In the next in our series of articles on how to improve your cashflow we take a look at margins, and how simply understanding them better, and focusing on them more regularly will have a knock on effect on improving your cashflow.
Simply monitoring and understanding the margins in your business will ensure you ask better questions about your cashflow performance. And as we all know, when we ask better questions, we get better answers and make better decisions – it’s a virtuous circle.
So, let’s look at a real life example of a business we saw very recently. The business owner came to us saying that he wasn’t sure if he should keep going, that times were tough, and while it felt like he was getting busier and busier, and working harder and harder, that he never seemed to have anything to show for it. He was forever having to keep a tight eye on the cash to see who and what he could afford to pay and in his words ‘robbing Peter to pay Paul’, with never enough left over to bring home. He was even considering taking out expensive credit cards ‘just to get through’ but was thankfully sensible enough to realise that this strategy could be the start of a viscous downward spiral.
But in other ways business seemed to be going really well – he felt that there was something there worth salvaging and asked for our help to better understand his position and help him make a decision about the future of the business.
We started by taking a very top line look at his accounts and noticed that over the last three years, while his sales had increased, his net profit margin had halved!
So, if you look at this in numbers… If his sales had been £150,000 and his net profit margin 20% (in this example we’re talking about a sole trade business, so the owner’s take home pay needs to come out of any available net profit) or £30,000 in the first year we looked at. Then two years later while he had successfully grown the business by 20% – which most would see as a significant accomplishment – the net margin had fallen to 10%… or £18,000.
As the realisation that he was being a busy fool (his words not mine) sank in, we turned to strategies to address the situation, and thankfully there are many… Here are the top three we looked at, and actually when we say top three, they are all completely interconnected:
First and foremost we agreed that there needed to be a price increase.
But, as is often the case, it’s more complex than that.
Through conversation we realised, that as jobs got larger and more complex, there was a limiting belief around what was a fair price to charge was, and on occasion fees were being reduced simply because the person quoting thought that it sounded far too high to them.
First action – cost all jobs correctly and no discounts.
We also realised that while hours being paid to freelancers had increased dramatically, freelancer hours charged on to clients had not seen a comparative increase. Now, outsourcing to freelancers and subcontractors is a great way to build and grow a business, but the real beauty of using a resource like this should be the flexibility it allows, the expertise it brings, as well as the fact that they should be considered a direct cost of sales rather than an unchanging overhead.
Second action – ensure all freelancer hours possible are charged on.
Furthermore, when a job is costed we agreed to set a freelancer time budget at the outset (even involve them in the costing), as we all know that work expands to fit the time available, and if someone is being paid by the hour where is the incentive to get something done quickly?
Relating to both points above we also agreed that a better understanding of the breakeven point in the business was required, not just annually, but broken down to monthly, weekly, even daily numbers so that everyone was clear on what was required in order to make this business work. And what’s more the desired sole trader take home pay (and including any tax liability) should be worked into this breakeven point to ensure this was achieved. From this we can then set margin targets per job and have something to monitor, evaluate and improve.
Third action – understand the numbers and set appropriate targets.
Naturally we also touched on the fear that if we increased the prices too much, then customers would leave. So I pointed out, that even if margins were back at 20%, and he increased his prices by just 10%, we could afford for 33% of the customers to leave without having any impact on the profit position. Moreover, at a 20% margin, with a 20% price increase, he could afford to lose HALF of his customers before starting to make a dint in the profit.
Have a look at our video below if you’d like to understand more about the impact of price increases and discounting on your margins and cashflow…
Now, I don’t know about you, but we both decided that we would rather take that risk and do a lot less work for the same amount of money, safe in the knowledge that it wouldn’t be 50% of the client base who would leave, and those that did would invariably be the ones who cause the most trouble!
Forth action – be confident!
So, from wondering whether he should go looking for a job, we are now very excited about what the future may hold…
What actions could you be taking in your business to improve your margins and better manage your cashflow??
Any thoughts, questions or comments as always will be gratefully received via any of our social channels, phone, email, or of course via the website contact us page – we look forward to hearing from you!