By now, the economic roller coaster we’re on has probably got you scratching your head and wondering what to do next. Should you cut prices, reduce overhead, spend more on marketing, or lay off employees? Some changes are likely necessary, but before you implement anything drastic, let’s take a look at how a small change to each of the four main drivers of net profitability affects the bottom line.
Assume for a moment that you determine to make a small, 1% increase in total sales or sales price, or a 1% reduction to cost of goods sold or overhead expenses. (I discussed a similar “1% Solution” in the April 2006 issue.) Which of these four changes most affects the bottom line?
For a hypothetical $1 million company with a 30% margin and 12% net profit (see the “Current” column in the table below), the greatest improvement to the bottom line is an 8.33% increase that comes from raising prices by 1%. Next best is a 5.8% increase in net profit that comes from a 1% decrease in the cost of goods sold. Increased sales and reduced overhead together improve net profit by 4%. (Download the spreadsheet here.)
So far so good. But if you are thinking about making changes across the board, this is what I suggest:
Increase prices by 1%. This should be hardly noticeable if you focus on selling to client needs rather than wishes and dreams.
Put half of that 1% increase into better marketing, and vigorously track the results.
Decrease COGS so that slippage is less than 2%, then cut another 1% through better purchasing and subcontract controls.
Finally, cut overhead by 1%. If you can do that without sacrificing employees, do so.
Returning to our example, the far right column in the table shows more than a 15% increase in net profit after all of these changes have been made.
Not bad. You may have to repeat this exercise in the coming months to get through this difficult period. Good luck!
—Judith Miller is a Seattle–based remodeling business consultant and trainer specializing in accounting, finance, and computerization. Visit her at the Remodeling Online Blogs, or at http://remodelservices.wordpress.com. Download spreadsheet.