Small business owners are almost always passionate about their products. You don’t put in the blood, sweat, and tears businesses require unless you believe you deliver value. Sometimes, however, that means they are more concerned with delivering high-quality products and stellar customer service than they are with profitability. After all, there are easier ways to make money!
Here’s the thing: you’re running a business, not a charity. Making money is what you do.
Ignore profitability at your peril – profit margins have the power to make or break a business. They’re the backbone of any retail business, safeguarding sustainability, growth, and longevity. Covering expenses like payroll, advertising, web hosting, shipment fees, and more, profits keep a roof over your head and food on the table (not just for you, but for your employees, too!).
Want to learn more? In this article, we’ll explore the basics of profitability: what it is, how it works, and some simple tips to maximise profit.
We’ll cover:
- What is Profitability?
- Factors Determining a Small Business’s Profitability
- 10 Ways to Improve Profitability for Small Businesses
What is Profitability?
Not everyone who runs a business really understands profit – in fact, it’s why many small businesses fold. Profitability, in a nutshell, is the money you generate from running a business. There’s the gross profit – the revenue you earn from selling products. And there’s the net profit – the money you earn from selling products after subtracting your expenses.
Maximising profit is the primary goal of all companies. Because profit determines the viability of a business, learning how to improve profitability should be an ongoing lesson for business owners.
Factors Determining a Small Business’s Profitability
Ever heard the phrase ‘you’ve got to spend money to make money’ – whoever said that had never run a small business. Spending more than you make is a simple way to go bust. But there are more factors of profitability to consider. These include:
- Cost Management: The ability of a business to manage its costs directly impacts profitability. This includes both fixed costs (like rent and salaries) and variable costs (like inventory or raw material costs). Efficient procurement, resource allocation, and waste reduction can enhance profit margins.
- Pricing Strategy: Setting the right price for products or services is crucial. A price that’s too high might drive away potential customers, while a price that’s too low could reduce profit margins. Effective pricing takes into account production costs, competitors’ prices, and perceived customer value.
- Sales and Marketing Effectiveness: A strong sales and marketing strategy can drive customer acquisition and retention. This involves understanding the target audience, effective advertising, utilising digital platforms, and ensuring a strong online and offline presence.
- Operational Efficiency: Streamlining operations and implementing best practices can reduce overheads and increase productivity. Efficient inventory management, embracing technology to automate tasks, and ongoing employee training can contribute to better profitability.
- External Factors and Market Conditions: Not everything is within your control. Economic conditions, regulatory changes, and shifts in consumer behaviour or preferences can impact a business’s profitability. Being adaptable and responsive to market changes while also understanding and mitigating risks can position a business for sustained profit.
10 Ways to Improve Profitability for Small Businesses
- Analyse Your Costs
- Determine Your Profit Margin
- Have an Honest Conversation with Suppliers
- Compare Profitability Across Sales Channels
- Look at Shipping Costs
- Cut Your Expenses
- Train Your Staff
- Increase Spend Per Transaction
- Prioritise High-performing Team Members
- Target Big Spenders
1. Analyse Your Costs
Be honest – how often do you really analyse your costs? Do you routinely delve into the details of your packaging and shipping expenses? Do you calculate the unit cost of each item? Can you reel off the nuts and bolts of your product cost structure? And do you make strategic adjustments to optimise your business?
If the answer is no – don’t start feeling regret. Get on and do it! The sooner you get a handle on your profitability, the better the chance of your future success.
2. Determine Your Profit Margin
You should determine your monthly and annual profit margin. Look at your books – clearly work out your product prices, how many units you sell, what your expenses are, and calculate your gross and net profit. You can also calculate your return on investment (ROI) – how much money you make for every pound you spend.
Once you know how much profit you make per product and overall, you can get a clear indication about where things are going very right or very wrong. Course correcting is a lot easier when you know where you are!
3. Have an Honest Conversation with Suppliers
Collaboration is key! Honest conversations with suppliers often lead to cost-effective manufacturing processes and better margins.
Manufacturers don’t want you to go out of business. They rely on you for their income and will work with you, where they can, to ensure the cost remains feasible. Leveraging these relationships not only optimises your cost structure but also strengthens your partnerships.
4. Compare Profitability Across Sales Channels
Maximising profitability doesn’t stop there – analysing your profit across sales channels is critical. For example, comparing profits between your business’s websites vs marketplaces vs in-store. How do the inbuilt costs of these different channels impact your overall profitability? And does sales volume make up for a lower profit margin? If not, consider how you spend your marketing budget and which channels you want to prioritise over others.
Remember: knowledge is power. Armed with a good understanding of these different selling mediums, you can configure your business, your team, and your resources towards the best ways to improve profitability.
5. Look at Shipping Costs
Shipping costs are another critical consideration you shouldn’t overlook. Often, companies ask customers to pay for shipping, adding the cost to the final payment. However, free shipping over a certain amount or as part of a subscription is common – see Amazon.
That can seem sensible – after all, it’s only shipping. Except when sending the package halfway around the world or across the country.
Nonetheless, free shipping for certain products or, in specific circumstances, can enhance customer satisfaction and reduce cart abandonment. But you’ll want to balance all these factors to ensure it doesn’t negatively impact profitability.
6. Cut Your Expenses
Profitability is a simple bit of arithmetic: subtract your expenses from your revenue. Small business owners often fixate on the latter and neglect the former – they’re both equally important, however.
Take a deep dive into your expenditure and business overheads, including packaging, staff, and import costs. In particular, look at fixed overheads like rent, property insurance, and utility costs. Cutting these expenses as much as possible not only increases your net profit but provides greater business stability.
7. Train Your Staff
Employee training is a pivotal aspect of maximising profit. A single employee mistake can end up costing you hundreds if not thousands. And, if an employee has an accident, your insurance costs can rise as a result.
Hold weekly safety meetings, ask staff for feedback on cost-cutting, and reward efficiency and high performance. A classic mistake of almost all businesses is punishing poor performance but failing to incentivise employees to go above and beyond.
8. Increase Spend Per Transaction
Upselling is a sales technique that convinces a buyer to purchase a more advanced or premium version of a product or service. That, as a result, increases the ‘spend per transaction.’ In simple terms, it’s much easier to convince the customer already interested in your products to buy a little more than to convince a stranger to buy anything.
For example, if a customer comes in to buy a pair of running shoes, your salesperson should also convince them they need a pair of quality running socks.
9. Prioritise High-performing Team Members
Got a team member who was born to sell? Or maybe they’ve configured your website to reduce costs? Whatever their special skill or talent, this person is worth their weight in gold.
Ensure they feel appreciated, reward their hard work, and incentivise them to stay with your company. That’s especially important for a small business – large companies tend to poach staff.
10. Target Big Spenders
Your sales aren’t spread equally between all your customers. If your business is anything like all the others, a few big spenders will be responsible for a surprisingly large proportion of your profit.
In fact, there’s something called the 80/20 rule (or the Pareto principle), which states that 20% of customers generate 80% of your revenue. Similarly, 20% of your products also generate 80% of your revenue. (This rule applies to some surprising number of situations.)
Focusing on profitable customers is a simple way to boost your ROI – after all, you don’t have to market to thousands of different people. Potential options include hyper-targeted recommendations, email marketing, or special loyalty offers.
Closing Thoughts
Profitability isn’t just another buzzword; it’s the literal lifeblood of your small business. The path to profitability involves evaluating profit margins, refining product designs, collaborating with suppliers, and analysing profits across sales channels.
Learn more about ‘How to Make More Money in Your Business‘ with episode #160 of The Resilient Retail Game Plan – our weekly podcast. We cover the top ways to improve your profitability.
For more insights, expert advice, and business-boosting guidance, Join the Club! Membership will get you one-on-one access and training with Catherine Erdly, a renowned expert in small business management.
