The Three Ways to Improve Profitability

Only three ways are available for you to increase your business's profitability:

• Decrease expenses.

• Increase margins.

• Increase sales.

Or you can do all three at the same time — that is, if luck and the small-business gods are with you.

Decreasing (or controlling) expenses

The biggest advantage that comes from controlling your expenses is that the right expense cuts have a direct short-term impact on the bottom line. For every dollar you save by eliminating an expense, you earn an extra dollar of profit. (Sure, increasing sales is another way of increasing profits, but an extra dollar in sales may only bring in 25 cents of profit.)

Of course, you see a world of difference between reducing the expense of your phone bill by switching to a company with a lower cost but comparable quality long-distance service and reducing the cost of your product by switching to a supplier that offers lower cost and lower quality. Higher returns from disgruntled customers — or worse, lawsuits from harmful products or services — can do more harm than good to your business's long-run profitability.

So, although operating a lean business is most desirable, you must be thoughtful about where and how to reduce your expenses. You must consider all the effects of cost cutting, not just the short-term bottom-line effects.

Controlling expenses is a cultural issue, which means that controlling expenses is a lead-by-example issue that begins with you, the business owner, and carries over to your employees. From the day you open your business's doors, you must pay close attention to its expenses, being careful not to spend money carelessly and being tactfully critical of those who do. If the boss sets the right example, the rest of the company is certain to follow. That's how a company culture flourishes.

After you make the commitment to maximize your profitability, the controlling-your-expenses option should always be the first place to turn. Everything you do in the process of controlling expenses will have a direct — and immediate — impact on your earnings.

Following are several specific cost-controlling measures, intended not only to give you specific ideas but also to put you in the frame of mind for getting specific on all your expenses:

• Don't pay unnecessary bank charges. Shop around if your bank is charging for services that you think you shouldn't have to pay for. Some banks today are aggressively pursuing small businesses. Just about everything is negotiable.

• Shop your telephone service every year or so. Everyone is discounting telephone services as technology and deregulation make prices more competitive.

• Ask for price quotes before you obligate yourself to services. Often the quotes won't hold up but they will give you a basis on which to negotiate subsequent charges. Also, always ask for itemized invoices.

• If you have employees, review your experience ratio with your insurance agent. Your experience ratio is the factor that determines your worker's compensation payment.

• Speaking of insurance agents, how long has it been since you've shopped for insurance? So, what are you waiting for?

Incidentally, don't let price be your only consideration. Nor should you automatically wave goodbye to your current supplier after you've found a lower price. Instead, be aware of the going rate in the marketplace and, where appropriate, change suppliers or press your current supplier to reassess the prices he's charging you. Squeaking wheels get the grease, and the effective control of expenses is no exception to this rule.

Remember that effective expense control is not a one-time event; it is an ongoing occurrence whose success or failure lies entirely in your hands.

Increasing margins

Gross margin represents the difference between the selling price and the cost of the product or service in question. If your product sells for $15 and the cost of that product (including shipping charges) is $10, then your gross margin is 33 percent (the $5 in margin or markup divided by the $15 gross sales price) and your gross margin dollars are $5 (the difference between the $10 cost and the $15 sales price).

The magic of increasing margins is that, similar to decreasing expenses, every dollar of income derived from the margin increase, assuming no reduction in sales, ends up as profit on the bottom line. In the preceding example, if the price of the product is raised to $16, the margin jumps from 33 percent to 37.5 percent, and the gross margin dollars increase from $5 to $6. Because it generally costs little to increase prices, the entire $1 of the price increase will be realized as profit, again assuming no reduction in purchasing from customers.

The tolerance of your customers to accept price increases will depend on such issues as competition, alternative products, and most of all, the customer relationships you maintain.

Every small-business owner should review the margins on every product or service at least once a year. Determine a time of the year when it makes the most sense to raise prices (usually at the beginning of the business's fiscal year), mark that date on your calendar in indelible ink, and start with your lowest-priced item and work up. Be sure to analyze the percentage of price increase on each individual item. Don't simply increase prices using an across-the-board percentage increase; look at each individual item. Also, be sure to aim for higher margins on the lower priced items and on those products that do not need to be as competitively priced.

Increasing sales

After your expenses have been zero-based and after your margins have been increased, it is time to do what every entrepreneur worth his weight in loan guarantees loves to do. Increase sales. After all, offense (increasing sales) is always more enjoyable than defense (cutting expenses). What's more, the results of a plan to increase sales can be easily measured.