There’s a way every business can be compared to others, in their industry, or sector for its efficiency.
Once a business employs 4 or more people, how efficient it is as it moves more into the management stage, can be measured with one often overlooked KPI.
This figure becomes very relevant over $700,000 revenue, when it can be used for comparisons of businesses – even from one service industry to another.
That figure is the Net Profit Margin.
It’s a figure that clearly needs far more attention in the business community - and that includes your own clients.
During more than 15 years of working with hundreds of different service and manufacturing businesses, with revenues from $700,000 to $20,000,000, while looking at their Profit & Loss Statements over a 3 year comparative time frame, these interesting facts came out…
- The Net Profit Margin was under 10% in 90% of all businesses
- The Net Profit Margin had decreased in 92% of businesses from year one to year three, irrespective of the revenue increasing or decreasing
- The majority of businesses had cash flow shortages regularly, unless/until the Net Profit Margin was above 15%
- There was no surplus cash for the business - unless the 15% figure had been exceeded
- Less than 12% of business owners knew what their business’ Operating or Net Profit Margin was when asked, or didn’t understand the terminology
- In nearly every case, those owners whose business Net Profit Margin was above 15% knew what the figure was
Also, business owners didn’t know if their figure was ‘good’ or how to go about increasing it, or that increasing it would increase their cash in the business bank account.
The majority of business owners when initially asked, ‘what do you want help with’ answered with ‘to increase sales.’
When queried further to ask why and to achieve what outcome, they replied with, ‘to increase cash flow.’
Less than 15% of owners understood that increasing cash flow is very different to increase cash in the bank levels.
An Opportunity for Your Firm to Help Your Business Clients
Simply ask your business clients if they understand what the Operating or Net Profit Margin for their business is and then if not, educate or explain what it is and why it’s important to focus on and look at every month and yearly.
This conversation can include what even fewer business owners understand and that is the effect on the Operating Profit Margin figure from a price rise.
Here’s a question to ask clients…
If the Operating Profit Margin is 4.5% and prices on everything are increased by 5%, what’s the new Operating Profit Margin, assuming no sales are lost and all other things are equal?
It’s an interesting question that stumps all but only a handful of business owners, and your own clients will probably be the same.
The answer is the Operating Profit Margin will increase to 9% (to save you reaching for a calculator).
That means the Net Profit doubled, from a small price rise (when the starting point is 4.5%). The increase varies from a 5% price rise, depending on the Net Profit Margin.
That result is quite extraordinary, yet so few struggling owners with low Net Profit Margin businesses would have any idea of those facts.
Increasing the Net Profit Margin is, I believe, the most important goal of a business, if/when the figure is below 15%.
Referring back to my list of facts again, 92% of businesses had a decrease of the Net Profit Margin over the 3 year time frame.
What that means is as the revenue increased, the available cash in the bank decreased.
And what that means is, to focus on increasing leads and sales as a way to increase cash in the bank is inefficient - for most businesses. Or not the smartest way to increase cash in the bank.
There are more strategies to increase it than just raising prices or reducing expenses too.
Some effective margin increasing strategies are;
- Running team meetings with all employees – this motivates them and helps to retain them
- Increase one’s attitude and aptitude skills with people, in order to accurately identify potentially poor performing staff - before hiring them and losing thousands in lost productivity income
- Hiring a teenager to do simple tasks, after asking all employees what simple tasks they would delegate if they had a choice
- Reduce the Acquisition Costs to ‘buy’ clients, by first of all measuring results of advertising, then testing more lead generation types
- Calculate the Cost Of Sale on every individual job with technical/income earner wages taken out to see gross profit margins. Share these with staff in weekly meetings to create accountability and ‘ownership’
- Introduce technical/income producing employee KPIs
- Invest in sales training, that includes how to answer the phone more professionally or face to face
- Introduce job descriptions to reduce ‘shared responsibility’ of tasks so the buck stops with one person
- Develop video induction systems for new employees. These have saved a week or two of new employee training time for the business owner
These are just some Net Profit Margin increasing strategies. Read this blog post to find out more.
Download a copy of Tim’s book LEVERAGE for more on increasing profit margins.
Tim Stokes
Author Bio: Tim Stokes is a 36 year experienced business owner and builder of 7 in service industries. In 1997 he began mentoring business owners in all aspects of business growth and lifestyle success with results published in national magazines. He’s no accountant, but he brings a fresh, very practical, intelligent point of view to growing businesses that his principal clients enjoy. He’s authored 12 books and The Academy of Business Mastery business management course with its systems and management tools. He’s respected for his contribution to clients of accounting firms who see the results. Tim believes the most important figure in businesses is the net profit percentage and specializes in increasing it with a full suite of time-proven strategies. Visit Tim's website to learn more about him.