Five Profit Margin Killers You Need to Eliminate
Posted: Tue Dec 10, 2024 7:21 am
Your business sales are growing, but you feel frustrated every month when you see your profits stagnate or even decline. If this situation sounds familiar, your business is likely a victim of profit margin destroyers.
Margin destroyers are oversights and inefficiencies across your business that may seem minor on their own, but when taken together, can mean the difference between a thriving business and one that struggles to survive.
The ability to eliminate margin destroyers separates the best companies from the laggards in every industry.
So how do you combat margin destroyers? The first step is to understand how profit is measured using your financial statements .
Two ways to measure profit
ABC Company Income Statement
Enlarge image
As you can see in the income statement example above , there are two measures of profit.
The first is gross profit . It shows how much money a company has left over after accounting for its direct costs to make a product or provide a service. Direct costs include labor , materials , and other expenses directly related to producing a product or providing a service. In this example, the gross profit margin (which represents gross profit as a percentage of sales) is 66% .
The second measure, net profit, is more comprehensive. It takes into account not only your direct costs, but also all your other expenses, such as indirect costs of operating the business, taxes, and interest paid on debt. After accounting for indirect costs, your net profit margin is only 12% of sales.
You can see that there are expense levels where margin destroyers can creep in. But it’s not just unnecessary expenses that can hurt your bottom line. You may also be failing to collect all the money you should be receiving from your customers.
The key to reducing and eliminating margin destroyers is to dissect your financial statements, highlight areas where you are losing money, and evaluate strategies you can use to prevent excessive costs and revenue leaks.
With that in mind, let’s look at five margin destroyers and how to eliminate them.
1. Setting prices that don't reflect your real costs
It is common for businesses to overlook or underestimate their expenses when setting their selling prices . For example, a landscaping company will charge for the time spent on a project but fail to factor in travel time to the site. Or, a manufacturing company may set prices that do not adequately cover overheads, such as operating costs related to running the office, maintaining equipment or paying the resource for accounting.
You need to take a close look at your direct and indirect costs to car owner database make sure they are reflected in how you calculate your profit margins and selling prices. This is especially important during times of rising inflation. Your suppliers are increasing the prices they charge you. You need to make sure your selling prices reflect this reality.
Are you worried that your customers will switch to a competitor if you raise your prices? But you have no choice. You are in business to make money, and that sometimes involves difficult choices and conversations. The best solution is to be transparent with your customers and explain what you are charging to provide them with a product or service. If your business is not competing at a fair price, you need to make the necessary changes to your business or operating model.
2. Keeping unprofitable products
Some products may be costing you money without you even realizing it. That's why it's important to analyze your financial data to determine the profitability of each product and service. You'll likely find that you have winners and losers.
Once you have identified unprofitable products and services, you can decide what to do with them.
Could you increase their selling price?
Should you keep the product because it represents a strategic tool to close other sales?
Is there a better way to produce or deliver it?
Or should you eliminate it completely?
3. Poorly managing customer relationships
It's a fact: Some segments of your customer base require more time and attention than others – and therefore cost your business more money, for example, because of a delay in delivering a document you need to start work, or requests for changes or additions that weren't in the contract you signed.
Too often, companies agree to do extra work for free. In one construction project, for example, we found that the company had done free work resulting from changes requested by the client that accounted for 10% of its total revenue generated from the project.
The keys to success in dealing with these kinds of margin destroyers? Planning and vigilance. Include in your contracts how changes and additions will be billed. Make sure your team always informs you of unforeseen requests before the work is done, and inform clients of what the cost will be.
4. Allowing direct and indirect costs to grow uncontrolled
Increased revenue can often lead to a lack of rigour in controlling spending. A close look at how your money is spent may reveal increased costs for things like new staff, vehicles, or advertising or marketing that aren’t generating a corresponding increase in revenue.
Pay attention to your gross margins. If they are falling, your productivity could be decreasing and you need to address the problem immediately.
In addition, to control indirect operating expenses, we recommend preparing and adhering to budgets. The amount budgeted for each item should be based on analysis rather than simply on the previous year's figures. Any significant increase should be subject to a cost-benefit analysis.
To cut expenses, use the 80/20 rule when deciding which ones to tackle first. Look at the items that make up 80% of your total expenses and work to reduce them. This is where you'll get the best results.
It's also a good idea to check the market periodically to see if you can get better prices on fixed costs, such as insurance, telecommunications services and maintenance contracts.
5. Neglecting to use technology
Technology-based solutions are invaluable in the fight to eliminate margin destroyers. They will help you assess what is draining your profit and optimize your operations, customer relationships and pricing.
You can use your accounting software to calculate your profit margins, track your expenses, and monitor your asset turnover, among other key performance indicators (KPIs).
Manufacturing companies can use software to monitor downtime due to production line changes and equipment repairs. Along the same lines, timesheet tracking software allows you to monitor staff productivity and generate data for invoicing.
Once you've identified the margin destroyers, you can work on continuous improvement by using a dashboard and KPIs to monitor progress toward your goals.
Margin destroyers are oversights and inefficiencies across your business that may seem minor on their own, but when taken together, can mean the difference between a thriving business and one that struggles to survive.
The ability to eliminate margin destroyers separates the best companies from the laggards in every industry.
So how do you combat margin destroyers? The first step is to understand how profit is measured using your financial statements .
Two ways to measure profit
ABC Company Income Statement
Enlarge image
As you can see in the income statement example above , there are two measures of profit.
The first is gross profit . It shows how much money a company has left over after accounting for its direct costs to make a product or provide a service. Direct costs include labor , materials , and other expenses directly related to producing a product or providing a service. In this example, the gross profit margin (which represents gross profit as a percentage of sales) is 66% .
The second measure, net profit, is more comprehensive. It takes into account not only your direct costs, but also all your other expenses, such as indirect costs of operating the business, taxes, and interest paid on debt. After accounting for indirect costs, your net profit margin is only 12% of sales.
You can see that there are expense levels where margin destroyers can creep in. But it’s not just unnecessary expenses that can hurt your bottom line. You may also be failing to collect all the money you should be receiving from your customers.
The key to reducing and eliminating margin destroyers is to dissect your financial statements, highlight areas where you are losing money, and evaluate strategies you can use to prevent excessive costs and revenue leaks.
With that in mind, let’s look at five margin destroyers and how to eliminate them.
1. Setting prices that don't reflect your real costs
It is common for businesses to overlook or underestimate their expenses when setting their selling prices . For example, a landscaping company will charge for the time spent on a project but fail to factor in travel time to the site. Or, a manufacturing company may set prices that do not adequately cover overheads, such as operating costs related to running the office, maintaining equipment or paying the resource for accounting.
You need to take a close look at your direct and indirect costs to car owner database make sure they are reflected in how you calculate your profit margins and selling prices. This is especially important during times of rising inflation. Your suppliers are increasing the prices they charge you. You need to make sure your selling prices reflect this reality.
Are you worried that your customers will switch to a competitor if you raise your prices? But you have no choice. You are in business to make money, and that sometimes involves difficult choices and conversations. The best solution is to be transparent with your customers and explain what you are charging to provide them with a product or service. If your business is not competing at a fair price, you need to make the necessary changes to your business or operating model.
2. Keeping unprofitable products
Some products may be costing you money without you even realizing it. That's why it's important to analyze your financial data to determine the profitability of each product and service. You'll likely find that you have winners and losers.
Once you have identified unprofitable products and services, you can decide what to do with them.
Could you increase their selling price?
Should you keep the product because it represents a strategic tool to close other sales?
Is there a better way to produce or deliver it?
Or should you eliminate it completely?
3. Poorly managing customer relationships
It's a fact: Some segments of your customer base require more time and attention than others – and therefore cost your business more money, for example, because of a delay in delivering a document you need to start work, or requests for changes or additions that weren't in the contract you signed.
Too often, companies agree to do extra work for free. In one construction project, for example, we found that the company had done free work resulting from changes requested by the client that accounted for 10% of its total revenue generated from the project.
The keys to success in dealing with these kinds of margin destroyers? Planning and vigilance. Include in your contracts how changes and additions will be billed. Make sure your team always informs you of unforeseen requests before the work is done, and inform clients of what the cost will be.
4. Allowing direct and indirect costs to grow uncontrolled
Increased revenue can often lead to a lack of rigour in controlling spending. A close look at how your money is spent may reveal increased costs for things like new staff, vehicles, or advertising or marketing that aren’t generating a corresponding increase in revenue.
Pay attention to your gross margins. If they are falling, your productivity could be decreasing and you need to address the problem immediately.
In addition, to control indirect operating expenses, we recommend preparing and adhering to budgets. The amount budgeted for each item should be based on analysis rather than simply on the previous year's figures. Any significant increase should be subject to a cost-benefit analysis.
To cut expenses, use the 80/20 rule when deciding which ones to tackle first. Look at the items that make up 80% of your total expenses and work to reduce them. This is where you'll get the best results.
It's also a good idea to check the market periodically to see if you can get better prices on fixed costs, such as insurance, telecommunications services and maintenance contracts.
5. Neglecting to use technology
Technology-based solutions are invaluable in the fight to eliminate margin destroyers. They will help you assess what is draining your profit and optimize your operations, customer relationships and pricing.
You can use your accounting software to calculate your profit margins, track your expenses, and monitor your asset turnover, among other key performance indicators (KPIs).
Manufacturing companies can use software to monitor downtime due to production line changes and equipment repairs. Along the same lines, timesheet tracking software allows you to monitor staff productivity and generate data for invoicing.
Once you've identified the margin destroyers, you can work on continuous improvement by using a dashboard and KPIs to monitor progress toward your goals.