The pricing of products and services is vital to profit.
To ensure you achieve a profit, it’s vital to know the true cost of the product or service and keep an eye on it, to avoid ‘margin squeeze’. That is, you have to be aware that you don’t allow costs to rise without increasing prices, the business must not absorb extra cost.
Market forces have an effect on pricing, but it’s not viable to continually absorb cost increases without price increases. And, it’s not always necessary to increase everything.
For example, a client recently told me they hadn’t increased prices for years. We did some analysis to find out what were their best selling products. On each of these, we agreed to a small increase with no resistance from customers. A small regular price increase is much easier to achieve that irregular big ones. Most customers expect a CPI increase and, if it’s written into contracts, it’s much easier to achieve.
Understanding gross profit, labour and product costs
The costing of products and services is vital knowledge to work out gross profit.
Gross profit is the difference between revenue and costs and is an important benchmark. The cost of products may include the creation, importing, freight, packaging, labour, warehouse and raw materials.
The cost of jobs may include labour, materials and out of pocket expenses. If gross profit is below expectations, it may be necessary to assess how products and services are costed and acquired.
For example, we had a client in a wholesale business whose packaging was a large portion of costs. When we questioned their ability to negotiate a better price with the supplier, they said it wasn’t possible. We did some shopping around and found a supplier who offered a 10% reduction. The regular supplier soon agreed to a similar reduction.
Labour is another example of cost management on jobs. It’s often the case where chargeable labour spends time doing non chargeable work such as administration. If you take the number of people, and calculate the total hours spent on admin multiplied by their hourly charge out rate, it’s often the case that the cost of employing someone else to do it, is less than the missed income.
Managing your overheads
Overheads can get out of hand where there is no budgetary control.
Owners don’t always have time to keep an eye on what everyone is spending, or shop around for the best deal. A budget can be a saver as well as keeping your banker happy. Also, giving someone the task of shopping around for better deals on supplies can be a saver.
One overhead that can get out of hand is wages. Often in a growing business, staff are employed to meet demand, without proper job descriptions. To avoid this happening, an organisational chart can be useful for a growing business.
To create an organisation chart, begin by listing all tasks in the business, then list who currently does them. Any overlaps and gaps should become obvious and job descriptions can be realigned to suit.
This way, you will be employing the right people, with the right skills who can fill the gaps in your business. This means that the right people will be earning the right wage and, the business will be positioned to grow.
Collecting debts
Debt collection is an area that has blown out recently.
Dunn & Bradstreet recently reported that average collection days were 55.6 days. Compare this to your seven day terms to see and see what affect this is having on cash flow.
Always include a Terms of Trade with any quote and invoice, so your customers understand the expectation.
Your business should issue an invoice as soon as the product/service has been delivered, or get a deposit or progress payments. Then follow up smartly.
Email follow ups for small amounts and phone calls for large amounts. Keep good records of reasons/excuses for late payment and, agree to outstanding amounts being paid off in instalments over a period.
It’s always advisable to have a debt collection clause in your Terms of Trade. If it comes down to needing to collect an outstanding invoice, then ensure that your customer know when this will occur. Talk to a lawyer about include a debt collection clause in your Terms of Trade to ensure your business is protected from bad debt.
Don’t drain your cash flow!
Stock and jobs can be a huge drain on cash flow.
Think of stock as dollars piled up on the stock room floor, and jobs in progress as dollars on the work room floor.
It really pays to reduce the time stock sits in store and the time that jobs wait to be finished and invoiced.
Good records and planning are vital to management of both.
There are some cost effective online systems available that can save thousands of dollars in working capital requirement to fund stock and jobs. Try Unleashed Inventory Software and WorkflowMax Job Management Software, both of which link to Xero Online Accounting Software.
Slowing down payment to suppliers is often the last resort where there’s cash flow problems. Often, we see suppliers being paid too quickly or worse being overpaid. A close eye on this area can provide much needed cash.
Sue Hirst is the director of CFO On-Call, Financial Controllers, who provide small/medium businesses with the opportunity to use the on-site skills of ex-corporate finance managers on an on-call basis, without the normal high cost of hiring one full time.
