I recently attended a seminar which was mostly about marketing. The presenter informed the room that sales were the most important aspect of business. Of course, they were telling the room that because they were selling marketing services and had a vested interest in the crowd purchasing their marketing product.
Lead generation and sales is being pushed as a major business solution today because the advent of the internet created a whole new market and channel for the widespread distribution of cost effective marketing communications.
Technology mat have advanced and the tools by which we operate our businesses may have changed but economics has not.
Sales are a wonderful thing to have but they can be a misleading indicator of business performance. WHY?
Whenever you produce one economic unit of measured revenue there will also be a direct unit of cost that is necessarily incurred in order to make that unit of sale available for distribution to customers. In other words, the cost must be incurred in order to have something to sell. All businesses, product or service based have direct expenses.
When direct costs are subtracted from revenue you are left with value added revenue which is the true indicator of business performance because it represents revenue available to the business for indirect operating expenses and profit.
In order to gain a better understanding of this concept let’s look at an example that will demonstrate its importance.
Company A Company B
Sales 500,000 1,000,000
Direct Expenses 150,000 800,000
Value Added Revenue (Gross Profit) 350,000 70% 200,000 20%
Indirect expenses 150,000 150,000
Net Profit 200,000 40% 50,000 5%
Company A produces half of the revenue of company B however company A produces its product and or service for 30% of its sales price whereas company’s product or service consumes 80% of its sales price.
As you can see this results in company A actually makes more money than company B despite having a greater sales figure. Is company B a better business because its revenue is higher?
Generally speaking the higher the margin, you make per unit of sale the less your business will rely on sales volume to control its ability to cover expenses and make profit. This means that to a limited degree your business will be protected from shifts in market demand.
Imagine if company B blindly took the advice of someone instructing them to fix their financial performance by increasing sales alone. The problem this strategy causes is that the actual economic margin will not have changed and the profit would only increase by the temporary increase in sales volume. Without increased investment in capacity to service the increased sales volume from an operations, human resource and finance perspective the increase in sales may harm the business more than it would help it.
Let’s say Company B increased sales by 50%. As a result, they needed to employ an extra customer service representative ($60,000) and spent an additional $50,000 on administration and support services.
Direct Expenses 1,200,000
Value Added Revenue (Gross Profit) 300,000 20%
Indirect expenses 260,000
Net Profit 40,000 3%
Even though net profit has increased by $10,000 the increase in sales has caused a decrease in profitability to 3%.
This is an illustrated example that demonstrates that business decision making involves more than just sales. Any decision you make in your business must have a positive impact on your economic engine and it profitability not just its turnover.
Always be careful who you accept business advice from. Business is about profit and has the same economic formula as it did 50 years ago. Make sure you seek assistance from adequately qualified and experienced business professionals who can help you fine tune your economic engine.
If you need want to save time and get the help you need to increase your profitability then please contact us at [email protected]