By Sherry Lutz Herrington
Now that we’ve examined how to find the “true bottom line,” let’s take a look at ways to improve it. “Impacting the Bottom Line
There are two basic pieces to the Profit and Loss. These pieces are income and expenses (including cost of goods sold).
Changes in either of these variables will affect net profit.
Let’s start with income. Projecting income can be complicated, but there are ways to generalize the process and try to change and improve revenue. Starting with the most recently completed period (generally a year) will help. Depending on your business, you can typically take total sales dollars and divide it by the number of sales to figure out your average sale. You can take just a month or two worth if you have a high transaction volume. This will make the numbers easier to calculate.
Once you have the amount of your average sale, then you can determine how many more sales you need to reach your next income goal.
Let’s say that you made $100,000 last year but you want to make $150,000 next year. You take $100,000 and divide it by the number of transactions you did during that same period. Let’s say that was 1,000, which means your average sale was $100. To increase your income by $50,000, you would need to make 500 more sales at your average rate. Not all your sales will be for the average. But overall it’s a safe number to use knowing that some will be more and some will be less.
If that is over a one-year period, then you could divide that by twelve months to see how many more sales you need to make each month to reach your goal. 500 divided by 12 equals 41.67. You will need to increase your sales by roughly 42 transactions per month, assuming your average sale remains the same.
If that seems like a huge jump or an impossible goal, there are a couple other variables that you could change instead.
You could raise your prices. If your average transaction is $100 but you increased your prices by 10% your average price would be $110 (theoretically speaking, of course). If you wanted to make $150,000 you would divide that by $110 to figure out how many sales you will need to make. $150,000/$110 = 1,363.64. Thus, you would need to make approximately 364 more sales a year or roughly 30 more per month.
The same formula could be used if you were to try to improve the average sale by either upselling (selling each client more) or adding products or services to your offering to entice your clients to increase their sales. If you choose to add more products or services, be sure they are a logical fit with your current offering. Going too broad will dilute your focus and may cost you more than it makes you.
Looking at the other half of the equation, let’s examine expenses.
Expenses fall into two categories: cost of goods sold (COGS) and operating expenses.
Let’s start with COGS. These consist of what you must spend to create your product or service. If you sell a product, you must either buy it from someone else or you have to make it yourself. If you buy it from someone else, you probably have no control over the price you pay. You might be able to shop around and find another source that costs less, but be sure the quality is the same or the value of your product may suffer.
If you make it yourself, then you may be able to streamline your process to reduce waste either in materials or time. This increases your margin. You can charge the same amount for the finished product, but it will cost you less to make it. Or you could try to find the materials at a lower cost, increasing your margin that way.
If neither of those options work for you, then you need to focus on the second category: operating expenses.
To operate a business there will be a certain amount of uncontrollable expense. That means there are things you must pay for but you have no control over how much they cost. There are still numerous expenses that you can affect. Examine each expense category to see if there is any way to reduce it. If it is something you purchase at a set price, like insurance, then perhaps it’s time to review what you’re paying and see if you can get it for less. It’s also a good idea to evaluate if the coverage you have is adequate.
If it’s not something you purchase for a set price, like office supplies or meals out, then you may be able to reduce these particular expenses. Neither of those are usually very large expense categories. Start with the categories that you spend the most on and see if they can be reduced.
Typically, your largest two operating expenses are payroll and rent. I don’t recommend cutting employee wages. However, you should examine your pay rates and staffing to be sure you are getting the most bang for your buck. If you have an overpaid employee who is not producing optimal results, you might consider replacing him/her with a lower cost person who works harder and can produce more. Staffing should be evaluated frequently. Don’t assume you have all the right people at any time.
Given the trend toward working from home, you may no longer need a big office. Consider moving out entirely or reducing your square footage to reduce your rent.
Each company is different. I encourage you to examine the expenses your company has to see where you might reasonably be able to make cuts.
If you can increase your sales, reduce your COGS, and reduce your expenses, then your net profit will increase.
The last piece of the puzzle is the money you spend that impacts the Balance Sheet, but not the Profit and Loss. As discussed in Part I of this two-part series, you need to pay attention to liability payments and owner’s draws.
Often liability payments are set at the time of purchase and can only be changed if you refinance the loan. Sometimes that’s worth looking at, but sometimes you have the best possible deal. In that case, you can consider paying off the loan more quickly so the payments will be done sooner. This means more money going out for a shorter period of time. Paying more will not improve the bottom line initially. Be sure you have the cash to cover the extra if you make this strategic choice.
When it comes to owner’s draws, first remember to never draw out more than your net profit minus your liability payments. If you live by that rule, you should continue to improve your cash. However, if you are running short on cash and want to improve the bottom line, then you may need to take even less. I know this can be painful. But sometimes it is necessary.
I see too many business owners treat their business like their personal piggy banks. Please don’t do that. Figure out what is available before you take your draws. If things are running tight and you need to reduce your draws, then I encourage you to do this same exercise for your personal finances. As a business owner, you are trying to make enough money to live off, but you also need to control your personal expenses. Leave enough money in the company to have a positive bottom line.
Breaking down your finances into these sections and examining each one carefully will help you improve the bottom line.
Any company can benefit from going through this process regularly. Even if your business is running smoothly and has no cash flow issues, it’s still good to evaluate each part of the company: income, COGS, expenses, liability payments, and owner’s draws. Being proactive and making strategic changes before a problem arises will keep your company operating profitably for the long run. A smart business owner understands and knows how to impact the true bottom line. -Impacting the Bottom Line
Sherry Lutz Herrington is the owner of Sherrington Financial Fitness, a business consulting and accounting firm specializing in strategic business planning and solid financial accounting for businesses. She is also the author of Strong Women Thriving (https://strongwomenthriving.com/), a blog which focuses on empowering women to be financially savvy, particularly after experiencing financial abuse. Sherry is currently writing a new book that both shares her personal story and addresses financial abuse. She can be reached at email@example.com.