If your profit margins are slim, you may need to give your business the adrenaline boost it needs.
Most, if not all, owners want their businesses to perform spectacularly, so they focus on sales. However, owners should also focus on increasing profits.
Let’s take you on a deep dive into our five profit-maximizing strategies.
You’ll not only learn how to maximize profits but also be given practical steps along the way that you can begin implementing today in your company.
You can jump to any one of these following strategies:
Determine What You Want Your Gross Margin to Be
Implement a Pay-For-Performance Plan
Know Your True Costs
How to Calculate Operating Costs & Increase Cash Flow
What goes into generating a single dollar of revenue in your business? Can you accurately define your true operating costs?
So often, we’ve heard owners say, “I take my material cost and multiply by X, then multiply my direct labor costs by Y, and that’s how I price.”
When asked where they came up with that formula, we normally hear: “It’s always been that way,” “It’s how my dad taught me,” or “It’s the only way I know how.”
Here is the simple truth about writing a quote. Before you put pen to paper, you NEED to know your exact cost to operate, overhead, labor efficiency, equipment utilization, and desired incremental profit.
Understanding your true operating costs will allow you to set realistic pricing in your bids, estimates, and quotes. Without it, you could be seriously underbidding your products and services, with disastrous results.
Fully Burdened Labor Rate
To better understand your true operating costs, start by calculating your fully burdened labor rate, or the total amount, per hour, of what it costs to run your business.
To figure out your fully burdened labor rate, take the sum of an employee’s given salary, overhead, selling, general and administrative expenses (SG&A), and any miscellaneous expenses, and divide that by the total hours worked.
Fully Burdened Labor Rate = (salary + overhead + SGA + misc. expenses) Total hours worked
Let’s put this in practice. Laborer A works 2,000 hours yearly and is salaried at $30 an hour.
Beyond salary, it costs $6 an hour for union benefits, $2 an hour for supervisor labor, and $12 an hour for corporate overhead, including insurance, rent, utilities, and other related expenses.
($30 + $6 + $2 + $12)2000= 2.5%)
We then calculate the costs for selling, general, and administrative expenses (SG&A). Take that number and divide it by the total number of hours a year and the hourly rate to determine the true hourly cost to run the business.
If you’re paying your admins $16 an hour or your machine shop guys $30 an hour, and you think that’s your true operating cost, you are making a mistake. If you think your true operating costs are their salaries plus their benefits, you’re still making a mistake.
Factor in your indirect costs, your SG&A, and your overhead, and every single penny that it costs to run your business effectively!
Years ago, American Management Services worked with a privately owned plumbing contractor in the Mid-Atlantic States, who was doing about $7.5MM, annually.
The client had no cash, a maxed-out line of credit, and the more work he did, the more money he lost. It was a clear indication, to our analysts, that he had no control over his labor and cost.
One of the first things we did was gain a complete understanding of what it cost the client to run their business, by the hour and by man, and determined that he was underpricing his services by about 20%!
We couldn’t go back and undo the contracts he had already bid on or the ones already in process. So we put in an interim, one-time incentive plan for his employees and sub-contractors to bring the projects under budget. Every hour that was under budget negated incremental losses and generated incremental profit.
We made sure that going forward his pricing would be 20% higher. Despite his initial hesitation, thinking he’d lose business with this massive change, he was quickly relieved to discover his win rate was not affected. His original pricing was so rock-bottom that the 20% shift did not affect his competitiveness.
We determined his fully burdened labor rate by calculating hourly rates for employees, inclusive of vacation time, insurance benefits, and taxes. Next, we analyzed employee productivity; how many hours were paid versus how many hours were productive.
It was an aggressive, intensive, and fun project that, two years later, saw his line of credit paid off. $7.5MM in annual revenue became about $8.5MM, and profits were over $500K a year.
Whether you are a $300MM operation with all the fancy ERP systems in the world, or a $7.5MM plumbing contractor working off Excel spreadsheets, understanding your true costs will allow you to:
• Quote better
• Control operations better
• Improve margins
• Improve profits
Determine Your Gross Margin
After you’ve established your true operating costs, you should determine your gross margin.
Let’s say that after calculating your true costs, and factoring in your SG&A and overhead, it amounts to 15% of every dollar of revenue generated. If you want to make a net seven percent profit, your gross profit has to be seven points higher than your SG&A.
That means you have to price the net at 22% gross profit; if your SG&A is 30% and you want to net a seven percent net profit, then your gross profit needs to be at least 37%.
Once you have your true costs, and they’re broken down between fixed, variable, and direct and indirect costs, then you’ll know how to reach your gross profit because it should be tied to what you want your net profit to be!
Please be careful not to confuse gross profit with gross margin. Gross profit is money left over after costs are deducted from sales. Gross margin, represented as a percentage, is the profit earned for every dollar of sales.
It should not be guesswork and assuming there will be profit for every sale never works.
Manage Your Business Properly
Manage by the numbers
Years ago, we worked with a commercial printer that was doing about $16MM to $17MM a year and was run by three siblings. Though the business was never extraordinarily profitable, cash flow was beginning to tighten.
The owners would regularly show up late for work, take three-day weekends, and play golf two to three days per week. They managed their business as if it were a self-sufficient machine, in which employees simply “did what they were supposed to,” sales grew on trees, and their customers kept coming back.
Comfort became complacency as the business atrophied from lack of direction, growth, and productivity. Competitors began picking off customers. Employees left due to a lack of direction, career growth, and opportunity. And it wasn’t long before the business closed its doors for good.
A $16MM organization became a vacant building in less than four years.
We wish we had met those three a year or two earlier to stop the slide.
If you’re too comfortable with the current state of productivity, sales, and cash flow, you might be headed into rocky territory. We believe no one should ever feel too comfortable.
Be honest with yourself. Are you complacent? Complacency is the mark of death for all business owners and entrepreneurs, and it’s imperative that you—Mr. or Ms. Owner—start addressing the issues before they spiral out of control. Here are some options:
- Ensure individual employees have specific KPIs
- Install a solid line of authority and approved processes
- Develop a focused business plan that everyone follows
- Stop paying commission
Ensure Individual Employees Have Specific KPIs
Everyone responsible for the sales target needs to have some sort of individual expectations. This allows you to track their progress more closely.
Start making cash flow forecasting part of your daily routine, and make adjustments accordingly.
By comparing and adjusting your cash flow forecasts to projections, you will be able to:
- Detect early warnings of a cash flow problem
- Ensure you can pay employees, suppliers, and vendors on time
- Keep track of customers who are behind on payments, and
- Make your business more adaptable to changes in your market
Giving staff a specific plan, target, and responsibilities lets them have a clear understanding of what is expected, and shows them where they can improve to help the overall sales goals.
Having a great year is fantastic, but a great year of companywide growth that tracks profits per employee ensures that you are getting a return on your biggest investments–your staff!
Solid Line of Authority and Approved Processes
Establish the proper channels for making financial decisions, from the sales department generating proposals to approving purchases for office supplies; make sure you are actively involved with these decisions.
Develop a Focused Business Plan That Everyone Follows
We’ve always been a proponent of having a living, breathing business plan, ensuring that everyone within your organization is well aware of it and understands its necessity. A business plan is the soul of your company. It establishes how the cash going in and out of your business is used to grow and secure your organization.
Every dollar of revenue should generate a commensurate percent of profits. As the owner, you must determine if you are getting enough pennies out of each dollar!
Boost Employee Motivation
With the implementation of pay-for-performance, consider paying staff for their contributions to the collected gross profit.
You’ll find that your team will become less complacent and more motivated to continue billing customers to ensure invoices are paid on time.
As the owner, you have every right to optimize your sales efforts to motivate staff and increase profits morally!
Hold Your People Accountable & Teach Them How To Execute
Everyone, from the owner down to the person mopping the floors, has to be held accountable for executing your plan and gross margin strategy.
This means knowing the financial state of the business at any given time and holding every department accountable to frequent reports and KPIs.
This includes:
- Installing a Pre-Determined Profit Plan
- Pushing Your Sales Team
- Protecting Your Assets
Install a Pre-Determined Profit Plan
Carving out a Pre-Determined Profit Plan (PDP) can transform how your business performs.
Our philosophy of pre-determined profit focuses on a profits-first strategy which is 110% opposite of a residual budgeting approach.
As opposed to collecting profits after paying all expenses, we focus on taking out profits first and then adjusting budgets accordingly to ensure all expenses are covered.
This can help fund a Pay-for-Performance plan, but we’ll dig into what that means just below.
Push Your Sales Team
The difference between succeeding and going under depends on how committed is your sales team.
If your business doesn’t have a disciplined and accountable sales program, it will be inconsistent in good times and could dwindle or fail in bad ones.
Instill persistence and professionalism, and stay on top of the numbers weekly.
Remember: You are only as good as your sales personnel!
Protect Your Assets
When we say ‘assets,’ we’re not just talking about your employees. Implement non-compete and non-disclosure agreements to protect your organization.
What’s preventing your sales team from jumping ship with crucial information meant to maintain your operation?
A good example of this was a past client of ours. We worked with a $16MM printing company in Delaware that was losing money for years.
At the time, the owners weren’t focused on sales, and 90 percent of their customers communicated with the inside sales support staff. Within two months of making the owners go on sales calls with their field reps and meeting with people in person, they were profitable.
After we left the project, the owners slipped back into their old ways. They let their sales reps in the field handle everything. They stopped talking to customers directly, and when two sales reps left, they took top customers with them.
Sales dropped 50 percent, and the company went bankrupt within a year.
Non-disclosure and non-competes protect your business from rogue employees starting their own business or working for the competition.
Sit down with a lawyer to get this implemented right as soon as possible if you haven’t yet!
Solid Line of Authority and Approved Processes
Establish the proper channels for making financial decisions, from the sales department generating proposals to approving purchases for office supplies; make sure you are actively involved with these decisions.
Implement Pay-For-Performance Plan
Anyone who has followed us on social media, or read any of our previous articles, has undoubtedly heard us preach how undeniably effective a “Pay-for-Performance (PFP) Strategy.”
A great example of this is illustrated in an email from our client. They confirmed how this strategy drastically impacted the performance of his organization:
“I spent this week handing out our Third PFP Check. We hit our target [in the] 2nd, 3rd, and 4th quarters. Our revenue last month was $560K, with a $150K profit making it our best winter in a long time.
“We paid out 44k to our employees with this PFP (4th Quarter), and it gives me great joy to use the PFP check as not only a thank you but as a motivational opportunity that we can do more.
“I can’t tell you how much I appreciate you for making me a better manager, sharper money man, and better leader.”
No Performance Pay, No Motivation
Before working with American Management Services, our client had virtually no cash reserves and barely broke even the year before after a history of losses. They owed back taxes to the IRS and state government, and the bank was pulling their line of credit.
The three things this client had going for them was their steady backlog of business, including some service contracts in hand, some uncollected accounts receivable, and a fantastic desire to be a champion.
There were little to no expectations for their employees, with many workers “flying by the seat of their pants” with their daily tasks. Needless to say, there was no performance-based compensation plan to motivate them. Ownership had potential, but they lacked the training to effectively manage the business.
Pay-For-Performance Strategies
The first step was to build a viable financial plan. Based on the various operational and organizational improvements, we implemented these strategies accordingly during the project’s life. We then carved out a PDP, this being the owners’ return on investment.
Any profit generated above the PDP level, or second-tier profit, would be put back into the business. This would help fund the Pay-for-Performance plan (PFP). In this case, 50% of the second tier was used to fund the PFP pool, which included ownership. This meant they, too, had the motivation to keep up with the program.
Once we had a targeted financial goal, we then reviewed each person’s contribution to that overall goal and created KPIs to measure them and a tracking tool to help the grading process.
A Share System
We then set up a “share” system where every employee-owned at least one share of the PFP pool. We then sat with each employee individually to discuss the respected value of their shares.
Once the final profit and loss statement for a period was reported, ownership would calculate the funding to the pool and each grade the employees made against their KPIs.
- If Employee A met all four goals, they would receive 100% of their share value
- If Employee B met three of the four goals, then they would receive 75% of their share value
From there, we would calculate each payment, using a calculator tool we created for them, and pay out against the plan. To protect ownership, we always reserved a portion of the earnings to protect against poor performance in later quarters. So, this way, profits from Q1 would offset a poor Q2.
We’ve found that most successful businesses always have a performance-based pay structure that encourages improved performance. A PFP plan is a must if you want to get the maximum effort out of your employees. For them to excel, they need to know what’s in it for them.
Our best advice to an owner who is just starting a Pay-For-Performance plan:
- Let your employees know that the way to make great money is to help the business make great money
- There is nothing wrong with setting clear and concise expectations
- Make sure these expectations are measurable and use that to drive the PFP plan
- If the business succeeds, then everyone should succeed, but the business comes first
- A well-founded PFP is key to ensuring the business reaches its minimal profit potential and that ownership, as well as the employees, are rewarded for exceeding that level
- Test your new PFP over at least two quarters before rolling it out
- Don’t confuse communication-based sales representatives as a PFP plan
- Don’t be afraid to ask for help from an advisor when developing a PFP plan
Remember To Hold Yourself Accountable
Here’s a bonus tip before you leave: None of these strategies will work if you don’t hold yourself accountable.
This is the most important part of maximizing profit. You can follow the strategies laid out above to a T, but if you don’t hold yourself to the degree of scrutiny that you hold your key people to, your efforts will amount to nothing.
This means setting clear goals and working diligently to meet them. Only by holding yourself accountable can you hope to achieve your full potential as a business owner.
If you’re not willing to do that, then you’re not committed to maximizing profits. So ask yourself: are you willing to do what it takes?
