4 little words that drive profits
(MoneyWatch) "It's the economy, stupid!" was the phrase that resounded coast-to-coast during the presidential election 20 years ago. It probably won Bill Clinton the Presidency.
The phrase, coined by Clinton campaign strategist James Carville, was originally intended only for members of Clinton's political team. The true power of these four words was not so much as a slogan, but rather their ability to focus every member and every aspect of the campaign.
"Interesting bit of history," you might say, "but how does this apply to running my business?" It cannot only apply to your business, but transform your bottom line. The trick is paraphrase Carville and say, "It's the margins, stupid!"
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What do you mean by margins?
Profit margins, and there are two of them to track. The first is your gross profit margin, and the second is your net profit margin.
Gross profit is kind of like a business' paycheck. The sales revenue represents the gross salary or wage amount. But the actual paycheck -- what is available to spend or save -- is quite a bit less. Just as an employee's take-home pay is lower after deductions such as taxes, insurance and FICA, a business' take-home pay is lower after direct costs are deducted. These direct costs are also called "cost of goods" (COGs) or "cost of sales" (COS).
Gross margin is the percentage of a company's gross profit (take-home pay) to sales. The formula looks like this:
Revenue minus COGS divided by Revenue = Gross Margin
Net Profit is the bottom line. It's what's left over after all the bills have been paid. Net profit margin is the percentage of that figure divided by sales. Here is the formula:
Net income divided by Revenue = Net Profit Margin
This detail is excruciating! I have a bookkeeper and an accountant to handle all this. Why should I, as a business owner, bother? Because...
Margins are your operational scorecard
By monitoring your margins, you can see where you are making money and where you are not. This transparency allows you to isolate your under- or over-performers and to spot trends. Tracking your margins can even alert you to possible theft or embezzlement. How can it do that? If prices and expenses stay the same but your margins are slipping, it is likely that someone is walking off with merchandise or money.
Un-managed margins will always erode from the pressure and on varying levels, such as competitive pricing, downstream cost increases, increased regulation and workforce expansion. Margins are maintained through operational efficiency. Margins are improved through operational excellence.
Margins are also volatile. Growth is not linear and margins are not static. Just as we strive to benefit from "economies of scale," we have to first pass through the "dis-economies of growth." Consider this: What happens when FedEx (FDX) gets another box after they've completely filled the plane? They have to put another plane in the air for that one box. That's an oversimplification, but you get the drift.
Focus, focus, focus
Profitability may be top-of-mind for you, but is it for your employees?
Profit funds raises, bonuses and benefits; it fuels opportunities; and when the economy is weak, profits safeguard jobs. Everyone benefits when a business is profitable.
You can get your employees to focus more on profitability in much the same way you do for sales and service. Show them what works by giving them the data behind it. Margins provide the perfect vehicle. You don't even need to share dollar figures -- just use percentages.
Here is a simple three-step process that's guaranteed to get results:
1) Incorporate and educate. Create the language.
2) Establish and regularly publish margins by division, location, job or responsibility
3) Celebrate heroes! Recognize and offer bonuses for cost savings and margin improvement. Here is a secret... recognition will drive this more than money.
It's what you keep that counts!
A business does not build wealth by sales alone. It's profit that flows from your income statement into the balance sheet, to reside happily in your asset column. It is there for you to invest, spend or squirrel away. Managing your margins forms the conduit. Getting your employees involved and invested turns on the power.
So repeat after me, "It's the margins, stupid!"
Readers, please use the comment section below to share your ideas for managing your margins.