Increasing sales, decreasing expenses and losing profits
November 6, 2006
Imagine your financial statements say that a department or even worse, your company, is unprofitable. The first thing that usually comes to mind is to decrease overhead - cut salaries.
This is the expedient solution. However, many times it isn't the right one.
Sometimes the right solution is to determine how to increase sales rather than to decrease overhead. If you've cut all you can, the only answer is to increase sales.
Here's why cutting overhead usually isn't the answer. Most people assume that cutting overhead will dramatically increase the bottom line, but as your company reaches a certain size, it won't. The best thing to do is to calculate Ruth's Rule No. 2:
To determine your break-even point:
Overhead divided by gross margin = sales
Here's an example:
A company currently has overhead of $500,000 per year and a gross margin of 40 percent. It decides that it needs to cut overhead and fires an office person which saves the company $40,000 (including taxes).
What is the decrease in sales experienced by cutting that person?
Before the cut: break-even sales = 500,000/0.4 = $1.25 million
After the cut: break-even sales = 460,000/0.4 = $1.15 million
So, by cutting that one person, the break-even point of the company only decreased by $100,000.
Hopefully this shows you that cutting a person isn't always the right choice. Other employees have to do this person's work. That may result in overtime and fears that the company is not doing well. Some employees may leave.
However, some overhead expenses can always be cut. Ask your employees. They know where the waste is. Ask the question: How can we decrease overhead by $100 per month?
If five employees have an answer, that will result in $6,000 per year added to your bottom line.
Too muchNow here's a question: Is increasing sales good?
I'll bet most of you said "yes" to yourselves when you read that question. However, the real answer is "It depends." Here's why.
Many years ago, I worked with a contractor who continually increased sales from year to year. He was happy with the growth of his business and he always had cash in the bank. He reached about $2 million in sales and growth stopped. All of a sudden, he could no longer pay his bills and he was struggling.
That's where I came in. An analysis of his business showed that he was actually losing 5 cents for every dollar that came in the door. How can you do that? It's easy if you don't track your inventory, estimate jobs costs, track your jobs and bill everything, or rely on your accountants to do your tax returns and give them insufficient and inaccurate data.
Here's another reason that increasing sales might not be good: If you have to increase overhead dramatically to improve sales, it might make your company have an end-year loss.
A break-even analysis at the new overhead level is critical.
Those of you in what I call "no man's land" (revenues between $800,000 and $1.2 million or $3.5 million and $4.5 million) have a tougher time because your sales volume usually doesn't justify your overhead cost at such revenue levels. You have to grow. When you do, you'll usually see higher net profits.
If you are running a profitable business with accurate financial statements, know your break-even point at different sales volumes and know that your company really is profitable, then increasing sales can be good.
Stop the vanity"Volume is vanity, profits are sanity" was a statement made a few years ago by a presenter at a Heating, Airconditioning, Refrigeration Distributors International conference that I attended. It has stuck with me ever since. One of your goals this year might be to keep the same level of sales and increase profitability by 5 percent. Increasing your bottom line will take work. It is much easier to increase sales - the simplest way is to just raise prices.
What if an increase in sales is justified? Insurance rates have risen, your employees want raises, gasoline prices are high. Those situations do justify price hikes. However, what if a new, experienced, lower-priced competitor is in your market? The company is targeting your customers. Yes, they will increase their prices once their base has been established. However, this won't happen for at least two years. What do you do?
First, you have to sell your company's services. Remind customers that for the high-quality service expected, extremely low prices are not possible. Second, look at increasing productivity at the same sales level.
For those of you who have the luxury of increasing prices and productivity, your bottom line should look wonderful at the end of this year.