Managing For Better Profits

Thousands, maybe even tens of thousands, of businesses make a fatal error each year when it comes to managing the growth and ultimately profits of their business.

There are countless stories of companies, even great companies, growing themselves broke and eventually growing themselves out of business.

It might not seem very intuitive to grow yourself broke - but in reality it happens way too often.

Luckily, I learned this lesson in Graduate School through an incalculable number of hours of case study and indirect experience and have been fortunate enough to retain those lessons while growing our own businesses.

Here is what usually happens to many (way too many) businesses:

When a company first opens its door (or launches online) growth is slow. Sales are limited and usually profits are non-existent or below par. That is just a fact of business. To combat this, the business owner or manager works tirelessly to improve the situation via product improvement and cost controls and eventually finds the right mix of marketing, product development and services that resonates with their targeted market - resulting in (finally) increasing sales.

But, having gone through this process, focused only on ways to improve top lines sales while their businesses struggled early on, many business owners tend to retain that same myopic focus as the business starts to come into its own. Who can blame them as this new positive trend could reverse itself in the very near future as well as knowing that what they have been doing is really working.

But, focusing on sales only means taking their eyes away from profits and it is these profits that the business is ultimately after - the very thing that accounts for long-term business success. Increasing sales does not necessarily result in profits especially if the costs to garner those sales are also increasing or that the majority of sales result in accounts receivable and not cash. It is cash that is the blood of any business as it takes cash to pay suppliers, pay labor, improve products and other offerings as well as to continue to be in the top of the mind of current or prospective customers (called marketing).

Thus, many growing businesses find themselves with outstanding sales growth of 20%, 50% or even 100% every month or year yet just do not have the cash to meet current obligations. And, when current obligations are not being met - the business is in trouble.

Given that so many businesses fall into this trap, new entrepreneurs tend to take this phenomenon as a given and strive even harder to grow top lines sales - which just augments the problem. But, it does not have to be this way. This problem can be easily fixed by simply changing ones focus from top line sales to profits.

If you have ever sat down and studied an Income Statement, you realize that profits consist of more than just sales. Profits also relate to costs (both direct or variable costs related to providing the business's products and services as well as indirect or fixed costs related to the overall business operations). These costs play a huge in the profitability of the business.

In accounting and finance practice, these disciplines spend an inordinate amount of time focused on margins. Margins are essentially the relationship or ratio between objects (in this case between sales and costs). Example, if your business sells a product for $10 and it only takes $5 to make it - than your business has a gross margin of 50% for each item sold. But, what happens when your overall sales volume increases rapidly and you are still selling each product for $10 but due to increased costs (more material purchases, more labor hours, more related direct expense with the production) your cost for each product (its marginal costs) increases to $7.50 per item. Sales volume might be increasing but gross profits margins are tumbling.

Further, there are some businesses that can continue to make $5 in gross profit for every item sold and find ways to maintain those margins but drops the ball when it comes to its indirect or overhead expenses. These businesses see sales increasing and margins holding steady yet they still find themselves unable to meet current obligations. They have found that increased administrative costs like marketing and promotions are resulting in increased sales yet fail to realize that these increased costs (their margins per product sold) are outstripping any benefits of the increased sales - thus, their operating margins are outgrowing their gross margins.

A second issue that many failed businesses faced while their sales increased yet their companies declined is poor cash flow management. Found from studying the company's Balance Sheet. Profits equal cash on hand; cash to pay obligations and finance any sales growth. Yet, many sales these days result directly in accounts receivables. And, as a method of keeping customers happy and keeping sales growing, businesses find themselves offering or extending credit to their customers via accounts receivables (allowing customers 30, 60, 90 or more days to pay). However, in order to fulfill those customers' orders, the firm has to pay (and pay NOW) for the materials and the labor and the overhead. If these stakeholders (your labor or suppliers) are unwilling to wait until your customers pay you - your business could very quickly find itself short of cash and as stated here before - if your business can not meet its current obligations (regardless of what your sales are doing) it will find itself in deep trouble (these other stakeholders are also trying to manage for their own profits or cash flow and thus need your payments today).

Businesses that find themselves with growing sales but are not managing for their profits soon find themselves out of business with huge debts and nothing to show for all that effort.

Why is this important? First, some businesses combat increasing costs or lack of cash flow during these growth periods by taking on outside debt - either in the form of business loans, lines of credit or asset-based financing. However, given the current state of our economy and the financial/lending markets, this option may not be available to growing businesses already struggling with cash flow issues. Second, poor management is clearly defined by a single focus mentality - meaning that by not looking at and focusing on the entire business and its long-term potential may or may not result in short-term sales pops but will almost certainly results in that old saying - here today, gone tomorrow.

Just look at the banking industry of the last few years. Their focus shifted to easy, short-term gains in the subprime markets - taking their eyes off their long-term goals and plans. And, if it was not for government bailouts (they did not have the funds to lend to each other) many more of these banks and financial firms would have now been a thing of the past - not to mention that this entire industry was put in jeopardy for this short-sighted sales focus.

Think about it this way. Much better to turn down business (slowing down sales) and still make a healthy profit than it is to grow your business broke. I would rather make $10,000 per month in profit while holding my sales growth to 2% (what I could manage for and afford) than to grow sales at 50% and not be able to pay my employees. And, this could be accomplished by simply changing my focus from sales to profit (the business in general).

As a parting note - it is profits that help grow a business not sales (my business could sell half of what your business does but make twice the profit) and only profits (not sales) can be plowed back to take advantage of new opportunities, purchase the latest equipment or technology or even to be siphoned off to pay investors, debtors or owners.

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