By Ed Rappuhn – SCORE Nashville
“Our revenue is increasing, but our profit is declining. What’s going on?”
Let’s look at your expenses in four ways:
Direct expenses are directly related to your product or service and include materials and labor. These increase with each sale. Negotiate with vendors to receive volume discounts. These costs should track with increasing sales resulting in greater profits.
Fixed expenses occur regardless of sales volume – think rent, utilities, salaries, etc. Do you really need fancy offices and top-end company vehicles? For many entrepreneurs, private office space is a luxury. There are numerous options for shared office space. You can schedule meeting rooms, receive mail and even share secretarial support for considerably less than leasing your own office and hiring a full-time secretary. A nice late-model, pre-owned vehicle is more than sufficient for almost all business purposes. Review all you fixed expenses.
Step expenses occur with growth. They can include fixed and variable expenses. Say you own a bakery producing at full capacity. If you want to sell more baked goods you need another oven and more employees. If you expand, profit margins will decline until you cover your new expenses. If you don’t expand, increasing prices or decreasing expenses is the only way to increase profitability.
Semi-variable expenses include advertising, travel and entertainment, convention attendance, etc. Spending here hopefully results in increased sales. There is a correlation between these expenses and revenue, albeit a delayed one. Control these expenses by looking at measurable results whenever possible.
Advertising rarely yields immediate results. It takes time to catch attention and cause action. On the other hand, if you have been using a certain method of advertising for six months and customers never mention the ads, it might be time to switch strategies.
First-class travel rarely, if ever, increases sales. Many successful companies have a policy of sharing hotel rooms. Even if that’s not your cup of tea, you can still cut expenses by staying in nice, limited-service hotels instead of 5-star, full-service hotels.
Consider attending conventions and networking in the exhibit hall and breakout sessions. Rent a hospitality suite one evening for your better customers and prospects. This personal touch may be more impressive than expensive booth space in the middle of dozens (or hundreds) of others.
Think of expenses this way. If you stay in a $600 hotel room vs. a $200 room for three nights, you have spent $1,200 more than necessary. Assuming a 40% profit margin, you need $3,000 in additional sales just to pay for the fancy hotel. That applies to all of your discretionary spending. Yes, you need to spend money to make money, but you don’t need to waste money. I’d rather take my share of the profits and go on a nice family vacation.
Ed Rappuhn is a mentor, workshop facilitator, and the past-chair of SCORE Nashville. SCORE mentors guide entrepreneurs in starting and growing their businesses. Sign up for a free SCORE mentor, find out about our reasonably priced workshops and other services, or volunteer to become a SCORE member at www.scorenashville.org. Email questions about your business to email@example.com watch for the answers in future columns.