Planning for Profitability
Famous business quote: If you fail to plan, you are planning to fail. Putting even minimal effort into planning improves your chances of being successful.
It is not unusual for business owners I have worked with to approach their business like this:
- Work hard to get sales
- Spend money on materials and labor to deliver those sales (this is your Cost of Goods, or COGs)
- Generate a positive gross margin
- Pray that gross margin is enough to cover expenses
- Close eyes and hope that, at the end of the year, the business has net income
Instead, I ask business owners to plan for profitability-to be intentional to ensure that they have a profitable year. I advise them to use this simple trick:
- Start with your desired net income
- Add your expenses to this number (this is the gross margin your business must generate)
- Add COGs (this is the sales revenue that you need to make the net income you want)
Here's an example to illustrate:
This approach has several advantages, such as:
- You are focused on net income from the get-go
- Everything you do-controlling expenses, managing COGs, and growing sales-is now visibly connected to net income
- You manage expenses more carefully and every penny saved becomes a penny in net profit
- It highlights the contribution margin
- How much in materials and labor are needed to produce one dollar of sales? And we need $100,000 in sales, of course. The breakeven point in this example is $83,333 in sales (Breakeven sales is determined by dividing Expense by Gross Margin percent). Breaking even is no fun. Unless it happens in July...
You have created a machine with three levers to pull to deliver net income: sales, COGs, and expenses.
- Sales: If you sell $1,000 more, you will have $600 more gross margin and net income
- COGs: If labor is 70% of COGs and you improve labor productivitiy by 10%, you will have reduced COGs and increased gross margin and net income by roughly $2,545
- Expenses: If you switch insurance agents and reduce business insurance costs by $2,500, you will have $2,500 more net income
Turn your income and expense statement upside down to increase your focus on generating net income. This "Plan for Profitability" can replace the guessing--wishing--praying approach and makes success more likely.
The Duquesne University SBDC provides free business consulting for entrepreneurs in the Greater Pittsburgh area. Click here to request free consulting, or contact the SBDC for additional help and information.
If you need help with understading the financial reports, please take a look at our upcoming Get Behind the Numbers workshop!
Don Lodge is a Business Consultant at the Duquesne University Small Business Development Center (DUSBDC). He is also a certified business coach who has worked with over 100 small business clients since 2002. His areas of expertise include profitability improvement, effective sales techniques, and employee relations.