Tag Archives | profit

Margin vs Markup

See Also:
Gross Profit Margin Analysis
Retail Markup
Chart of Accounts (COA)
Margin Percentage Calculation
Markup Percentage Calculation

Margin vs Markup Differences

Is there a difference between margin vs markup? Absolutely. More and more in today’s environment, these two terms are being used interchangeably to mean gross margin, but that misunderstanding may be the menace of the bottom line. Markup and profit are not the same! Also, the accounting for margin vs markup are different! A clear understanding and application of the two within a pricing model can have a drastic impact on the bottom line. Terminology speaking, markup is the gross profit percentage on cost prices or cost of goods sold, while margin is the gross profit percentage on selling price or sales.

Effective Ways to Optimize Profitability

So, who rules when seeking effective ways to optimize profitability?. Many mistakenly believe that if a product or service is marked up, say 25%, the result will be a 25% gross margin on the income statement. However, a 25% markup rate produces a gross margin percentage of only 20%.


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!

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Markup vs Gross Margin: Which is Preferable?

Though markup is often used by operations or sales departments to set prices it often overstates the profitability of the transaction. Mathematically, markup is always a larger number when compared to the gross margin. Consequently, non-financial individuals think they are obtaining a larger profit than is often the case. By calculating sales prices in gross margin terms they can compare the profitability of that transaction to the economics of the financial statements.

(Try the calculators at the bottom of the page to discover for yourself which is better!)

Steps to Minimize Markup vs Margin Mistakes

Terminology and calculations aside, it is very important to remember that there are more factors that affect the selling price than merely cost. What the market will bear, or what the customer is willing to pay, will ultimately impact the selling price. The key is to find the price that optimizes profits while maintaining a competitive advantage. Below are steps you can take to avoid confusion when working with markup rates vs margin rates:

Establish a Price

Still deciding whether to use margin or markup to establish a price? Easily discover if your company has a pricing problem and fix it with either margin or markup. Download the free Pricing for Profit Inspection Guide to learn how to price profitably.

margin vs markup, Effective Ways to Optimize Profitability

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Effective Ways to Optimize Profitability, margin vs markup

Margin vs Markup Chart

15% Markup = 13.0% Gross Profit
20% Markup = 16.7% Gross Profit
25% Markup = 20.0% Gross Profit
30% Markup = 23.0% Gross Profit
33.3% Markup = 25.0% Gross Profit
40% Markup = 28.6% Gross Profit
43% Markup = 30.0% Gross Profit
50% Markup = 33.0% Gross Profit
75% Markup = 42.9% Gross Profit
100% Markup = 50.0% Gross Profit

Margin Calculator

Markup Calculator

(Originally published by Jim Wilkinson on July 24, 2013)

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Customer Profitability

See also:
Identifying Profitable Customers
Segmenting Customers for Profit
3 Benefits of an Analysis of Customer Profitability

Customer Profitability Definition

The customer profitability definition is “the profit the firm makes from serving a customer or customer group over a specified period of time, specifically the difference between the revenues earned from and the costs associated with the customer relationship in a specified period” (Wikipedia). In other words, customer profitability focuses on the profitability of a specific customer. How much revenue do they bring in? How much time, resources, etc. do they require from your company? By calculating the profitability of each customer, you have some great business insights on productivity, resource allocation, etc.

For example, if your customer service department is overwhelmed with work, then you can assess the number of requests per paying client. If a customer that is at the towards the bottom for revenue and the top for requests, then you can conclude several things. Those can include that you need to either increase their price, fire that customer, or limit the amount of requests for that customer.


Click here to Download the Pricing for Profit Inspection Guide


The Purpose of Measuring Customer Profitability

Customer profitability is a key metric utilized to inform decision making in various areas of the company. These decisions affect the value exchange between the customer and the company. Once we measure the profitability of our customers, we are now able to understand who our customers are and how we make a profit. It can provide great insights on the business that lead to focusing on what is best for the customer.

How to Measure Customer Profitability

Before you measure customer profitability, you need to confirm how your company calculates revenue and expenses. Remember, Profit = Revenue – Expenses. Some companies recognize revenue when it is received (cash basis accounting). But we recommend that organizations use accrual basis accounting – or recognize revenue when it is earned. If you are bigger than a hot dog stand, then you should be using accrual accounting. In regards to expenses, it’s also important to allocate as many expenses through the customer as possible. Think about capital, debt, operational costs, etc.

Once you have figured out the respective revenue and expenses for a specific customer, then you are able to calculate its profitability. Next, you need an analysis all of your customers.

Customer Profitability Key Performance Indicators

There are various KPI’s that can help you understand how your customer profitability is doing at the moment. Here are examples of a few:

Average Revenue Per User (ARPU)

A measurement of the average revenue generated by each user or subscriber of a given service. Use the following formula to calculate the average revenue per user (ARPU):

 Total Revenue / Total # of Subscribers 

Customer Lifetime Value (CLV)

A projection of the entire net profit generated from a customer over their entire relationship with the company. Use the following formula to calculate the customer lifetime value (CLV):

Annual profit per customer X Average number of years that they remain a customer – the initial cost of customer acquisition

If your customer isn’t valuable or is costing you too much, then reassess your pricing. Click here to learn how to price for profit with our Pricing for Profit Inspection Guide.

Customer Profitability Analysis

Customer analysis, defined as the process of analyzing customers and their habits, is one of the most important areas of study in a business.

By observing the actions of various customers you start to see a trend of what your average customer is like and what their habits look like. This is a hint at who your target market could be. Behavioral trends amongst customers are important in how your company decides to carry on their marketing efforts. Once you analyze your customer base and determine your most profitable customers it is important to allocate the majority of your efforts towards them to make your most profitable customer your target customer.

Managing Customer Profitability

Managing customer profitability is larger than just the sales or fulfillment of product/service for the customer. It also includes marketing, finance, customer service, product, and operations. If you manage the profitability of customers, then you will have a better chance of catching areas of inefficiencies.

Areas to Improve Profitability

Some ways to improve customer profitability are to change the way you provide commission to the salesperson. Instead of paying their commission based on revenue, base it on the profitability. This can either be focused on the margin percentage (i.e. a sliding scale) or on the dollar amount in profits.

Why It’s Important to Manage

Managing customer profitability is important for various reasons, not only does it set you apart from the competition by providing more value to your customers, but it also improves the company’s revenues. When you manage customer profitability you are making the value exchange from company to customer more efficient and more profitable.

If you are looking for other ways to improve profitability, then download our Pricing for Profit Inspection Guide.

Customer Profitability Definition, Measure Customer Profitability

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Customer Profitability Definition, Measure Customer Profitability

 

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Realizing Profit Potential

Over the years, we have asked our clients what business issues keep them up at night. Consistently, realizing profit potential was one of the top issues that kept business owners up at night. Is there money left on the table that hasn’t been realized? Is there potential that hasn’t been capitalized on yet? As a financial leader, it’s your job to maximize the profitability of your company.

Realizing Profit PotentialWhat is Profit Potential?

Profit potential indicates the capacity for a company to make more money in future business and trading transactions. I like referring to it as the monetization of your total capacity to drive earnings. Furthermore, profit potential measures the profit a company can achieve if all their operations are at peak efficiency. This includes pricing, efficiencies, operations, turnover, etc. Also, look at profit potential as the maximum revenue with the lowest possible costs. It’s important to keep in mind that “potential” hints at what a company can accomplish with ideal conditions. But most companies do not meet these conditions in reality. Also, be realistic about peak performance. For example, a manufacturing plant simply can not run at 100% capacity. There is down time for things like maintenance.

A great way to start realizing profit potential is to look at your pricing. Click here to learn how price effectively with our Pricing for Profit Inspection Guide.

Steps to Realizing Profit Potential

What are the steps to realizing profit potential? While I could probably write hundreds of different ways to realize a company’s profit potential, I have compiled a few steps that every small to medium size company can focus on first.

Focus on Throughput

Throughput is “is the number of units of output a company produces and sells over a period of time.” Remember, only units both produced and sold during the time period count. Profit potential lies between producing X number of products while simultaneously reducing operating and inventory expenses.

Do not forget to take into consideration your Total Units produced must consider down time for routine maintenance.

To calculate throughput, use the following formulas:

Throughput = Productive Capacity x Productive Processing Time x Process Yield 

Throughput =   Total Units    x  Processing Time  x  Good Units 
             Processing Time       Total Time        Total Units 

Analyze SG&A

Another step to realizing profit potential includes analyzing your company’s SG&A expenses. SG&A stands for Selling, General, and Administrative expenses. It is also known as overhead. When a company analyzes SG&A, they will realize this is the easiest place to looking for unrealized profit potential. Does your company have a large number of non-sales personnel? Are those employees needed to operate? If not, then merge responsibilities for those employees into the roles of essential personnel. Do you carry a lot of expenses that if cut would not disrupt either the manufacturing or sales processes? If so, then analyze whether those expenses are necessary or required.  Do you have sales people that are compensated with a base salary when it should be commission based?  How did you build your budget for SG&A this year? Did you just take last years budget and add 5%, or did you really analyze SG&A?

If you have cut all the SG&A possible and are still not profitable, then take a look at your pricing with our Pricing for Profit Inspection Guide.

Realizing Profit Potential

Know What Is Valued

Companies are giving away more value per dollar of revenue than ever before. That’s what marketing teams are being taught to do. However, many companies are giving value away without being able to actually afford it. Look at your minimum viable product. Is all the extra bells and whistles you are adding to your product and service actually adding value to your bottom line? Ask yourself whether customers would leave if you cut those extra “value-adders”. If you determine that they would not leave, then streamline your product and/or service.

Of course, I am not saying to decrease the quality or tear away value that is actually valued. However, companies should know what the company values. Then, they should focus on that. For example, Tesla offers an incredible experience with its technology. It’s no doubt that they have found value in their vehicle. But what if Tesla started including a fuzzy steering wheel cover? Their customers would probably think that the fuzzy cover is tacky and does not add much value. They want to feel the leather under their finger tips. Therefore, Tesla should stop spending money purchasing the unwanted fuzzy steering wheel covers for their customers.

Address Your Culture

Another thing that may be impacting your profitability is your company’s culture. When you address your culture, look at productivity, efficiency, accuracy, moral and the people.

For example, a sales driven firm knows they could be more profitable. They have reduced their costs and priced their products for profitability. However, there is still something missing. The financial leader walks through the sales department, factory floor, and ends up in the customer service department. There are no smiles, yelling, and phones slamming. Unfortunately, no matter how hard sales and operations worked, customer service representatives were loosing more customers than normal. The financial leader discovered that their culture was all about making the sale and delivering it. They did not value servicing customers or continuing to build a relationship with those customers.

In another example, a company noticed they were only focusing on the unprofitable or lower margin clients. The profitable customers did not have the same level of attention. Instead of loosing the unprofitable clients, they chose to pull back support and created a paid support program. If those needy customers wanted more support, then they were going to have to pay for it.

Analyze Pricing

Are you pricing for profitability? By now, you should have looked at your COGS and SG&A (or operating expenses). If you have already reduced those costs as much as possible, then determine if you are profitable or not. If you are still not profitable or as profitable as your shareholders want, then you need to make changes at the top – pricing. Access our Pricing for Profit Inspection Guide to learn how to price profitably.

Realizing Profit Potential

Realizing Profit Potential

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Adding Value as a Financial Leader

Adding Value as a Financial LeaderThe role of the CFO or financial leader of an organization used to be termed as a “numbers cruncher”. For many reasons, The Strategic CFO has been working tirelessly to coach, consult, and mentor CFOs, Controllers, and others in the finance and accounting function to go from being a number crunchers to a value-adding financial leader. In addition, the role has naturally evolved to go beyond finance. McKinsey reports that 41% of the CFO’s role isn’t even in finance and accounting. As a result, adding value as a financial leader has dramatically changed.

Adding value as a financial leader goes beyond accounting and finance. The CEO needs a wingman – someone to guide them, provide strategy, and back up with a financial plan. To learn how to be a wingman, click here to access our How to be a Wingman guide.

Adding Value as a Financial Leader

We define “value”, in regards to adding value as a financial leader. But, how does one add value? They are a steward of both financial and non-financial performance. They are also responsible for partnering with other business, supporting business strategy, and sustaining value-adding strategies. In other words, adding value as a financial leader simply means supporting the organization (specifically the CEO) to do what they do best – cast the vision for the company.

Value-Adding Financial Function

In order for the finance function to be value-adding, the function (AKA the CFO) needs to have buy-in from the organization’s leadership. This buy-in allows that financial leader to oversee HR, IT, tax, finance and accounting. The finance and accounting function must support these departments or areas of business in order for it to be value-adding.

If the CFO of an organization is what we call a CFnO, then nothing will ever get done and no value will come out of that role. However, if the CFO provides data and analysis to allow the CEO to take a calculated risk, then that role will be value-adding

The Changing Role of the CFO

With technology advancements, more regulations, and additional complexity, the role of a CFO is completely different from 20 years ago… Even 5 years ago.

How Does a CFO Add Value?

Adding Value as a Financial LeaderThe three legs of an organization include sales, operations, and accounting. If one of those legs is falling short or is more successful than the other leg, then the stool risks tipping over. How does a CFO add value? A CFO adds value by understanding on each of those legs equally.

A financial leader or wingman needs to go beyond the accounting and finance function. To learn how to be a wingman, download our How to be a Wingman guide.
  A good CFO truly understands the operations side of the business.

Convert Accounting From a Cost Center to a Profit Center

Accounting is often seen as a cost center. That’s not a new thought or revelation. But the accounting department has the opportunity to convert itself from a cost center to a profit center under the direction of the right financial leader. How do you make this change? You focus on your margins, working capital and cash flow. As an accounting department, you do not have the ability to make sales. However, you do have the ability to identify waste, or better ways of buying insurance, or signing leases, reduce overhead, increase profit margins, and work to bring more down to the bottom line. In a McKinsey Special Collection, they outline that,

Valuing such initiatives often requires nuanced thinking. Although some transformations include radical changes, most create significant improvements on the margin of existing operations. That requires an understanding of the organization’s marginal economics—that is, the costs and benefits of producing one additional unit of product or service. When managers have a clear understanding of the marginal value of improving each of the activities that contribute to performance, they have the potential to redirect an entire transformation.

Streamlining Operations

Look at efficiencies in the operation. Understand the measure of throughput if you manufacture something, look at labor hours and efficiency if you provide services. Your monthly dashboards as CFO should include accounting and financial measures, but also operations metrics.

Customer Service

Working to respond to customers quicker and with more satisfactory answers should be a priority of the company. One indicator that I manage in my business is customer turnover. It’s much easier to keep a customer than it is to find a new customer. Therefore, streamline your customer service processes. This can include getting more responsive tracking software, hiring better or more representatives, training every employee to respond to customers.

Days Sales Outstanding (DSO)

It is common to have a collections department if you are a larger organization. But if you are smaller the collections effort often lies with the sales people who have the relationship with the customer, and sometimes the collections effort is done by someone in accounting.  It really should be the person with the client relationship.  Either way, make sure someone is following up with collections.  You would be surprised how many times I have walked into a business and one side of the business thinks the other is following up on collections, when in reality no one is.

Want to get more tools that can help you become more profitable, streamline operations, and collect A/R quicker? You can access that and so much more in the SCFO Lab. Click here to learn more. 

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Adding Value as a Financial Leader

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Adding Value as a Financial Leader

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What “Non-profit” organizations have in common with “For-profit” companies

Non-Profit vs For-Profit

The term “Non-profit” is slightly deceiving. Non-profit does not mean “no profit.” In reality, it means that the organization is not in existence for the sole purpose of making profits. Successful non-profits know how to effectively earn profits. Then they need to know how to recycle those funds back into the organization’s mission and operations. We’re taking a look at non-profit vs for-profit entities.

Non-Profit vs For-Profit

Non-profits have a lot in common with for-profit organizations. Classify both organizations as business entities. This is because they expect to earn profits. If losses are incurred, the organization is at risk for shutting down. A surplus of revenue over expenses is essential for ensuring the continuation of both non-profits and for-profit entities.

Both often create legal separation between the organization itself and its members. This protects members and employees from financial and legal liabilities. Most for-profits have full-time employees and managers, and many larger for-profits also have chief officers to handle management of the entire business. Although non-profits often have volunteers as staff, larger non-profits need a full-time staff of employees, managers, and chief officers to support the organization. Both non-profits and for-profits often have a board of directors of elected officials who oversee the organization or company.

Many for-profit business strategies and management techniques are effectively incorporated into non-profit organizations. Creating and implementing budgets and cash management are financial management tools that are vital to maintaining operations. Cash is king. If a for-profit or non-profit does not have enough cash reserves to continue operations or to provide services, the organization is probably on the road to failure. Since revenue can often be hard to predict, control of expenses is critical in budgeting. Not only are budgets a method for allocating resources, but they also provide a way to control expenses. Just as a for-profit company needs a financial team and manager to plan and budget enough funds for operations and developments, a non-profit needs a financial supervisor to plan and budget sufficient lead-time to get grants and funds for organizational programs.

Clear Goals and Objectives

Most importantly, goals and objectives must be clear for all members of both for-profit and non-profit organizations. If different members and employees are not working toward the same mission, then the organization will not be on the right path to success. The end goal of a for-profit most often would be maximizing profits and financial benefits for its owners and/or shareholders. The end goal of a non-profit should be ensuring that there are enough profits to continue making a difference. Also, they need to provide for the “greater good” of the community, nation, or the world.

Click here to read more about Non-profit vs Not-for-Profit.

Non-Profit vs For-Profit

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Managing the Banking Relationship in a Growing Market

extending lineBusiness is rarely easy.  Even in a growth market, there are still challenges.  They are just different challenges than in a recession.

Managing the Banking Relationship in a Growing Market

In Houston, we are seeing companies who are continuing to grow and generate cash. As they seek to expand their operations and invest in infrastructure, they are running up against the debt limits set by their bank. Right now, banks want to lend money!  That is how they earn a profit.  Unfortunately, a lot of companies are not making it easy on them.

Pursuing an aggressive tax-minimization strategy may generate cash to a point, but makes it difficult for banks to lend the company money once the tax savings aren’t enough to fuel growth.

Companies who violate the concept of sustainable growth, by borrowing more than the company’s internal growth rate can sustain, tie their banker’s hands and often make it necessary to seek sources of funding outside their bank.

Another obstacle for the bank loaning more money is the regulators.  Since the financial meltdown, bank regulation has increase dramatically and the banks have to keep the regulators happy.  We’re finding that in order to get more leverage, companies often just need to address the bank’s issues in a manner that makes sense.

Bankers hate surprises. Consequently, the key to a successful banking relationship is communication. Openly communicating your plans with your banker not only gives them confidence that you know where you are going, but gives them the opportunity to help you get there.

Learn how you can be the best wingman with our free How to be a Wingman guide! Be the trusted advisor your CEO needs.

managing the banking relationship

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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.

Learn how to apply concepts like this in your career with CFO Coaching.  Learn More

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!

analysis of customer profitability

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