What are the drivers that affect your profitability?
Want to make your company more profitable? Profit drivers are factors that have an significant impact on your bottom line and can significantly increase your profit. Owners have to grapple with loads of information about their business but knowing which financial and non-financial information to really focus on to increase profits is crucial.
The drivers of profit
The main drivers of profit will be financial profit drivers. However, there are several non-financial elements in your business that will also boost your profit. Depending on the products or services you sell, your profit drivers may vary within these categories.
Financial profit drivers
There are 6 key financial profit drivers in any business:
- Fixed costs
- Variable costs
- Sales volume
- Cost of debt
Pricing can have the greatest impact on profit. Many people think they can’t increase prices for fear of losing customers. But ask yourselves: How many customers could I lose and still make the same profit? If you increase your prices by 5% and lose 2% of customers, you may still earn more.
You shouldn’t keep selling at the same level for years. Pricing of raw materials go up, fuel goes up, salaries go up. You need to monitor margins to see when it’s time to increase your prices. Factor in small, regular increases into contracts. If you don’t raise prices, you could see your gross profit reduce significantly over a number of years.
2. Fixed costs
Fixed or ‘overhead costs’ are less in your control than price and can remain the same regardless of your output. These types of expenses include rent, power, heat, light, machinery etc. It’s worth doing a cost analysis and reduction exercise to save money, regularly check that you’re getting the best prices, if theres room for negotiation or you there are new deals on the market.
3. Variable costs
These will vary depending on production output. Variable costs are a constant amount per unit produced. As output increases, they will increase but if the output decreases the variable cost also decreases. Examples are materials used in production and direct labour rates. Negotiating better supplier contracts can help. But beware that you negotiate but dont cut quality in the process, by trying to buy cheaper as poor quality will negatively impact profits in the future.
4. Sales volume
Many business owners believe that just a rise in sales to new customers or cross selling products and services drives greater profitability. Business growth does not always equal profit growth. Just increasing volume will not grow your profit (unless you get discounts for buying larger quantities or economies of scale in production for example). You can’t just increase volume in isolation there are three key areas you should tackle at the same time:
- Increase your number of customer base
- Increase the quantity of transactions per customer
- Increase the average amount spent per transaction
Also See: 10 ways to avoid business insolvency
5. Cost of debt
Assessing how much your debt is costing you and restructuring can help profitability. For example, if you’re paying relatively high interest rates on loans and current interest rates have decreased, you could look at refinancing existing debt. This could reduce both your monthly payments and your interest payments.
Profitability occurs not only in sales, but also in your warehouse. The only way to truly improve cost effectiveness is to keep tight control of your inventory. You should be accurately tracking inventory levels, turnover, cycle times and write-downs and write-offs.
Non-financial profit drivers
There are many non-financial profit drivers that also impact your bottom line:
- Number of leads
- Lead conversion rates
- Marketing spend
- Customer attrition rates
- Customer satisfaction
- Quality of your product or service
- Employee training & morale
- Unprofitable products or services
Ranking your profit drivers
Depending on the type of business you run, the most important profit drivers may vary. You should understand and rank the relative importance of your own business drivers. This will help you prioritise what you concentrate on first.
So, it’s important to step back and ask yourself the question: ‘What are the drivers that affect profitability in my business?’ You should ensure you have strategies in place to review each of the profit drivers in your business.
You should generally always start with price as this is the most powerful lever in your business profit equation and it can have an immediate impact on profits. However, if possible, you should work on all of the profit drivers in your business.
To maximise the success of your company, grow your business and increase your profits, take the time to perform a profit driver analysis. It will help you work out where to place emphasis and make changes to increase your profitability across the board.