Improve Profits ▸ Ignore Your Bottom Line.

Every business owner wants to grow profits. And because profitability is, by definition, measured by net income (the bottom line of the income statement) it’s only natural to focus on things that affect it directly. But too often this focus limits our thinking and leads to short-sighted solutions.

Problems with Bottom Line Thinking

Concentrating on the bottom line can limit thinking to just two options, “cut expenses” and “grow revenue”. This can lead to three problems:

1. Cutting expenses is often the fastest and easiest way to increase net income. However it too easily leads to short-term decisions that undermine longer-term profitability.

2. Growing revenue normally requires an increase in sales and marketing costs. This directly conflicts with reducing expenses.

3. A focus on expense-cutting narrows the debate and prevents other options from being fully considered – or considered at all.

Hey, I know! Let’s cut the call center budget by 5%.

Here’s a short example. We’re pretty sure that reducing our call center budget will almost immediately improve our bottom line. And so, by freezing wages, reducing staff hours, and cutting training and equipment costs, we shrink our call center budget.

The result? Our net income increases slightly for a few months but staff morale drops, customer satisfaction slips, up-sell percentage goes down and the sales close rate falters.

Whoops.

Instead, Grow Gross Profit

What happens if we move the discussion away from net income for a minute? Instead, let’s try to increasegross profit (revenue minus cost of goods sold).

First, the obvious options become “grow revenues” and “decrease cost of goods” which don’t directly conflict.

Second, increased gross profit provides more cash to invest in expenses. Treating expenses as investments substantially changes perspective: expenses are no longer necessary evils or something to be minimized; they must produce a return that improves gross profit.

And third, the shift away from expense-cutting allows other options to surface and be considered.

Hey, I know! Let’s invest an additional 5% in the call center budget.

What if we invested a bit more money in our call center? We could expand the hours of service, provide better staff training, and develop a new self-service website.

Yes, the increased cost might reduce our net income for a couple of months. But morale goes up, customer satisfaction rises, up-sell percentage increases, new referrals are up and, because of all this, we think we can raise prices on some products.

Nice.

Five Ways to Increase Gross Profit

Use these five topics to start off your discussions about increasing gross profit:

1. What opportunities do we have to increase revenue by raising prices?

2. Can we improve cost of goods sold by getting more efficient, reducing product costs or better utilizing assets?

3. What sales and marketing efforts should we invest in to increase revenues in the short- and medium-term?

4. What new products and services should we develop that will increase our revenues in the medium- and long-term?

5. What opportunities do we have in our general and administrative area to positively affect revenue or cost of goods sold?

Keep in mind that any potential alternative must favorably and quantifiably answer at least one of these two questions:

– Does it increase our revenue?

– Does it make us more efficient?

But wait, there’s more

As an added bonus, our discussion will almost certainly highlight items that don’t improve gross profit. Which should lead us to ask, “Can we cut these items without negatively affecting our business?”

Shifting our thinking from net income to gross profit has a powerful affect on our business’s performance. Good luck!

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First published November 12, 2014

This Post Has One Comment

  1. Tom McKay

    This is differently a way to look at the P&L that has not been presented frequently. Review of the P&L would be interesting, but using this type of thought in pro forma information could help the small business to plan future strategy.

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