Making your biz a profit centre (II)
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- Category: SME toolkit
- Written by with Bridget Olotu
- Hits: 1410
What this piece seeks to do for micro business units (MBUs), small and medium enterprises (SMEs), home-office business owners (HOBOs), community-based organisations (CBOs) and cooperative groups in Nigeria is to develop in the operators a profitability mentality in the running of their various enterprises.
I want to challenge you small business to dream and work yourself out of that financial misery. If you are in business, the business must be able to take care of you. This is because there is opportunity cost for your time, money and other resources. Ability to distinguish between what contribution and profit are can change the financial picture of your business and make you more determined and focused to run a profitable business as a reward for your time, efforts and resources.
Contribution is the difference between selling price and variable costs. If Adamu sells a Golf car for N350,000 in a month and the cost of the car is N250,000, there are other fixed costs like rent, insurance, telephone, administrative expenses, salaries and so on before he can finally decide what his profit is. So it is wrong for him or someone else to declare that he made N100,000 as profit. If his monthly rent is N15,000, insurance per vehicle is N5,000, telephone bills is N5,000, salaries for himself and security guard on a monthly basis is N45,000, monthly administrative expenses are N10,000, then the profit is (Contribution – fixed costs), that is, (N100,000 – N90,000). The monthly profit for such a sale is N10,000. Now, if this business continues to perform like this for the next 12 months, then, he would be making N120,000 profit per annum. Depending on his vision for the business, this profit level for such a business is very low.
Another example: I once lived with an enterprising Aunt several years ago who was a big-time trader. She was a dealer/wholesaler of a popular soft drink. Every two weeks, the soft drinks company supplied her with a lorry-load of the product and after two weeks, she sells off everything to her numerous retailers. But she wasn’t really making money like that from the business. As at then, she was making N100 on each crate of soft drinks times the number of crates on each lorry. She could only get by as a result of volume sales and turnover rate of soft drinks sold every two weeks. However, her retailers were making more money on each crate. Now, they too determined their take-home by the number of bottles they sold to their customers. My Aunty had a truck she used for the business. She had a driver and a driver’s boy who supplied these drinks to her retailers. She paid them on a monthly basis. She fuelled the truck and took care of the maintenance costs and other fixed costs of the business. However, she succeeded in that business because she capitalised on volume sales and turnover rate, which was selling 2 lorry-loads of soft drinks every month and having a ready market for the soft drinks. To increase her profit in business, she diverted some of her funds into selling of eggs. She supplied eggs to many retailers in that community where lived at that time. She had numerous customers buying her eggs. She also was into several other businesses that brought in steady cash flow to the business.
Making your business a profit centre
Business owners and financial managers will monitor the profitability of a business very carefully because profit is seen as the most important performance indicator in businesses. To measure one’s profitability in business, the following methods are adopted.
1. Profit margins.
This is one way of measuring profit and it is done by calculating profit as a proportion of turnover, usually as a percentage. It is used to compare the performance of a business in different periods when turnover changes or performance of different sized businesses. There are two common profit margins.
Gross profit margin.
This is the amount of profit a business makes after direct costs have been subtracted from the turnover (sales). It is therefore represented as Gross Profit = turnover – cost of sales. It is the profit before overheads (indirect costs) are subtracted. For a retailer, gross profit would be turnover minus the cost of buying goods for resale. For a manufacturer, it would be turnover minus the costs of raw materials, components and direct labour. The Gross Profit Margin or Mark-Up is the gross profit expressed as Gross Profit divided by turnover times 100.
Net profit Margin.
This is the amount of profit after all costs have been subtracted from turnover (sales). It is calculated as Net Profit = gross profit – overheads or turnover – cost of sales – overheads. The net profit margin is expressed as a percentage of turnover. The net profit shows how effectively a business has controlled its overheads and its cost of sales. It can be calculated as Net Profit divided by turnover times 100.
2. Return on capital.
Capital is the money invested in a business by the owners. The return on capital is the amount of profit expressed as a percentage of the capital invested in a business. Owners can use this to measure how well their investment in the business is doing. It can be expressed as Return on Capital = Net Profit divided by capital times 100.
When comparing profit measures, it’s important to compare similar businesses. The profit margins and returns on capital may vary from industry to industry and from business to business. Fair comparisons can only be made between businesses if they operate in the same industry and have the same characteristics.
Increasing profit in your business
In business books, we are taught that profit can be made on two levels: raising prices and lowering costs. So to increase your profit in business, you can do the following:
1. Raise your prices.
Your business will get more revenue for every unit sold and if costs remain the same, then profit should improve. However, demand for your products can also fall as a result of increase in prices. Except of course, your product has inelastic demand for it. That is, increase in price does little or nothing to the demand.
2. Reduce costs.
You can also make more profit by reducing your direct and indirect costs. This can be through using existing resources more efficiently and buying cheaper resources. Other things to also do to increase profit might include:
3. Increasing the volume of sales.
Many low margin businesses will do better when they increase their volume of sales. For instance, when the guy who sells razor blades locates his business close to abattoirs and restaurants where razor blades are used to shorn slaughtered animals, his sales will increase and then profit will also increase if the cost remains the same. Adamu, for instance, will also make more profit on the car business if he sells more cars every month. If his costs remain the same, his profit will also improve.
4. Locate a niche market.
A niche market is a market in which a limited and clearly defined range of products is sold to a specific group of customers. Niche markets can make business owners rich. If you supply bags of flour to bakeries, sell your ice-block products to soft drink sellers and large quantity users of that product, you are in a way selling to niche markets. So, discover the niche market for your business rather than just selling to everybody.
5. Diversify your business and increase more revenue channels.
My Aunt did that. She diversified into selling of eggs and other products. This increased her revenue channels, and as her costs remained a bit constant, she made more profit for herself.
6. Invest idle funds.
Don’t keep idle funds as a business owner. While it is important to keep cash for transactionary and precautionary purposes, it is also important to invest your idle funds in liquid or near liquid investments.
7. Change your business.
If your business is a low margin business or a declining business in a dead industry like typewriter and allied businesses, then change your business.
8. Locate high profit margin businesses and start there.
Look around to see what business other people are in that provides them with enough cash and profit to pay for their overheads, take care of themselves and the business and leave some profit for the future. You don’t necessarily have to start big doing this business. You can start from the lowest entry point. Just make sure there is a huge market for the new business.
Business is not just an art (involving people-management skills), it is a science. You need to know what you are doing, have facts to support the reason you should remain in a business and carry out, from time to time, market analysis to determine whether your business is profitable or not and what you should do to make it profitable or whether you should quit entirely and divert your time, money and other resources into something else.
(Concluded)
Articles
Making your biz a profit centre (II)
Category: SME toolkit Written by with Bridget Olotu Hits: 1410
What this piece seeks to do for micro business units (MBUs), small and medium enterprises (SMEs), home-office business owners (HOBOs), community-based organisations (CBOs) and cooperative groups in Nigeria is to develop in the operators a profitability mentality in the running of their various enterprises.
I want to challenge you small business to dream and work yourself out of that financial misery. If you are in business, the business must be able to take care of you. This is because there is opportunity cost for your time, money and other resources. Ability to distinguish between what contribution and profit are can change the financial picture of your business and make you more determined and focused to run a profitable business as a reward for your time, efforts and resources.
Contribution is the difference between selling price and variable costs. If Adamu sells a Golf car for N350,000 in a month and the cost of the car is N250,000, there are other fixed costs like rent, insurance, telephone, administrative expenses, salaries and so on before he can finally decide what his profit is. So it is wrong for him or someone else to declare that he made N100,000 as profit. If his monthly rent is N15,000, insurance per vehicle is N5,000, telephone bills is N5,000, salaries for himself and security guard on a monthly basis is N45,000, monthly administrative expenses are N10,000, then the profit is (Contribution – fixed costs), that is, (N100,000 – N90,000). The monthly profit for such a sale is N10,000. Now, if this business continues to perform like this for the next 12 months, then, he would be making N120,000 profit per annum. Depending on his vision for the business, this profit level for such a business is very low.
Another example: I once lived with an enterprising Aunt several years ago who was a big-time trader. She was a dealer/wholesaler of a popular soft drink. Every two weeks, the soft drinks company supplied her with a lorry-load of the product and after two weeks, she sells off everything to her numerous retailers. But she wasn’t really making money like that from the business. As at then, she was making N100 on each crate of soft drinks times the number of crates on each lorry. She could only get by as a result of volume sales and turnover rate of soft drinks sold every two weeks. However, her retailers were making more money on each crate. Now, they too determined their take-home by the number of bottles they sold to their customers. My Aunty had a truck she used for the business. She had a driver and a driver’s boy who supplied these drinks to her retailers. She paid them on a monthly basis. She fuelled the truck and took care of the maintenance costs and other fixed costs of the business. However, she succeeded in that business because she capitalised on volume sales and turnover rate, which was selling 2 lorry-loads of soft drinks every month and having a ready market for the soft drinks. To increase her profit in business, she diverted some of her funds into selling of eggs. She supplied eggs to many retailers in that community where lived at that time. She had numerous customers buying her eggs. She also was into several other businesses that brought in steady cash flow to the business.
Making your business a profit centre
Business owners and financial managers will monitor the profitability of a business very carefully because profit is seen as the most important performance indicator in businesses. To measure one’s profitability in business, the following methods are adopted.
1. Profit margins.
This is one way of measuring profit and it is done by calculating profit as a proportion of turnover, usually as a percentage. It is used to compare the performance of a business in different periods when turnover changes or performance of different sized businesses. There are two common profit margins.
Gross profit margin.
This is the amount of profit a business makes after direct costs have been subtracted from the turnover (sales). It is therefore represented as Gross Profit = turnover – cost of sales. It is the profit before overheads (indirect costs) are subtracted. For a retailer, gross profit would be turnover minus the cost of buying goods for resale. For a manufacturer, it would be turnover minus the costs of raw materials, components and direct labour. The Gross Profit Margin or Mark-Up is the gross profit expressed as Gross Profit divided by turnover times 100.
Net profit Margin.
This is the amount of profit after all costs have been subtracted from turnover (sales). It is calculated as Net Profit = gross profit – overheads or turnover – cost of sales – overheads. The net profit margin is expressed as a percentage of turnover. The net profit shows how effectively a business has controlled its overheads and its cost of sales. It can be calculated as Net Profit divided by turnover times 100.
2. Return on capital.
Capital is the money invested in a business by the owners. The return on capital is the amount of profit expressed as a percentage of the capital invested in a business. Owners can use this to measure how well their investment in the business is doing. It can be expressed as Return on Capital = Net Profit divided by capital times 100.
When comparing profit measures, it’s important to compare similar businesses. The profit margins and returns on capital may vary from industry to industry and from business to business. Fair comparisons can only be made between businesses if they operate in the same industry and have the same characteristics.
Increasing profit in your business
In business books, we are taught that profit can be made on two levels: raising prices and lowering costs. So to increase your profit in business, you can do the following:
1. Raise your prices.
Your business will get more revenue for every unit sold and if costs remain the same, then profit should improve. However, demand for your products can also fall as a result of increase in prices. Except of course, your product has inelastic demand for it. That is, increase in price does little or nothing to the demand.
2. Reduce costs.
You can also make more profit by reducing your direct and indirect costs. This can be through using existing resources more efficiently and buying cheaper resources. Other things to also do to increase profit might include:
3. Increasing the volume of sales.
Many low margin businesses will do better when they increase their volume of sales. For instance, when the guy who sells razor blades locates his business close to abattoirs and restaurants where razor blades are used to shorn slaughtered animals, his sales will increase and then profit will also increase if the cost remains the same. Adamu, for instance, will also make more profit on the car business if he sells more cars every month. If his costs remain the same, his profit will also improve.
4. Locate a niche market.
A niche market is a market in which a limited and clearly defined range of products is sold to a specific group of customers. Niche markets can make business owners rich. If you supply bags of flour to bakeries, sell your ice-block products to soft drink sellers and large quantity users of that product, you are in a way selling to niche markets. So, discover the niche market for your business rather than just selling to everybody.
5. Diversify your business and increase more revenue channels.
My Aunt did that. She diversified into selling of eggs and other products. This increased her revenue channels, and as her costs remained a bit constant, she made more profit for herself.
6. Invest idle funds.
Don’t keep idle funds as a business owner. While it is important to keep cash for transactionary and precautionary purposes, it is also important to invest your idle funds in liquid or near liquid investments.
7. Change your business.
If your business is a low margin business or a declining business in a dead industry like typewriter and allied businesses, then change your business.
8. Locate high profit margin businesses and start there.
Look around to see what business other people are in that provides them with enough cash and profit to pay for their overheads, take care of themselves and the business and leave some profit for the future. You don’t necessarily have to start big doing this business. You can start from the lowest entry point. Just make sure there is a huge market for the new business.
Business is not just an art (involving people-management skills), it is a science. You need to know what you are doing, have facts to support the reason you should remain in a business and carry out, from time to time, market analysis to determine whether your business is profitable or not and what you should do to make it profitable or whether you should quit entirely and divert your time, money and other resources into something else.
(Concluded)