“I never lost money turning a profit.”
Bernard Baruch wrote that straightforward statement about the importance of making a profit. In order for any business to be healthy, it must have the best gross profit it can possibly achieve. Bottom line – it’s the number one thing that contributes to paying salaries, rent, marketing, and all the other activities involved in running a business. Yet, how many accountants even know what their gross profit percentage even is?
For definition purposes, Investopedia defines gross profit as “a company’s total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage.” So the Excel formula is (Sales-CGS)/Sales, which isn’t hard to calculate.
Let’s look at how businesses can find more gross profit, and the gross profit KPIs (Key Performance Indicators) to use to focus more on what really matters in business. (KPIs are explained in one of my previous articles.)
“Profit in business comes from repeat customers, customers that boast about your project or service, and that bring friends with them.”
W. Edwards Deming provided that elegant definition of the key elements needed to generate a profit. Whether you’re a start-up or larger company, happy customers bring others. So as an organization, how do you measure customer success? Here are some elements that can be evaluated on a daily basis, which is a key component of KPIs:
- Complaints not resolved in X hours
- Orders shipped on time
- Clients producing top 20% profit
- Number of client referrals
Act-On, creators of software that tracks a prospect’s behavior on a website, uses a business model to proactively engage with clients during the course of the year – they don’t wait until the contract renewal date to say hello. A great KPI measure for Act-On is the number of proactive touches it has with clients each month so they meet their goal for outstanding communication. Staying top of mind is huge in client relations.
I recently presented at a conference of Turfgrass Producers International. These businesses are regional and rely a great deal on customer and employee referrals in the communities they serve. Yet many weren’t tracking the critical KPI client referrals or new hire referrals. Showing pictures and getting quotes from happy staff and clients can add to your business.
“Business is all about solving people’s problems – at a profit.”
Author Paul Marsden made that enlightening statement. I recently ran an experiment in several LinkedIn Groups, including the QuickBooks and Business Coach LinkedIn group, and asked the following question: Are sales commissions a cost of goods sold or an operating expense? It was amazing to see the responses to this simple question. One side argued that sales commissions are a transaction cost, and thereby should be categorized as a cost of goods. The other side commented that commissions aren’t direct labor and materials used to produce the product, and therefore should be categorized as operating expenses, which is below gross profit on the financial statements.
In my opinion, I feel we need to make the financial statements more meaningful to the business owner and management team so they can make decisions that will have a positive impact on the company. If sales commission is a variable expense that can be easily calculated and measured, why not show it as part of cost of goods? If it explains better the profitability of the product, then that sounds like critical information to make a decision. Forget about GAAP for the minute and understand it’s OK to have financials that help managers better understand their business and another set that helps explain what happens to investors. Know your audience!
So by definition, gross profit measures how much you make on every sale. If you can split out your commission costs to employees and partners, why not reflect as a cost of goods. Recently, there was a call by the financial community for meaningful financial statements, so why not start there?
Sales Compensation Analytics
I conducted research on sales compensation analytics for QCommission (see Figure 1). The review included evaluating how companies tracked sales, cost of goods and variable sales compensation transactions, and the impact on gross profit. I found in looking at all the KPIs and dashboards available, the most meaningful KPIs used by business owners are the following:
- Product profitability
- Territory profitability
- Customer profitability
- Sales and profits per rep
Figure 1: Sales Compensation Analytics Control Panel
These are the critical elements that help a business manage on a daily basis for the success of the company.
I recently interviewed Chuck Moyer, who is the founder and president of Fat Margins, a business dedicated to helping owners increase their profit margins and build truly valuable businesses. He’s also the author of “Profit Margin Magic,” a ten-lesson, self-study program for business owners that teaches the principles discussed.
Chuck shared with me a great white paper he has written called “The 7 Profit Eating Myths That Are Costing You a Fortune Right Now.” In this free white paper, he shares some tips on how business owners can attract more profitable customers. Chuck noted, “Per the U.S. Dept. of Commerce, only 1 out of every 20 new businesses becomes profitable and survives 10 years. The cause of at least 80% of the failures is that businesses sold their products and services at prices that were too low to produce high enough profit margins.” He further explained, “Studies have proven that 92% of all businesses underprice their goods and services, even though price is a key determinate of profitability. A 1% increase in price will increase the company’s net income by a minimum of 11%.”
One of the other myths Chuck addresses is that not all customers are equally profitable. We all have clients in the service industry who are high maintenance and thereby eat into our profits. As a consulting business, you only have so much time to sell, so those who require more of it either should be charged more for it or at a higher rate to accommodate the extra hand-holding. The issue this raises is whether you’re tracking the profitability of your top 20 clients so you even know the changes over time.
Early in my career, I worked in broadcasting where we sold “time” to advertisers. Once past, time is gone, but each day is a present that should be highly valued and priced to maximize your time. This is particularly important in the service industry. So how about a KPI that also measures and values your personal time as a life-balance issue, such as number of times to the gym each week or hours volunteered in the community. It will help better define your true profit margin.
Free resources available include:
- Free KPI Assessment Form
- webKPI List of Top 100 KPIs
- Bernard Marr’s The 75 KPIs Every Manager Needs to Know
- KPI Library