It goes without saying that continuously improving profitability in a business is key to its sustainability. In South Africa, some 80% of small businesses fail within the first three years. Various factors contribute to this failure rate, but in business terms the final nail in the coffin is a continued lack of profit.
Fortunately there are ways to improve profitability. Whether you are starting out or have an established business, consider implementing some of the below strategies. It will serve you well to do this exercise annually to ensure profitability remains centre stage.
1. Always Have a Budget
A budget is a financial roadmap. Always create a budget detailing the expected income and expenses ahead of a new financial year. This will allow a business to plan how much money it has available to spend on things like advertising and salaries, while at the same time providing a concrete revenue number to work towards in order to cover all these expenses. Without a budget, a business is operating in the dark, which is arguably not the best recipe for success.
2. Keep Business and Personal Finances Separate
Most business owners intend to grow their business. Growth requires money. If you are constantly dipping into the business’s bank account to pay school fees or fund a weekend away with friends, there will not be much left to reinvest in the business. Using a business account as a personal account also complicates accounting for business expenses. Rather pay yourself a salary (based on your personal spending plan) and finance your personal life from your personal account.
3. Know the Input Costs and Which Products Drive Profitability
The cost of sales is arguably one of the most important numbers in a business as it determines how much money is left over to cover operating expenses. Remember to consider all costs related to selling a product in this calculation, including freight and shipping charges, storage and other direct costs.
Once a business knows what it costs to sell each product, it will be able to determine the profitability of individual products. Consider strategies to increase sales of the most profitable products and review the viability of less profitable products.
4. Set Appropriate Prices for Products and Services
If you have a clear idea of revenue and costs (including your required salary), you will be able to set informed prices. Be sure to set prices that cover all the costs and reflect the value of a product or service. To do the latter, you should also know how much time you spend on bringing a product to the market or delivering a service to a client. This calculator is a useful tool for service providers to determine viable rates for their services (it is aimed at freelancers but many of the same considerations apply).
Knowing the numbers will also allow you to evaluate the potential of discount pricing strategies. Offering new or existing customers a discount can be an effective way to improve sales. However, it is not wise to implement such strategies if it will ultimately damage profit margins.
5. Know What You Are Paying For
Always know what the business is paying for. Know which expenses are paid monthly and exactly what once-off payments are for. What is the business paying in bank fees and is this the most affordable package? Is the insurance still suitable? When hiring a venue for an event, what is included in the fee and will additional expenses be required? Do not get caught out by hidden fees and add-ons.
6. Keep Your Customers Happy
It is cheaper to sell to existing customers instead of new ones. Firstly, a business saves time and marketing expenses if it does not constantly have to find new customers to replace old customers; and secondly, happy customers are more likely to recommend the business. Word-of-mouth is the most powerful marketing tool. Always deliver a great product and service to give loyal customers a reason to talk about your business.
7. Be Selective with Your Customers and Partners
Not all customers are good for business. Unfortunately, some customers are slow payers (or do not pay at all), while others can damage a brand and put off the type of customer a business actually wants to attract. Trust your gut and do not be afraid to show away someone you suspect might be a problematic customer.
The same applies to potential business partners. The entrepreneurial journey is a lonely, at times overwhelming one. Do not join forces with someone simply because you are tired of travelling alone. Be sure that the venture will truly benefit the business.
8. Pace Your Growth
Growth is exciting and flattering. All small businesses want to be in the position where they need to take on more staff or expand their product range. Be mindful though of growing too quickly. A small business should only take on more responsibilities if it is able to execute its current responsibilities excellently all the time. If a business is fraying at the edges when it is still small, it will not be able to deliver the required service level when it expands.
9. Carefully Manage Inventory Levels
Inventory management can be a tricky affair. It is tempting to maximise economies of scale when producing a product. However, the cost of carrying an inflated inventory might wipe out the additional margin a business makes by lowering production costs. It might also leave the business in a position where it has to reduce prices or write off obsolete stock. On the other hand, sales might be lost if there is insufficient inventory available to fulfil orders. As with all other business functions, knowing the numbers is key. It is imperative to know how long it takes to obtain more stock and how many units your business is likely to sell in this period.
10. Use Technology Suited to Current Operations
Most applications have different packages to suit every level of business. Sign up for a package that meets the business’s current needs and upgrade once it has outgrown the offering. Do not fall for the bells and whistles of the full package when they are not yet needed. Also consider free options, especially when a business is starting out.
11. Outsource Where Possible
One of the advantages of our online world is that various experts are always at one’s fingertips. Consider outsourcing administrative functions to free up time to focus on doing what you do best in the business. There are instances when appointing a team member full-time makes more sense, but it is generally more efficient for small businesses to outsource.
The same argument applies to assets. A co-working space might suit a business’s needs better than a fixed office rental, and renting a delivery vehicle for occasional deliveries can be more cost-effective than buying one.
12. Invest in Your Team
Every employee is a potential sales representative, regardless of their official role. If you treat employees fairly and with respect, educate them in your strategy and philosophy, and reward them in a manner they value, they are more likely to brag about the business. They will also be more likely to be sensitive to business expenses and take initiative when costs need to be reduced.
13. Implement Expense Claim Policies
Establishing rules limiting employees’ travel, entertainment and other business expenses might seem counterintuitive in light of the previous point about investing in the team. However, employees benefit from having clear guidelines about which business expenses will be reimbursed. It also prevents an unhappy situation where one employee always claims more than others. In terms of team morale, it is best not to have grey areas around reimbursable business expenses. At the same, it will increase profit if unnecessary expenses are eliminated.
14. Pay on Time to Avoid Penalties (And Institute Penalties on Late Payment)
A penalty on late payment is one of the most infuriating expenses, especially when it could have been avoided by better internal controls. Late payments often occur because of poor accounts payable management and belated regulatory submissions, e.g. VAT and tax. Never pay more than is necessary.
At the same time, consider instituting late payment penalties on invoices issued by the business. Late payment is a massive problem for small businesses in South Africa. Levying penalties on slow payers is not a fool proof solution, but it might encourage some customers to pay quicker.
15. Leverage VAT Registration
In South Africa, businesses can voluntarily register for VAT if their turnover was or is expected to be over R50 000 in a given 12-month period. Registration is compulsory if turnover exceeds R1 million in the same period.
VAT registration can be used in certain cases to improve profitability. For example, if all suppliers and customers are VAT registered and a business has a high cost of sales, it should generally benefit from registering voluntarily before turnover exceeds R1 million. However, a more service-oriented business with little input costs should usually delay registration until it is compulsory.
Bear in mind that a business has to submit VAT returns every two months once registered for VAT. In addition to the added administrative burden and accounting expense to prepare the VAT return, a business will face penalties should it submit a return late. It is therefore important to only register for VAT voluntarily if it is certain to improve profitability.
Bonus: Ditch the Guilt When Making Business Decisions
This is the single most important tweak that will increase the profitability of a business and is especially relevant to women. Whether you feel guilty about charging the fee you deserve or saying no to a toxic customer or employee, you are directly affecting the business’s bottom line. Your business’s profitability ultimately depends on you. Do not expect someone else to make the difficult decisions for you, and do not feel bad for being brave enough to make them.
There are always ways to increase profit in a business. Some strategies are easier to implement than others, but all rely on having a thorough understanding of the numbers and processes in the business. Contact us if you need help getting a clear view of your finances and strategy.