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Increasing Your Company's Profitability

Chart 1

Graph 1
There is a basic rule taught in business courses everywhere that states the two primary goals of any business. The first goal is to make a profit and the second goal is to stay in business.

The idea of staying in business is all about providing first-class customer service that will lead to satisfied clients returning for more and referring you to everyone they know. How this is done is the subject of other articles in the future. What I want to address here is the first goal of making your business profitable.

Profit is defined in my dictionary as "the return received on a business undertaking after all operating expenses have been met." In other words, profit is what's left after everything and everybody is paid. By taking a closer look we can see that there are only two ways of increasing the profit of a company: increasing income or reducing expenses.

Let's look first at increasing the income. Gross income can be increased by charging more for goods and services (raising prices), selling more goods and services (more jobs), or some combination of the two.

Raising prices has the immediate effect of opening up the profit margin, as long as there is not a parallel increase in operating expenses. The fear many share about raising prices is that the increased price will cause fewer customers to buy, and therefore there will not be an overall increase in profit. While this is possible, the dynamics show us that there is a very small likelihood of this happening. Based on a simple test exercise, it can be proved that if you increase your price by 20 percent, you have to lose 40 percent of your volume before you actually make less money. And even then you are only working half as hard (Chart 1).

My experience is, with the increase in prices there is not a loss in overall volume. In fact, while I don't expect you to believe it, my experience has been that with the increase in price there is often an increase in business volume as well. I can't explain this logically, but it is true. Why not prove me wrong? I dare you.

Another way to increase income is by selling more. Selling more services increases profit in two ways. First, increased sales, even at the same profit margin, means more dollars. Second, even though increased sales will increase job-related expenses, increased gross sales distributes the fixed expenses over a broader base and, therefore, increases the profit margin per sale.

But it is the combination of higher prices and increased sales that will show the most increase in profit.

Looking at the expense side, business expenses in a service company can be divided into two general types: fixed expenses and variable (job-related) expenses. Fixed expenses are those that are needed just to open for business, and will continue at the same rate regardless of how much or how little business is transacted. Examples of fixed expenses include rents, utilities, phones, insurances, clerical/accounting, equipment payments and the like. Another name often used for fixed expenses is overhead.

Variable expenses are those that are tied directly to production. These expenses increase or decrease based on the amount of business transacted. Some examples of variable business expenses include fuel, cleaning chemistry, labor, and the like.

The relationship of all of this can be seen if we chart all these factors on one axis. The greater your price is per unit, or job, the steeper the income line is and the faster the profit margin will open up (Graph 1).

Remember, the best way to increase profitability is by controlling costs and increasing your price. This is not theory, it is fact. Business is a game of numbers, and you control those numbers.

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Recent Articles by Tom Hill

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