The holiday season has past us again, and after family visits and turkey dinners, it’s time to be reflecting on last year’s performance and how to maintain or improve profitability. 2020 brings more challenges to Californian business owners:
- Minimum wage increases;
- New privacy laws for businesses operating in California;
- Assembly Bill 5: Status as Employee or Independent Contractor; and
- Employment Law changes covering such things as: Leave and Benefits; Discrimination and Harassment and Occupational Safety and Reporting.
As we asked last year, do you have a plan to measure your performance in 2020 against past years? Do you have a budget for this year? Have you reviewed how your performance was in 2019 against 2018? Have your business drivers changed at all? What was better and what was worse? What are the metrics that are meaningful to your business?
If you’re looking to improve the profitability and value of your business, there are two things you should consider:
If your business primarily sells products then we use this formula:
Gross Margin: Revenue – Cost of Goods Sold divided by Revenue
If your business is primarily a service business then we use this formula:
Operating Profit Margin: Revenue – Expenses divided by Revenue
The higher the percentage, the better the result. This is a key ratio used to measure business performance, and ultimately this will impact the value of your business too. More importantly, by comparing margins over several years you can evaluate the fluctuations and trends in profitability.
Improve Gross Margin
There are a number of ways to improve gross margin:
- Raise prices, if appropriate and it won’t negatively impact your overall sales. Inflation-adjusted increases are generally accepted without too much challenge and this could add 2-3% to your top line.
- Evaluate your business lines by profitability. If you have multiple product/service offerings evaluate each by gross margin, and if possible by historical gross margin trends. Which product line is adding to your business? What are the products or services dragging your performance?
- Can you renegotiate with your vendors? Do this when you understand the value of the vendor contract.
Of course, these actions are going to be tough if your suppliers are raising their prices or you’re on the receiving end of a vendor re-negotiation!
Manage Operating Expenses
Operating expenses are associated with the general running of your business. Controlling your operating expenses will help you improve your profit. Here are some areas to evaluate:
- Review your ongoing (forgotten) expenses. Do you have the best cellular and internet plans for your business? It’s amazing how willing the big carriers are in continuing promotional discounts in order to retain your business.
- Staffing: are your staffing levels and staff skill sets appropriate for your business? How can you ensure that your staff will improve their productivity? Investing in appropriate training courses can reap vast rewards for your business.
- Automation: How paper-based is your organization? There are now many no-code and low-code platforms that help you automate tasks. Spreadsheet.com is one of many platforms that turns spreadsheets into applications.
- Outsource functions: Can you outsource high cost non-core functions such as human resources, technology and finance? Could you use a lower cost state to remotely support your business?
- Risk Management: Risk management costs are an increasingly significant cost for California businesses. There are a number of different options worth considering to reduce your insurance costs including group collective and self-insurance.
Keep a Dashboard
Track your performance throughout 2020 against your previous year and budget targets. Ensure that you track the important metrics to your business whether it be sales growth, margin, employee turnover or customer satisfaction.
The better your understanding of your profit drivers, the better you’ll be able to maximize the value of your most valuable investment: your business. An example dashboard is provided below. For more information on financial dashboards please contact us.
Shannon Lowther, CFA, ASA, ABV, is managing partner with Bakersfield-based Central Pacific Valuation. She specializes in the valuation of businesses, business interests and intangible assets. Shannon can be reached here.