Moving ahead
There comes a happy stage for most entrepreneurs when the grinding and grubbing eases off. You’re past the break-even stage, you’re profitable and you can start to focus your mind on what else you might achieve.
At its basic level, you might decide that all you want is to provide yourself with a good income and your ambition is limited to maximising the income, not just in the short term but for the future too. But for others, income maximisation is not sufficient. Instead, you can see opportunities to transform yourself from a small business into a larger business. You may even decide that you want to go for growth in a major way, ending up with looking to obtain a quote on one of the stock markets – the growth of the Alternative Investment Market (AIM) has been a huge success for the stock market, and more than 3,000 companies have raised money on it. After all, there are businesses in the FTSE-100 that 20 or 30 years ago were still small. And ironically some of the companies with major stock market values are not huge at all but are valued very highly by investors. Companies may have relatively small revenues, may still be unprofitable but are nevertheless worth millions because of their perceived potential by stock market investors.
Generating large capital values from a business that you start is a roller- coaster, and many businesses lose their founders along the way. Someone else with different management skills may be needed to take up the challenge on your behalf. What you want to achieve is to maximise the value that you can obtain for your efforts.
What is in this chapter?
How to increase profits
The billion-dollar question is: ‘How can I increase my profits?’ The whole of this book should help you to do so: the sections on how to set up your business in the most efficient manner and those on how to plan and control your business, how to increase your sales and how to manage the workplace properly. All of these can help you to make bigger profits.
However, if you strip running a business down to bare essentials, there are three main ways to make bigger profits. The first two methods are what you would use for the short term; they apply particularly if you are struggling to reach break-even point. But any well-run business should constantly be on the lookout for the sort of improvement you can make. The two methods are cutting costs and increasing prices.
The third way of increasing profits will take longer to achieve the desired result. It is selling more. It will also, very often, involve you in spending more money to carry it out.
The quickest way of selling more is to try to sell more to your existing customers. This implies that your existing customers are happy with your service or product. That is the first step – focusing on and improving the quality of what you do already. Selling more may require greater investments in promotion or selling effort, but obviously your aim should be to make the existing levels of investment work more effectively for you.
You should not overlook the few occasions when you can increase profits by altering your sales mix; it may even mean selling less. This may occur if you have a range of products, one or more of which does not cover its costs. The answer: rationalise your product line. An investigation of your customers may reveal that some of the very small ones do not buy sufficient quantity to cover the cost of selling to them. This may also lead to the conclusion that selling less means higher profits. There may also be the odd occasion when you can alter your sales mix by introducing a product on which there is no profit but that improves your overall profits. For example, a loss leader encourages more purchases of higher-priced products and increases total profits.
In the longer run, there are two more moves that can result in your business showing more profits. You can sell:
- The same product, but to new markets.
- A new product to new or existing markets.
Both of these may involve substantial investment by your business (see Chapter 14, ‘Building customer relationships’). If so, you cannot undertake these until you are past the break-even point and generating profits from the existing products and market.
Cutting costs
This is the most effective way in the short term of increasing your profits and the top priority in a recession if your bottom line is being squeezed (see Example 1). You should get into the habit of thinking how many extra sales you have to make to pay for an increase in costs. For example, if your product sells for £100 and your costs for each product are £50, this means that every time you spend an extra £1,000 in your business, you have to sell another 20 of your product to stand still in terms of profit.
The best way of keeping an eye on costs is to have very strict cash control and to carry out regular audits of costs. Do not necessarily assume that because you looked at the costs last month you will not be able to find room for cutting now. Use the audit checklist to go through all the cost areas. Look at each item afresh and ignore history.
Example 1
Jason Bottomley has a web site selling specialised fridge magnets. He is currently making profits of £15,000, but he does not regard this as sufficient to give him a comfortable living. He wants to increase his profits. His forecast sales and costs look like this:
| Sales | £120,000 |
| less direct costs | £60,000 |
| Gross margin | £60,000 |
| less overheads | £45,000 |
| Net profit | £15,000 |
Jason wants to look at how his profit would be affected if he could cut either his direct costs by 10 per cent or his indirect costs (or overheads) by the same amount. It would look like this:
| Cut direct costs by 10 per cent | Cut indirec costs by 10 per cent | ||
| Sales | £120,000 | £120,000 | |
| less direct costs | £54,000 | £60,000 | |
| Gross margin | £66,000 | £60,000 | |
| less overheads | £45,000 | £40,500 | |
| Net profit | £21,000 | £19,500 |
This shows that if Jason could cut direct costs by 10 per cent, his profit would increase by 40 per cent; if he could cut overheads by 10 per cent, profit would increase by 30 per cent. In fact, he estimates that every time he manages to cut both direct and indirect costs by only 1 per cent he would have more than £1,000 extra income. Quite small cuts can lead to a big jump in income.
Checklist
- Raw materials: are there any alternative suppliers who are cheaper for the same quality and delivery? Can you renegotiate your existing terms from your present supplier? Everything is negotiable and is worth trying.
- Stocks: this ties up cash, which means bigger interest charges at the bank. Can you keep lower stocks by organising yourself more efficiently?
- Efficient systems: are all repeated jobs standardised in your business? For example, if you have to do a lot of quotes, is there a standard form that simply needs filling in? Or are you drawing up a fresh form each time you quote? Does this apply in all business areas, financial, production and personnel, as well as selling?
- The range of products: is the gross margin you get on each product satisfactory? Does one product require a much greater share of overheads than others? If you stopped selling or manufacturing one of your products, what effect would it have on costs and profit?
- Customers and suppliers: are your customers taking too long to pay? And are you paying your suppliers too promptly? If you’re doing either of these, you are using up cash you do not need to. This means either extra interest charges on your overdraft or less interest because you have less on deposit.
- Number of employees: your payroll has the extraordinary ability to mushroom with sales; this includes not only staff directly involved in production or manufacture but also administrative staff, the so-called overheads. The trick is to keep the same number of employees while achieving higher sales. Can you improve their productivity?
- Payroll costs: what you pay for staff is not just their salary and benefits. You also have to pay employer’s National Insurance. If a pay rise is due, would your employees consider accepting extra contributions to a pension arrangement or childcare vouchers instead? You do not pay National Insurance on this form of ‘pay’, and it’s tax-efficient for the employee too.
- The right person for the job: a lot of time and money is wasted recruiting, training and subsequently dismissing unsuitable staff. Putting a lot of effort into finding the right people in the first place, and not just grabbing what pops up, can be cost-saving.
- Your own time: managing your own time better can save money too. Try to sort out some system of priorities in jobs to be done. There are quite a range of time-planning software systems available. See if you can find one that suits you.
Increasing prices
There is no automatic link between prices and costs. This means you do not need to feel uncomfortable about raising your prices, even if you have not had an increase in costs. And quite small increases in price can lead to a big jump in profits. Example 2 demonstrates how effective a price rise can be.
Real life is not as simple as this. Increasing your prices could lead to a fall in sales volume if you are operating in a price-conscious market. This is one of the reasons why you should think carefully about creating some sort of image or impression for your product (see p. 121), such as high quality or good service, so that the sales of your product are not so price-sensitive. To sell on the basis of price alone is a dangerous strategy (see p. 181).
Example 2
Jason looks at the effect of increasing his prices by 5 per cent all round. His new forecast looks like this:
| Sales | £126,000 |
| less direct costs | £60,000 |
| Gross margin | £66,000 |
| less overheads | £45,000 |
| Net profit | £21,000 |
Jason can get an increase of 40 per cent in his profits for a 5 per cent price increase.
Checklist
- Discounts: try to avoid giving discounts, or if you are giving quantity discounts, make sure you stick to the quantity set. It can be very tempting if you are competing head-on with a competitor to try to win the sale by offering a discount. Keep your nerve and try to emphasise the benefits of your product or service.
- Payment discounts: do you give a discount for your customers paying by a certain date? Have your customers started to take the discount whether paying by that date or not? Is the discount too big? Do you need it at all, or could you achieve the same effect by better chasing?
- Price discrimination: can you divide your customers into distinct groups and charge some groups a higher price than others for a slightly different product? Chapter 15, ‘How to set a price’ has more about price discrimination (p. 189).
- Better-quality product: is there scope to upgrade your product with some improvements? Can you charge a higher price to give a better margin?
- Inflation: adjust your prices to allow for the effects of inflation.
- Contracts: try including price escalation clauses in your terms and conditions for any product you are selling.
- Minimum order: Is it too low? Small orders can take as much time to administer and carry out as large ones, so see if you can set your minimum order at a level that ensures it is at least making a contribution.
Selling more
The third way in which you can increase your profits is to sell more of your products or service (see Example 3 below). This is the most difficult to achieve, and the results will not show up in the short term; however, potentially increasing your sales gives the greatest increase in profits of the three. You are unlikely to be able to double your prices or halve your costs, but you might be able to double the amount you sell.
Your first approach should be to try to sell more of the same products to the same market. You will already have invested time and money in researching this market and refining your product to meet customer needs, so the extra investment needed may be minimal.
You can increase your sales by more effective promotion or better selling. The one method of trying to increase your sales that you should avoid like the plague is cutting your prices. This achieves little except starting a price war because your competitors feel forced to follow suit, and putting pressure on your profit margins and your own profit level.
Cutting prices can increase your profits only if the increase in volume generated is enough to offset the smaller profit you make on each item sold. This could apply only in markets that are very price-sensitive; and in this sort of market, cutting prices is most likely to lead to severe price competition. Think twice before you act.
Example 3
Jason looks at the figures on the assumption that he could increase the amount he sells by 5 per cent, while keeping prices and overheads the same:
| Sales | £126,000 |
| less direct costs | £63,000 |
| Gross margin | £63,000 |
| less overheads | £45,000 |
| Net profit | £18,000 |
Jason finds that a 5 per cent increase in the volume of the sales means a 20 per cent increase in his profits.
Checklist
- Image: have you thought clearly about how your product is positioned? Can it be differentiated more from your competitors’ products?
- Advertising: are you aiming your message in the right place? Are you getting as much press and social media coverage as you could? Is your advertising consistent with the style of your product?
- Selling: have you clearly articulated your benefits? Have you prepared a detailed analysis of how your product compares with competitors? Have you developed proper scripts, either for person-to-person selling or telephone selling? Are you following up all leads, pursuing leads to turn them into quotes and converting quotes to orders? Prepare a breakdown of sales statistics, of conversion from leads to quotes to orders and analyse where you are going wrong.
- Remember: increasing sales means increasing working capital, so your business may need more finance.
Doing all three
In practice, you will try to do all three at the same time: cut costs, increase prices and sell more. It is astonishing the effect that very small across-the-board improvements can have on your profit (see Example 4 below).
Example 4
Jason thinks that he could manage small improvements in all areas by cutting costs by 1 per cent, increasing prices by 1 per cent, and increasing amount of sales by 1 per cent. Doing all three would have this impact on profits:
| Sales | £122,412 |
| less direct costs | £59,400 |
| Gross margin | £63,012 |
| less overheads | £44,550 |
| Net profit | £18,462 |
This means an increase in profits of 23 per cent and gives Jason an extra income of £3,462. The moral is never to despise small improvements. They can transform your profit.
Going for growth
Growth businesses are the cream. There are several subtle differences between the growth companies and the rest. What marks them out?
The motivation of the entrepreneur, the team leader, is what drives the business. If you are looking at your business solely to provide you with an income, you’re unlikely to have the oomph to push the enterprise into fast growth. The same consideration applies if you have set up your own business because you prefer the lifestyle with its attendant freedom and options to that of being an employee in someone else’s company. To make a success of founding a growth business, a driving force is likely to be that you have the ambition of wealth. You want to make yourself financially independent; you want to give yourself that quantity of ‘drop dead’ money (that is, to know you’re financially so secure that you can tell someone to drop dead if you are so minded!).
Without this extra ingredient, the determination to create wealth, there may not be enough motivation to push the business into the highest level of growth. Fast growth is uncomfortable and painful. It creates pressure points and stresses internally. It often requires an unreasonable owner to dragoon unwilling employees to produce the impossible. If your aspiration is simply to create a good lifestyle for yourself, you’re unlikely to have the necessary drive to grow a business quickly.
Requirements for a fast-growing business
How do you make your business fast-growing? It’s possible to identify a number of key requirements. First, the quality of the management is crucial – and that means you and your team. You need to have the character to lead your team; you need a broad set of business skills, including sales and marketing, often gained through management experience in a large company, and the ambition to grow fast. A good education, often a higher-level qualification, may also help. Masters degree courses in entrepreneurship are becoming increasingly popular at business schools in the UK. If you have already run and sold a successful business, this will give you a head start for two reasons: you’re more experienced and less likely to make mistakes, and you may have finance available.
Your team needs to be balanced: there needs to be someone who is skilled in finance and accounting, someone in marketing and sales, someone in production and so on. And it makes sense for the team to be offered incentives based on growth, such as share options.
As for the business, it is also possible to identify some factors that contribute to growth. Businesses that select a well-defined market opportunity, frequently a market niche, will find that their salespeople are knocking at a door already ajar. Beware the product that is unique but that as yet has no clearly defined customer base. People must want to buy your product.
It is important to develop a culture within your enterprise that focuses on product quality and customer satisfaction. It can make your whole business much more confident to know that you are selling a product that people hold in high regard and that customers are satisfied. It can be very demoralising for employees to deal with dissatisfied customers.
Businesses that are technology-based and that are constantly striving to introduce efficiencies through the clever use of technology will also have a head start on the fast-growth route. Innovative businesses, which have a competitive advantage, can also make larger strides than the average company, as long as the product is one the consumer wants to know about. Finally, many fast-growth businesses are also exporters. If you have a product with global demand, the potential market is larger.
Phase 2 money
Going for growth usually means raising more money. Not always. You may have created that elixir of business, a cash-generative model, and be able to fund your own expansion with your own resources.
In most cases, to expand you will need to raise outside money. Chapter 23, ‘Raising the money’, explains some of the ways you can do this. But Phase 2 money is likely to be different in that it is likely to be substantially more, come from outside sources and be risk capital rather than loans.
However, longer-term loans from your bank could provide the development capital you need for expansion. So revisit your bank manager armed with your essential business plan and forecasts.
But many businesses will be looking to raise risk capital from outside investors in exchange for shares in your company. The size you are now considering may be outside the scope of business angels or crowdfunding. So your choices may be to approach a venture capital organisation or a venture capital trust to raise development capital. Or to consider a stock market flotation.
The advantage of going to the stock market is that it enables investors to buy and sell their shares. This also means that it allows you the opportunity to expand your business by buying other companies in exchange for shares. Once your shares are publicly traded, your company should be valued higher than it would be if it were still a private company (but this is not always the case).
Which stock market?
There are several stock markets. The main London stock market is probably the least suitable. Unless you would be valued at a reasonable amount, £200 million say, small companies get lost and overlooked in favour of the blue chips. The London Stock Exchange* also operates Techmark – a subgroup of companies within the main market. It includes established companies in high-tech industries, such as computers, software, telecommunications and biotechnology. There is also a facility for relatively new, fast-growing companies to join Techmark. Usually, a company needs at least a three-year track record before qualifying for listing, but special rules allow growth companies with a shorter record to join Techmark.
Your choice is probably between two markets suitable for innovative, fast-growing smaller companies. The Alternative Investment Market (AIM) is very suitable for raising sums of money for companies looking for expansion. Unfortunately, floating on the AIM can be very expensive because of the due diligence that needs to be carried out by the advisers. Generally, most of the funds would be raised from institutions rather than private investors, although private investors might buy your shares after the company is listed.
The other option is ISDX*, a London-based stock exchange operated by ICAP. ISDX is a market for small and medium-sized companies. The requirements for floating on ISDX are less demanding than those for AIM. For example, there is no minimum trading record or minimum market capitalisation. The main admission criteria are a corporate adviser to sponsor your float, recent published audited accounts, being able to demonstrate adequate working capital, no restrictions on the transfer of your shares, and the shares must be acceptable for electronic settlement.
There are disadvantages in taking money from the public and becoming a quoted company. You have to meet the rules and regulations, which can be quite onerous, and accept that you have an additional layer of responsibility to your shareholders. Your business is no longer a private company, able to do what it wants with the profits and, in particular, your own rewards.
Managing change
Fast expansion gives you growing pains. Your tightly knit team becomes more loosely knit; the personal element is diluted. You will cease to know personally every bit of information, every customer, every supplier, because growth means delegation.
Managing the next stage of growth means you have to focus on four elements: people, organisation structure, processes or working procedures, and technology.
Employees are scared of change. So even if it is very positive, because your business is growing fast, you have to watch out for the developing resistance to changed responsibilities, changed hierarchies of responsibility and changed chemistry for developing teams.
The structure of your organisation needs to be flexible to allow for growth, but you will find it creaking at regular intervals. And one of the absorbing tasks of management is how to adapt a structure to ensure that you meet your requirements over the next phase of business growth.
Working procedures need to be documented and updated regularly. Instead of you explaining jobs to new members of staff, existing employees will be explaining them. Unless procedures are written, you can end up losing control over the efficiency of your staff.
Finally, technology plays an important role in growth. Use of technology can improve the efficiency of your workforce and enable more jobs to be done by fewer people. Constantly be on the lookout for ways that tasks can be streamlined and aided by technology.
Growing companies might consider setting up an internal web site, which could be for company data, such as price lists, purchasing details, policies, sales presentations and so on. Company knowledge is captured in this way, doesn’t walk out of the door in the head of a leaving employee and is accessible by all employees from their computers at work, at home or away on a sales trip.
Summary
- There are three ways you can increase profits: you can cut costs, increase prices or sell more.
- The quickest way of boosting profits is to cut costs and increase prices; but the greatest long-term potential comes from increasing your sales.
- Do not dismiss any improvement that can be made because it is too insignificant. A series of tiny changes in the right direction can lead to much bigger profits.
- Growth can be achieved by focusing on certain key requirements, such as a balanced team, a broad skill set, a well-defined market opportunity, a focus on product quality and customer satisfaction, and an emphasis on the clever use of technology.
- Raising Phase 2 money to fund expansion may mean risk capital from outside investors.
- Managing change needs careful planning of employees, organisational structure, working procedures and technology.