The Essence of Strategy // The Essence of Profitability // The Essence of Marketing // The Essence of Funding // The Essence of Cash flow
Five by Five – Module 2
THE ESSENCE OF PROFITABILITY
Have you ever heard the phrase “running on the smell of an oily rag”?
The essence of profitability in a business is effective cost control.
Every dollar that goes into the costs of a business is a dollar that isn’t left
in the business as profit.
Think about it. If you can maintain your customer service levels and quality on 10% less costs, then all that saving will flow to your bottom line, otherwise known as profit. If you are able to procure stock in trade for lower costs, those savings will flow direct to your bottom line.
The flow of money into your business begins with payments from customers BUT the more that gets consumed with the expenses the less you will have left as profit. While it can be very nice to have new equipment and fittings in your business, you must remember that your business is not your home. At home you make things as comfortable as possible. In that environment you are a consumer. In a business, however, you are not in it for comfort and lifestyle. Your prime objective is to generate returns in profits and cash flow, which is why your attitude to cost must be entirely different.
Imagine all the hard work of getting a customer, convincing them that your product or service is what they want, and then finding that you make virtually nothing out of it! Many businesses end up in this position; we call it ‘profitless prosperity’! Making lots of sales, generating lots of activity, but with nothing to show for it at the end of the day. Sales increase but there never seems to be any additional money or profit left over.
This is the reason why cost control is absolutely essential, and a first step to obtaining business financial mastery. The key to mastering cost control is to understand the nature of the different types of costs (or expenses) in business.
There are basically two types of expenses in a business;
1. Expenses that vary with the volume of business and are known as VARIABLE.
2. Expenses that do not vary with the volume of business and are known as FIXED.
The essence of profitability in a business is effective cost control.
Every dollar that goes into the costs of a business is a dollar that isn’t left
in the business as profit.
Think about it. If you can maintain your customer service levels and quality on 10% less costs, then all that saving will flow to your bottom line, otherwise known as profit. If you are able to procure stock in trade for lower costs, those savings will flow direct to your bottom line.
The flow of money into your business begins with payments from customers BUT the more that gets consumed with the expenses the less you will have left as profit. While it can be very nice to have new equipment and fittings in your business, you must remember that your business is not your home. At home you make things as comfortable as possible. In that environment you are a consumer. In a business, however, you are not in it for comfort and lifestyle. Your prime objective is to generate returns in profits and cash flow, which is why your attitude to cost must be entirely different.
Imagine all the hard work of getting a customer, convincing them that your product or service is what they want, and then finding that you make virtually nothing out of it! Many businesses end up in this position; we call it ‘profitless prosperity’! Making lots of sales, generating lots of activity, but with nothing to show for it at the end of the day. Sales increase but there never seems to be any additional money or profit left over.
This is the reason why cost control is absolutely essential, and a first step to obtaining business financial mastery. The key to mastering cost control is to understand the nature of the different types of costs (or expenses) in business.
There are basically two types of expenses in a business;
1. Expenses that vary with the volume of business and are known as VARIABLE.
2. Expenses that do not vary with the volume of business and are known as FIXED.
VARIABLE EXPENSES
Key Definition: Variable expenses are expenses, which vary relative to sales volume, and so their key driver
is sales volume.
A variable expense example may be the cost of the product that you sell. For instance, if you are selling widgets in your business, then the more that you SELL, the higher the overall cost of the widgets will be that you BUY in order to sell them. You may be able to negotiate a lower cost per unit with higher volume but the total expenditure will vary with the volume.
Variable expenses are less dangerous in your business because they are only incurred when a sale is made. There is revenue directly associated with each variable expense, so in theory, there will always be the income to offset the expense.
is sales volume.
A variable expense example may be the cost of the product that you sell. For instance, if you are selling widgets in your business, then the more that you SELL, the higher the overall cost of the widgets will be that you BUY in order to sell them. You may be able to negotiate a lower cost per unit with higher volume but the total expenditure will vary with the volume.
Variable expenses are less dangerous in your business because they are only incurred when a sale is made. There is revenue directly associated with each variable expense, so in theory, there will always be the income to offset the expense.
FIXED EXPENSES
Key Definition: Fixed expenses are expenses that do not vary relative to sales volumes.
Fixed expenses occur whether or not you make a sale, and so are NOT driven by volume. A typical example of a fixed expense would be the rent on your business premises. The landlord will expect you to pay the rent whether you have made sales or not. Many landlords do have some understanding of business and may grant a rent-free period to a tenant when they first lease premises. However, there is no direct link between sales and rent.
Rent is a fixed expense and does not vary with sales.
There are different risks for variable expenses compared with fixed expenses. As a general rule, variable expenses are associated with getting product to customers. Often they form the COST of sales. As a result it is more risky to run these on “the smell of an oily rag” than fixed expenses, which are generally not associated directly with servicing customers. Whether you sit on a leather executive chair or an old apple box case will have little bearing on your customer’s experience, BUT it WILL have an effect on the profitability of your business.
Many opulent expenses are driven by lifestyle or comfort considerations rather than by sound business reasoning.
Make yourself a promise that you will leave your lifestyle and comfort requirements at home and bring your business mindset to your business dealings. Making good profits will allow you to have a better lifestyle AFTER making a success of your business and NOT before.
If you are starting in business after being an employee for many years do not expect the same conditions as when you were an employee. You will need to ‘tough it out’ while establishing your business, and if you push too much expense into the business at an early stage it will negatively affect its performance. Doing it a little tougher at the beginning will pay HUGE dividends in the long term and allow your business to be a success.
The biggest mistake to make is trying to look successful before you are successful and acting as though you are. Such pretense can only be sustained as long as you can borrow money BUT it will cripple you in the short term and possibly even be the cause of your business failing in
the long term.
The essence of profitability is effective cost control; maximising the gap between your income and your expenses.
Fixed expenses occur whether or not you make a sale, and so are NOT driven by volume. A typical example of a fixed expense would be the rent on your business premises. The landlord will expect you to pay the rent whether you have made sales or not. Many landlords do have some understanding of business and may grant a rent-free period to a tenant when they first lease premises. However, there is no direct link between sales and rent.
Rent is a fixed expense and does not vary with sales.
There are different risks for variable expenses compared with fixed expenses. As a general rule, variable expenses are associated with getting product to customers. Often they form the COST of sales. As a result it is more risky to run these on “the smell of an oily rag” than fixed expenses, which are generally not associated directly with servicing customers. Whether you sit on a leather executive chair or an old apple box case will have little bearing on your customer’s experience, BUT it WILL have an effect on the profitability of your business.
Many opulent expenses are driven by lifestyle or comfort considerations rather than by sound business reasoning.
Make yourself a promise that you will leave your lifestyle and comfort requirements at home and bring your business mindset to your business dealings. Making good profits will allow you to have a better lifestyle AFTER making a success of your business and NOT before.
If you are starting in business after being an employee for many years do not expect the same conditions as when you were an employee. You will need to ‘tough it out’ while establishing your business, and if you push too much expense into the business at an early stage it will negatively affect its performance. Doing it a little tougher at the beginning will pay HUGE dividends in the long term and allow your business to be a success.
The biggest mistake to make is trying to look successful before you are successful and acting as though you are. Such pretense can only be sustained as long as you can borrow money BUT it will cripple you in the short term and possibly even be the cause of your business failing in
the long term.
The essence of profitability is effective cost control; maximising the gap between your income and your expenses.