Sales are great, but wouldn’t they be better if you were actually able to reap the rewards? Many CEOs that were not trained with an accounting/finance background struggle to understand profitability. They think that if sales are great, then the business is great. But when sales increase, inventory and overhead increases. Productivity also decreases – due to exhaustion or overwork. Collections lapse because there isn’t a “pressure” to collect. And unfortunately, that is when companies suffer the most. Sales start to decline, but they don’t change their habits. In this Wiki, you will learn how everything below sales on your income statement is critical to your company’s success and how you should be maximizing your bottom line – net income – at any stage of your company’s life cycle. Let’s look at how maximizing your bottom line in 3 simple steps can happen.
What is the Bottom Line?
First, what is the bottom line we are referring to? It is the net income on your income statement or P&L statement. This is what you have left after all the costs of goods sold, administrative expenses, and overhead have been subtracted from revenue. We look at this number carefully because that is how much you are able to put into retained earnings or reinvest back into your company. In addition, the amount can be used to issue dividends to their shareholders. Maximizing your bottom line should be an integral part of your company’s processes.
[box] Profitability starts at the top of the income statement. If your prices are not set to create profitable environment, then you will be not able to maximize the bottom line. Learn how to price for profit using our Pricing for Profit Inspection Guide. [/box]
Maximizing Your Bottom Line In 4 Simple Steps
There a are several ways to maximize your bottom line – some more extensive and time consuming than other. But there are 3 areas to focus on to maximize your bottom line – including productivity, overhead, and collections.
1. Productivity is Key
It’s been a common theme among business blogs and news sources (Entrepreneur, Forbes, WSJ, etc.) to improve productivity. Why? Because productivity is key in maximizing your bottom line. But what really happens when you improve productivity? You have more supply, decrease the cost to produce 1 unit, and increase sales. It speeds up your operations so that you can fulfill more orders for quickly.
2. Manage Overhead
Great revenues have very little meaning if your overhead costs are not properly managed. Look deeper into your overhead expenses and find out if there are any costs you can reduce or completely remove. The problem is often more complex than large expense accounts on the P&L. You must interact with various departments to think critically and solve problems. Ensure that every single overhead cost is necessary to provide the desired service levels. Maximum controllability over costs leads to higher profits for the company to reap.
3. Collect Quicker
Collections are an important part of business. If a company sells $10,000 worth of product but only collects $3,000, then their cash is tied up in inventory, etc. As a result, they experience a cash crunch. We have worked with clients who were in the same situation and they neglected to ever collect the outstanding balance. Their bottom line suffered, but they didn’t think to look at their collections process. There are two metrics that you can look at to monitor collections and use to collect quicker.
The first metric is DSO. Do you know your Days Sales Outstanding (DSO)? This is a great measurement to know where you are currently and how by making slight adjustments, you can increase profitability. Use the following formula to calculate DSO.
DSO = (Accounts Receivable / Total Credit Sales) * 365
The second metric to look at is Collections Effectiveness Index (CEI). This is a slightly more accurate representation of the time it takes to collect receivables than DSO. Because CEI can be calculated more frequently than DSO, it can be a key performance indicator (KPI) that you track in your company. If the CEI percentage decreases one month, then leadership are alerted that something is going on. The goal here is to be at 100%.
CEI = [(Beginning Receivables + Monthly Credit Sales – Ending Total Receivables) ÷ (Beginning Receivables + Monthly Credit Sales – Ending Current Receivables)] * 100
Another method to collect quicker is to tie receivables to the sales person’s commission. This will not only encourage your sales team to be part of the collections process, but it will help keep your company cash positive.
Effective Strategies for Improving Profitability
While we’ve been focused on maximizing your bottom line as your current financials stand, we also wanted to share some effective strategies for improving profitability.
Price for Profit
Are your prices leading to a satisfying net income? If not, then these are some questions you can inquire:
- Are additional costs being reflected on the price?
- Are you using Margin vs Markup interchangeably?
- Is your overhead being covered?
The solution might be simple: Adjust your price!
[box] Learn how to price for profit using our Pricing for Profit Inspection Guide. This whitepaper will help you identify if you have a pricing problems and how to fix it. [/box]
Create Standard Operating Procedures (SOP)
Also, create Standard Operating Procedures (SOP). SOPs are step by step instructions written by a company to assist employees in completing routine procedures. They are necessary in a company to ensure operations run smoothly. The better your company’s SOPs are, the more efficient it will run. Create operating procedures that are simple, easy to read, and most importantly make them lead to a purpose.
Focus on Profitable Customers
Identifying profitable customers is instrumental to a company’s success. Once you completely identify your most profitable group of customers, focus your attention on them. Use your marketing funds primarily on you most profitable customers. A customer outside of that target market is still a viable customer, but they just shouldn’t receive as much marketing attention since they are not their primary and most profitable customer segment.
When maximizing your bottom line, start with your prices and pricing process. Access the free Pricing for Profit Inspection Guide to learn how to price profitably.
[box]Strategic CFO Lab Member Extra
Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.
Click here to access your Execution Plan. Not a Lab Member?
Click here to learn more about SCFO Labs [/box]