P1M4 Four Ways To Increase Profit

his module is an extension of and builds on the work we did in the last module.

If you found it difficult and you don’t feel you get it yet, please read the training material again and do the exercises – P1M3 How Profit Is Created.

My aim is to help you to understand your business finances and learn how to manage for profit.

You will be doing yourself a disservice if you go through this Pillar 1 training too fast.

Driving Your Business Forward

The last module introduced you to the cost volume profit relationship and the break even model.

It showed you that a few things determine your profit…I call these profit drivers:

  • The volume sold,
  • Your selling prices and
  • Your costs.

In this model I will be introducing you to another business growth model …and then bring it into line with the cost volume profit model you’ve now mastered.

This new model is important because it focuses more on external drivers and in particular what you want your customers to do.

If you know what you want, you can put into place marketing strategies (Pillar 4) to make it happen.

I’ll then give you some practical tips to monitor your contribution if you found that difficult.

We will also look at some more complicated break even point calculations which may fit better with your business.

Jay Abraham’s 3 Ways To Grow A Business

The model I want to introduce you to has developed by marketing great Jay Abraham and is called the Three Ways To Grow A Business.

You will find much more in the detailed notes and we will keep coming back to the thinking throughout your time in Your Profit Club.

Very briefly the three ways to grow a business are:

  • More customers
  • More purchase transactions
  • Higher average spend per transaction

When I first met this model, I underestimated it and didn’t understand the power of it. Don’t make the same mistake.

Read: Three Ways To Grow A Business

Digging Deeper

The three ways to grow a business are simple – more customers, more transactions and a higher transaction spend.

But let’s dig a bit deeper into these drivers.

The number of customers depends on the number of leads you attract, the number of those leads you convert into customers and the number of customers you lose.

This Three Ways To Grow A Business model has been very influential and it underpins many of the business development programs I’ve seen.

My only criticism is that it focuses on top line sales growth and not profit growth.

We saw from the what-if examples in the last module, we can’t assume that just because Sales increase, profit will increase.

The Bankers Mantra

I’m going to tell you one of my favourite business sayings and it is well worth writing down on a post it note and sticking it somewhere you can see it every day.

“Turnover is vanity, profit is sanity and cash is reality”

It’s known as the Banker’s Mantra because your bank manager doesn’t care about what your Sales are doing, just whether you are making money.

Big public companies have what’s known as an agency problem because the management of the business is divorced from the ownership of the business and can follow their own agendas.

Managers gain power, status and usually extra income from the company being bigger.

Shareholders gain wealth from the company profits.

And bigger sales don’t necessary lead to better profits.

This false concept of “big is best” creates a rush for mergers and acquisitions because it is easier to grow a business by buying on with other people’s money than it is to grow a business organically.

Unfortunately studies on acquisitions show that most destroy shareholder wealth.

The promised 2 + 2 = 5 argument turns out to be 2 + 2 = 3

You may not have any intention of acquiring another business but I have still seen the “we want bigger sales” idea come across in small businesses, even at the expense of profit.

Crazy but it sounds better at the golf club to say your sales are half a million instead of two hundred thousand and even better to when you can round up to one million.

People can brag about turnover without giving much away about their real financial performance.

But you’re not going to be like that are you?

Let’s focus on profit and live the Banker’s Mantra.

Changing To The Four Ways To Profit Model

I’m very conscious that wearing my accountants hat, I told you there were three ways to increase profit and when I pop on my marketing hat, I now say there are three ways to grow any business.

Let’s reconcile the two.

We know what matters for profit is contribution and fixed costs.

And we can take the logic of the Three Ways To Grow model and refocus it very simply.

If we stop thinking average sales value per transaction and start thinking average contribution per transaction and then also build in the fixed costs, we have a Four Ways To Increase Profit Model.

1.    More customers

2.    A higher contribution value per transaction

3.    More transactions per customer

These three together will create a bigger contribution

4.    Lower fixed costs

Equals more Profit

We now have a profit model which focuses on what we want to persuade customers to do…and at the same time is in line with the accountants’ cost volume profit model.

This will form the basis for your own profit model, perhaps split into first transactions and subsequent transactions…or the different lead sources you use to attract new customers.

It’s time to get back into practical issues to help you to find your contribution rates.

Job Tracking

If you provide a one-off, customised products and services, the idea of an average contribution per sale will seem very strange. Your jobs vary too much for there to be a reliable average.

You should be tracking sales, costs and contribution / profit to the job level to maintain control and understand what is happening at a meaningful level.

Only then can you start to think in terms of average jobs and that might be split into small, medium and large categories.

Read: Job Tracking if relevant

(In these next few sections I am giving help to different types of businesses who may struggle to apply the profit model. Please don’t get bogged down in complexity in situations which don’t apply to you.)

Product Tracking

If you provide very similar products or services to different customers, then the job tracking will create a lot of administrative effort for little productive information.

Because your products are relatively standard, performance is consistent and you can collect your information at a product level.

Read Product Tracking (if relevant)

Generic Product Tracking

If you sell standard products to all customers you can track financially by product group and work with a contribution percentage.

For example an entertainment store sells CDs, DVDs and books.

It doesn’t make sense to track at the customer/product combination or unique product level unless you’ve got a fancy computer system.

It’s enough to know that on average you make £1.20 contribution when you sell a CD, £2.30 when you sell a DVD and 80 pence when you sell a book.

Alternatively, because DVDs can be single or box sets, and books can range from a cheap paperback novel to an expensive specialised text book it may make more sense to work with average contribution percentages which adjust for the different values.

Read: Generic Product Tracking (if relevant)

Next we’d better look at how contribution percentage can be used in our Break Even model.

Break Even Analysis Using Percentages

Sometimes it is not possible or practical to use units of sale in a break even point calculation.

The calculation using contribution rate percentages is simple.

The break even point sales value is the fixed costs divided by the average contribution rate.

Read: Break Even Point Calculation Using Percentages (if relevant)

Monitoring Your Business With Equivalent Units

It is nice to have a volume measure if possible but it doesn’t have to be directly about the products.

Lawyers and other professionals think in terms of billable hours. So if that job takes 50 hours and another takes 500, it doesn’t make any difference to billable hours.

Hospitals can use patient-days as a better measure than the number of patients in a month for the people who have to stay in.

A manufacturing plant can use machine hours.

Read: Monitoring Your Business With Equivalent Units (if relevant)

Contribution Per Limiting Factor Or Constraint

If you have one resource  which is a bottleneck  or a constraint in your business then it is essential that you recognise this limiting factor in your thinking about maximising profit.

Quite simply, the task is to get as much contribution as possible from the constraint and that means prioritising on the basis of contribution per hour of the constraint used up.

A particular constraint to look out for is your own time. Products and services which consume your time may look good on paper until you look at your own return per hour spent.

Read: Contribution Per Limiting Factor

What To Do

If the last module was very long, I know this one can be tough because we are moving from a generic model to looking at how you can apply the ideas in your business.

It will be worth it although it may take some perseverance. You will have a much better understanding of how your business creates profit and how you can improve it.

Step 1 – Establish Your Base Case

You’ve got some number crunching to do based on your last accounts or your estimates of what is happening.

Remember what matters more is to be approximately right and not precisely wrong.

You can gradually refine your numbers as you get more information and bring your accounting systems up-to-date.

You may even want to get your accountant or bookkeeper involved but I want you to own the numbers. Make sure the numbers make sense to you and feel right.

Read: Preparing Your Base Case For The Four Ways To Increase Profit

This may seem more daunting than it is. You are only focusing on a few numbers to be able to apply the Four Ways To Increase Profit model.

Step 2 – Updating Your Base Case

Great if you have  recent numbers but you may have had to go back to accounts six months or more out of date.

Try to update your base case to what is happening now in your business.

Read: Updating Your Base Case

I talk you through some changes and how you can get a feel for your numbers.

How To Double Your Profit

My aim for your membership of Your Profit Club is to help you to double your profit.

It is ambitious and I want you to see the different ways you can do it because I believe you will find it inspiring and liberating.

Profit = (Customers * Transactions * Average Contribution) minus Fixed Costs

It’s a simple but powerful formula which gives you a choice where you focus your attention – or you can try to improve each area systematically with what you will learn in Your Profit Club.

Read: How To Double Your Profit

Manipulating The Profit Formula

The standard profit formula is:

Profit = (Customers * Transactions * Average Contribution) minus Fixed Costs

If you know the profit you want and you’ll make a few assumptions, you can find out what the other number needs to be.

I’ve done the permutations for you

Read: Manipulating The Profit Formula

What To Do (Recap)

Another big module packed with information so let’s recap what I want you to do.

  • Go back to your last accounts and calculate your Four Ways To Profit Formula.
  • Update for current sales information and make assumptions on contribution and fixed costs.
  • Calculate your current baseline – check your arithmetic.
  • Consider including a just in case contingency in your fixed costs because things do change and it is better to be cautious.
  • Calculate the ways you can double your profit.
  • Look at the different ways you can do it. What changes to the profit drivers appeal most? What look the most likely sources of extra profit?
  • Consider whether you have a limiting factor in your business…that’s something that constrains how much you can increase your profit.
  • If so, you need to prioritise so the limiting factor earns you the most money.

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