There are five basic ways in which a firm can have a direct effect on its
profitability:
(article continued below ...)
1. Increasing sales volume. Increasing sales volume may appear to be an easy
way of increasing profitability, but this is not necessarily the case.
-
Selling more and more is not the key to increased profitability: profit
requires sales, but sales does not equal profit.
- If you increase your sales
volume, you must at the same time rigorously control costs, prices, capital
employed, and your product/service mix. Be sure that none of these four other
components of profitability increases disproportionately; if they do, increased
sales reduce instead of increase profit.
- Trying to increase your sales by
employing an additional sales rep or trading in a bigger geographic area only
produces more profit if the extra sales produce at least enough extra profit
(not revenue) to cover the extra costs.
- If you cut prices and margins to
generate more sales, you need to achieve a considerable increase in sales volume
- otherwise total revenue falls while costs remain the same.
- Increases in
small volume orders may hinder profitability instead of boosting it because of
inherent administrative costs such as invoicing and dispatching.
- If you
extend credit in order to encourage more sales, the company will have to bear
the costs - with a knock-on effect on profitability
- Selling more of all your
existing product/service lines or introducing new ones may increase your sales
volume, but be sure you know the contribution each line makes. Selling more of
loss-making lines is bad business unless it is necessary in order to raise sales
of profit making ones.
- In some circumstances you can increase profits by
reducing sales. Surveys have shown that a wholly disproportionate amount of cost
and effort is sometimes invested to achieve a small amount of sales revenue. It
is not uncommon to find that 50 percent of deliveries made account for only 15
percent of sales revenue. Or there's the 80/20 rule: 20 percent of your clients
account for 80 percent of your profits. Consider what would happen if you
reduced your sales by a selective 10 percent.
2. Reducing costs and/or ensuring that costs are fully recovered where this
has not previously been the case. Investigate and calculate your true costs in
total and for unit sales. You cannot adjust your costs in relation to other
parts of your business unless you know what they are. Consider the effects of
specific cost reductions carefully - arbitrary reductions may not produce the
desired results in the long term. Seek advice from your accountant, your
auditors, and your bank manager.
3. Improving the product mix
(varying the relationships between the volumes
of individual products or groups of products sold). Your product/service mix
reflects the combinations in which the products or services you provide are
sold. The mix is normally derived from a series of historical accidents rather
than from careful planning and analysis, and consequently it many not be as
profitable as it could be.
Examine each product you sell in terms of the costs attributable to it and
the net margin it makes. You may find that the products producing the highest
unit gross profit and making the highest percentage contribution to your sales
volume also attract a disproportionate amount of your selling costs.
You may find, for example, that you should aim to sell more of A and B, which
you have found to be profitable, to supply less of C and D, which are of limited
profitability, and to eliminate loss-making E and F from your sales portfolio.
Consider the impact this will have on the other four factors - for example, a
well-founded change in your product/service mix may lead to reduced volume of
sales but increase your profitability.
4. Raising prices selectively or
overall. Raising selling prices is a
potential route to increased profitability (or at least to maintaining the
current level of profitability when it might otherwise fall), but there are of
course pitfalls. Although customers may accept price increases if they are part
of a general price adjustment in your business sector (in which case you are
likely merely to maintain your overall level of profitability), raising prices
in isolation without losing business (and thereby risking reduced profits)
requires either a near monopoly, a vast difference between your products and
your competitors', or a carefully thought out and implemented policy and sales
strategy.
5. Reducing the capital employed in the
business. Obtaining a good return on
capital and reducing the capital tied up in your business normally improve
profitability. Identify the categories of capital employed in your business and
consider whether the following strategies can apply to any of them:
- Exercising tighter control of credit
- Reducing inventory levels
-
Introducing outsourcing or expanding its scope
- Exploiting information and
telecommunications technologies more fully
A change in any one of these affects the others. Any change, made or planned,
voluntary or involuntary, must therefore be considered in the context of all
others; changes made in isolation may not have the expected impact on
profitability
======
