Tag Archives | gross margin

3 Benefits of an Analysis of Customer Profitability

analysis of customer profitability

Over time weeds grow in any garden. In the same way, unprofitable customers work their way into your company. To avoid the high costs of low profit customers, you should perform an annual analysis of customer profitability. Therefore, weed your garden of customers who are sapping your profits and cash flow.

Although there are many ways to look at your customer base, some of the factors to consider are sales volume, gross margin, profitability, number of transactions, and average sale per transaction. Looking at this information will not only shed light on those customers who are a drain on company resources, but highlight opportunities to sell more to higher margin customers who have low activity.

Analysis of Customer Profitability Benefits

1.  The elimination of customers that are costing you money.

Sometimes the costs may be indirect. Firing the customers with low gross margins is straightforward, but what about the customers that pay a good gross margin but require a lot of effort from operations? Not only do you need to address gross margin but you need to consider the costs to service that customer.

2.  Focus!

If you get rid of the clients that are high maintenance, then it frees your organization up to focus on the more profitable customers. While a successful strategy might be to cross sell additional products or services to those clients who value the relationship, another strategy would be to target new customers with the same characteristics as the good clients you have today.

3.  Increased Productivity Across the Organization

The benefits of weeding out high-maintenance, low profit customers will reach across the organization.  The sales department benefits by focusing their prospecting on the right clients who value and will pay for the company’s products and services. Operations and finance will realize improved productivity in servicing only those customers who are reasonable in their demands for service.  No more getting beaten up on margins, “special” payment terms, or Friday afternoon rush jobs!

The bottom line is the advantage of customer profitability analysis is improved profitability and cash flow! The two ingredients necessary to grow a company faster.

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Your CEO needs to understand each customer’s profitability and for you to be their trusted advisor. Click here to learn how you can be the best wingman with our free How to be a Wingman guide!

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analysis of customer profitability

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Margin Percentage Calculation

See Also:
Margin vs Markup
Markup Percentage Calculation
Retail Markup
Gross Profit Margin Ratio Analysis
Net Profit Margin Analysis

Margin Percentage Definition

Gross margin defined is Gross Profit/Sales Price. All items needed to calculate the gross margin percentage can be found on the income statement. The margin percentage often refers to sales or profitability which may help lead to several key understandings about the company’s business model as well as how successful the company is at maintaining its cost structure to gain the proper amount of sales. Analysis of margins within a business is often useful in controlling the price in which you need to sale as well as a control on the cost associated to make the sale. Look at the following margin percentage calculation process.

(NOTE: Want the Pricing for Profit Inspection Guide? It walks you through a step-by-step process to maximizing your profits on each sale. Get it here!)

How to Calculate Margin Percentage

In this example, the gross margin is $25. This results in a 20% gross margin percentage:

Gross Margin Percentage = (Gross Profit/Sales Price) X 100 = ($25/$125) X 100 = 20%

Not quite the “margin percentage” we were looking for. So, how do we determine the selling price given a desired gross margin? It’s all in the inverse…of the gross margin formula, that is. By simply dividing the cost of the product or service by the inverse of the gross margin equation, you will arrive at the selling price needed to achieve the desired gross margin percentage.

For example, if a 25% gross margin percentage is desired, then the selling price would be $133.33 and the markup rate would be 33.3%:

Sales Price = Unit Cost/(1 – Gross Margin Percentage) = $100/(1 – .25) = $133.33

Markup Percentage = (Sales Price – Unit Cost)/Unit Cost = ($133.33 – $100)/$100 = 33.3%

Margin Percentage Calculation Example

Look at the following margin percentage calculation example. Glen charges a 20% markup on all projects for his computer and software company which specializes in office setup. Glen has just taken a job with a company that wants to set up a large office space. The total cost needed to set up the space with computer and the respective software is $17,000. With a markup of 20% the selling price will be $20,400(see markup calculation for details). The margin percentage can be calculated as follows:

Margin Percentage = (20,400 – 17,000)/20,400 = 16.67%

Using what you’ve learned from how to calculate your margin percentage, the next step is to download the free Pricing for Profit Inspection Guide. Easily discover if your company has a pricing problem and fix it.

margin percentage calculation, Calculate Margin Percentage, Margin Percentage

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Lower of Cost or Market (LCM)

See Also:
Accounting Principles
Accounting Concepts
Generally Accepted Accounting Principles (GAAP)
How to manage inventory
Inventory Cost

Lower of Cost or Market (LCM) Definition

Lower of cost or market accounting is generally based off of the accounting concept conservatism. It generally states that certain accounts should be stated at their historical costs or market costs whichever is lower.

Lower of Cost or Market (LCM) Meaning

The lower of cost or market means that accounts like inventory will often show unrealized gains or losses depending on how historical costs and market costs relate to each other. This means that if the market is lower than what it cost the company to produce a product, then the company is operating at an unrealized loss. The Gross Margin may be higher, but the true and actual costs to the company are higher. If it is the other way around the company will be operating at an unrealized gain in which the company’s historical costs are lower than the market. It should be noted that the market cannot exceed the sales price and likewise it cannot be less than the profit margin that a company would realize.

Lower of Cost or Market (LCM) Example

David is responsible for the accounting of inventory for Wawadoo Inc., which specializes in the production of widgets. After careful analysis David finds that the costs to the company to produce a widget cost $10 a piece. However, market conditions have worsened over the past few months, and the value of the inventory on hand is now only equal to $8 a piece. Therefore, David must write down the inventory on Wawadoo’s books by $2 for every widget in stock. Note that if you were selling these widgets for $12 then the company was producing a gross margin of $2. However, with the reduction in market cost many of Wawadoo’s competitors will drop their selling price. Thus Wawadoo must drop its price as well. If Wawadoo were to drop its selling price to $10 the company would be operating at breakeven because of the current inventory on hand.

lower of cost or market

 

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Financial Jargon

See Also:
Categories of Banks
Finding the Right Lender
Funding Source Versus Lender
How to Manage Your Banking Relationship
Interest Rate
Is it Time to Find a New Bank?

Financial Jargon

My client, Elliott, met a friendly banker at a networking function. The banker told him, “I like your business and would like to loan you and your company money”. Elliott spent time with him because he believed if he got to know him it would be easier to borrow money. But, when the time came for Elliott to borrow the money, the answer he got was no.

Elliott called to tell me he did not get the money and was upset because he thought the banker was his friend. My answer to Elliott was, “he probably is your friend. But, you are not getting what you want from the banker (money) because you are not communicating in his language.”

Elliott got mad during our conversation and said things like banks don’t loan you money unless you really don’t need the money. Then to make matters worse, I told him you, are probably right. He thought just because the banker was his friend and friends help friends in time of need, the money would be his for the having. After we talked a while and he settled down, I told him the problem. Bankers are the individuals who have invaded earth from another planet. They come from the planet known as Financial World. They look and act exactly like the rest of us that inhabit earth with one exception, their language. The language they speak is known as Financial Jargon.

Financial jargon or the language of accounting can make it difficult for the CFO and CEO to work seamlessly together to move the company forward. Learn the language of business in our CFO coaching workshop – the Financial Leadership Workshop.

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What is this Language of Financial Jargon?

Elliott asked, “What is this language of Financial Jargon?” I told him financial jargon is English or any other language spoken on planet earth but the majority of the human race does not understand the meaning of the words bankers speak. He asked, “Are you talking about financial ratios?” I told him yes, and gave him examples such as current ratioreceivables turnover, net working capital, gross margin, debt coverage, and debt to equity, which are just some of the terms in the language of Financial Jargon.

Sure, Elliott owns a business and survived college where he had taken a finance or accounting course. He even told me he had to memorize all the formulas to earn the grade he received. However, he went on to say, nobody told me I needed to understand the true meaning of these ratios to communicate with an alien known as a Bankers.

Ratios Hold Different Meanings for Bankers

Well, I told him these ratios do have different meanings to your banker than you were taught. Not enough time to teach him the entire language so I just explained one. I said debt to equity ratio could be defined as total debt to shareholders net worth. In college, you were taught this shows how leveraged a company is, in that the lower the ratio, the stronger the company.

To your banker, this ratio tells him who really owns your company; you or your creditors. Bottom line, if this ratio is high, your banker feels they are not talking to the owner of the company and will not loan you any money. So, Elliott, before you try to borrow money again, let’s make sure you are presenting your case in banker’s language.

Instead of using financial jargon around the executive team that doesn’t understand that language, break it down for them. Learn how you can be the best wingman with our free How to be a Wingman guide!

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The KISS Principle can be “Simply Stupid”

How often have you heard a business owner say “Why would anyone include depreciation, or rent, or insurance and many similar costs, in their Cost of Goods Sold? It’s best to keep it simple!” They want to apply the KISS Principle, but it can be simply stupid.

The KISS Principle can be “Simply Stupid”

Well for many reasons, such expenses should be included in COGS. Including:

So in many cases, the KISS principle – is “Simply Stupid” because it results in overpayment of the GMT, and obfuscates the real cost of a product or Service. And incidentally, it is GAAP. Just look at public company annual reports… Almost assuredly, your bank LOC requires financials prepared in accordance with GAAP.

Keep it Real.

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KISS Principle

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