Robert bought a sporting goods store three years ago. So far, he hasn’t been able to take any pay for himself. His wife is asking, “Is this a business or a hobby?” This is probably a good question for every business owner to ask themself. If you aren’t earning the kind of money that you could earn at a job, is there a part of your business that is really a hobby?
In a small business you are likely working more hours and under more stress than you would be working for a boss. In addition, you are putting capital at risk. You may have borrowed from family, friends, banks, and credit cards to provide this opportunity. Your family has every right to wonder why there isn’t more benefit to them from their sacrifice.
In Robert’s case, the answer was relatively simple. He did need to increase sales, but that wasn’t the biggest issue. His sales were close enough to $1,000,000 that we will just call it that for this example. However, a quick look at this Profit and Loss Statement and his big issue jumped off the page. His gross margin from sales was only 37%. The industry average was 45%, and some in his business were reaching 50% margins. (If you are not quite sure how to calculate or find your “margins,” see our last post here.
On $1m in sales, a difference in margins between 37% and 45% or 8% would yield additional income of $80,000 a year. Since Robert was just about at break even, this would mean taking home $80,000 a year to his family. If he were to use best practices that some in the industry were using, he could get another 5% and now he is making a respectable $130,000 for his effort. This increase comes without adding a single dollar to sales!!
Your margins are determined by a long list of issues, but lets look at the top four:
1. Selling Price
2. Purchase Price
Robert started with what seemed to be the easiest place to attack; selling price. He had a meeting with his sales staff and made it clear that the discounting of product had to stop. The new policy would be that all discounts had to be run through him.
When Robert looked at his P & L the next month (this is why getting statements out quickly matters), he saw an increase of 2% in margin. He dug a little deeper and saw that discounts were still happening. He decided to put in a bonus plan that paid out to his sales staff based on the overall margin for the shop’s sales.
At the end of the month, he found that margins were now up to 41%. His bank account was starting to show some growth.
Now Robert reviewed purchasing. Was he getting the best deals, or had he become lazy and started to trust his suppliers too much. You see, it is the unusual supplier who is going to give up their margin unless you ask for better pricing. In fact, you may need to bring in competitors and challenge every cost.
You may be able to increase margins by buying larger quantities, taking advantage of deals, and looking for closeout offers. Robert dug in and found his margins increased another 2% due to better buying tactics.
Next, Robert tackled the product mix. Some items had 35% margins based on the manufacturers suggested prices. Other items had 50% margins. Some had even higher margins. He sat down with the staff again to discuss how their bonuses would be increased if they would sell more of the 50% margin products.
When the next P & L came in, Robert was thrilled to see that he average margin was now at the industry standard. He had one more place to find some additional profit. That was in shrink.
Shrink effects margins in two ways. One is theft. The other is obsolescence. Robert created a new inventory and carefully evaluated what was and wasn’t selling. You see, companies who sell products often become museums of stale products. Robert put on a huge sale to move out old products that weren’t selling. This created a huge cash influx that he could now use to buy specials or larger quantities of items that were selling well.
His next P & L had a bit of a shock. His margins went down again. Of course, this was a one-month blip due to his having sold so much old product at a discount. With a clean inventory, he should start to see improvements in the next month.
Robert also took a look at procedures that might reduce shrink from theft. He found articles that showed more theft came from employees than customers. So he evaluated ways that would attack both of these possible problems.
Over the next few months Robert was able to consistently hit 45% margins, and he continued to work hard on purchasing. The result of freshening his inventory and training his sales force had a side benefit. Sales went up, too. Robert is a perfect example of paying close attention to his financial statement month-by-month and creating over $100,000 per year in additional income for his family.
Next time, we will look at how carefully evaluating the P & L for overhead and other costs can also make a marginally successful business into a great asset.