quality for a price that is commensurate with that.
How to take better decisions based on your profit margins
Amalie: Being an online business, people will not take into consideration the programs that they need to run their business. For example, if they’re a designer, the Adobe suite. When you give a price of something, it needs to include those things that you buy or spend money on in order to serve clients. You’re really just hurting yourself by not including those things. All those things should be part of part of what it costs to hire you.
Angie: When you initially set your prices, it does need to include all those different subscriptions that you need to go to market. They might be a fixed cost, but you still need to figure out how those impact your bottom line. And then if you’re doing regular and systematic price increases, those subscription fees, as they go up over time and inflation happens, they will be accounted for. What won’t be accounted for as is again like when a global pandemic hits and all of a sudden your in-person offering needs to go online and you have to buy technology to support that new way of doing business. In those cases, then you can increase the price out of cycle, so to speak. And if you’re increasing the price out of cycle, it shouldn’t be considerable because you’ve been regularly managing your price increases and building it into a systematic approach.
Angie: The only thing that I want to add is, it’s all about measurement. You can’t find your way if you can’t see the runway. So the plane is not going to be able to take off if there’s not a runway there and measurement starts in your accounting file; that accounting file needs to tell the story of your business. It needs to tell the story of your business health, as well as the unhealthy parts of it. Because that’s the story that helps you build funding when you need it, sell it when it’s ready to be sold and pay yourself and put food on your own table. So I just really encourage people if they’re not great with their books, accounting, and understanding those concepts, hire somebody and invest the time to figure out how to read those financials. They will give you a path, a runway to work with.
And that’s it for today! We hope this interview has been helpful to you. See you on the next episode!
To listen to the full episode click here. https://systematicexcellenceconsulting.com/podcast/
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