Very rarely (until I’ve given them a good slap) do they start by asking “how much profit do we want to make and keep?”
And so the usual outcome is that regardless of what turnover is, the bottom line stays flat or even goes down.
The problem with turnover
The problem with focussing only on growing turnover is that it doesn’t pay enough attention to the factors that determine whether you make a profit or not. Turnover is a blunt tool, and is only part of the equation of making profits.
“But I’m not doing it just for the money” you may say. That’s fine, whatever works for you. But if you enjoy your business and want to run it for at least the next few years, you’ll need a decent profit if you want more than to just scrape by.
Growing turnover often means:
- Dropping the gross margin to get the sales.
- Being less aware of the gross margin you’re achieving, as all focus is on hitting sales numbers.
- Allowing longer payment terms, especially if you’re targeting bigger customers.
- “Buying” business at a low margin, just to get a foot in the door.
- Giving settlement discounts, or volume rebates to bigger customers.
- Lowering your credit standards to bring in new customers to hit sales targets, so bad debt increases.
- Increasing marketing costs to bring the business in, without being sure that spend is an investment and not just an overhead.
- You might bring in a new sales person to target new markets or customers. Anyone who employs sales people know this can be a lottery and can take up to a year to know if they’re paying their way or not.
- You start thinking about what you’ll need to cope with all this growth and suddenly overheads are sprouting legs and running away.
A cycle of reducing profits and cash
I see a lot of businesses who are constantly “investing in their infrastructure” ready for when the sales growth kicks in. Except it doesn’t, or at least not enough to cover the growing overheads. And so their net profit falls.
Their cash is being eroded, they have less money to spend on the things that would bring sales in, and so they can’t take advantage of key opportunities as they come up.
Actions you can take
- Get focussed on your bottom line profit and make sure your business strategy is about more than just a sales target.
- Control your gross margin closely. When you’re growing sales it’s the first thing to suffer.
- Train your sales staff to really understand the gross margin and what affects it (I know, sounds obvious but I work with many who don’t)
- And of course watch your management accounts like a hawk to make sure your profit forecast is exactly where you want it to be.
We’ll talk about the flip side of maximising the profits from your existing turnover, and there’s a great story about how WH Smith are increasing margins despite falling sales that I’ll share with you well.