How to increase profit in your business
Revenue AND expenses drive profit
Some businesses are focused on growth and consider revenue to be the most important thing, whereas others are not so concerned about growth and have a strong focus on cost control. When considering how to increase profit in your business, it’s vital to look at both sides of the ledger.
Two profit drivers
The profit equation is pretty simple – it contains two variables that drive the profit:
Profit = Revenue minus Expenses
In my experience, most businesses focus on revenue when they want to increase their profit. This can certainly work, but often the revenue benefits can simply be gobbled up by increased expenses. Cost control is an extremely powerful, but often neglected, way to boost your profits.
Driving profits by cost control instead of revenue growth has a huge advantage because every dollar saved goes straight on to your bottom line. This is very different from profit growth by turnover, because of the effect of profit margin. The best way to illustrate this is by a worked example to see the effect of the two profit drivers.
To keep the maths simple, let’s assume the annual revenue in your business is currently $1m and you operate at a 10% profit margin, which means you generate a profit of $100k per year and have expenses of $900k.
Now let’s say you want to increase your profit by 30%, i.e. you want to generate a profit of $130k per year. There are three ways to approach this – focus solely on turnover, solely on costs, or a hybrid approach that considers both profit drivers.
Drive profit by increasing revenue only
Assuming your cost base remained the same and you focused solely on turnover, the numbers look like this:
- Profit = $130,000
- Profit margin = 10%
- Revenue = $1,300,000
- Expenses = $1,170,000
Using this top line strategy, you can see that in order to add $30k to the bottom line profit, you would need to increase your revenue by 30%, or $300k! This is because your expenses have also increased by 30%, or $270k.
Drive profit by reducing expenses only
Assuming your revenue remained the same and you focused solely on expenses, the numbers look like this:
- Revenue = $1,000,000
- Profit = $130,000
- Expenses = $870,000
- Profit margin = 13%
Using this cost control strategy, you can see that in order to add $30k to the bottom line profit, you would only need to reduce your expenses by 3.3%, or $30k!
The big advantage with the cost control strategy is the entire cost savings go straight onto the bottom line, unlike the revenue strategy, where the increased turnover is eroded by increased costs. Clearly, cost control is a very important part of the equation that should be considered.
Hybrid approach to driving profit
In the hybrid example, let’s say you adopt a 50/50 approach, i.e. half your increased profit comes from revenue and half comes from cost savings. The numbers would look like this:
- Revenue = $1,150,000
- Profit = $130,000
- Expenses = $1,020,000
- Profit margin = 11.3%
Using this hybrid strategy, your revenue increases by 15%, or $150k, and your expenses increase by 13%, or $120k, i.e. your cost base or profit margin, has improved.
What’s the best approach for your business?
It’s clear from the above examples that it’s vital to focus on both revenue AND expenses in your business if you want to increase your profits. The best approach for your business will depend on a range of factors, such as your own objectives, timing, team, product mix, client base, market conditions, etc.
Depending on your resources and the specific nature of your business, you might take a two-stage approach, i.e. focus on opportunities for revenue growth first and then move on to cost savings, or look for cost savings first and then focus on revenue. Alternatively, if you have the team and the time available you could work on both items concurrently.
I suggest asking yourself the following questions to help you arrive at the best approach:
- What is your timeframe – how quickly do you want to achieve your profit target?
- What is your profit target, in % terms and $ value?
- By how much and how quickly would you need to increase your revenue if your cost base remained the same?
- By how much and how quickly would you need to decrease your costs if your revenue remained the same?
- How achievable is the revenue-only approach or the cost-only approach?
- If you adopted a hybrid solution, what would be the revenue and cost targets that are achievable and would give you the best chances of success?
Understand your profit drivers to hit your target
Making sure you consider both sides of the profit equation is vital to success in your business. If you consider only revenue or only expenses, you’re missing half the picture. Setting yourself a profit target and working out the best way to get there will make all the difference!