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Baking A Million Cupcakes Won’t Make You a Millionaire, But Understanding Your Cost of Goods Sold Will

It is natural to wonder about the cost of doing business with products we see stocked on the shelf every day. The famed “entrepreneurial curse” strikes when I least expect it, especially when I go out to eat. A $25 steak tastes the same if made at home for much less. 

As business owners, it is imperative that we know the costs associated with creating our product in detail. We must understand every component of our product: 

• The direct labor costs
• The overhead costs of materials used to create it
• The operational costs of being in business
• And foremost, the cost of profit that we will expect

This practice ensures that our pricing is right on the money. 

I have found, however, that many owners are unfamiliar with their pricing as it relates to their costs. Some argue that they know for sure that their customers will only pay a specific price, or that there are so many moving parts that pricing is inevitably futile. 

When I received this feedback, I realized the owner had spent years figuring out what was essential for their business’s profitability and had been unsuccessful. 

Here’s the deal: most profitable small businesses are not sheer luck; instead, they are born out of concrete data and an understanding of their costs. 

Cost Optimization: Setting the Stage

A local bakery I frequented had been in business for twelve years. On the surface, this business seemed to be successful. They had a large following on social media and seemed to be busy during their open hours. Unfortunately, the owner worked six days a week in the bakery and spent much of her time at home working on “business owner” tasks. She could not turn enough of a profit to hire mid-level leaders to assist her in running it. 

To discover the problem, I asked the owner what her most popular product was. Cupcakes were the top-selling product, but the owner had no idea how much it actually cost the business to make and sell them. 

Cost Analysis Example

If the main product (the cupcakes) had been making her profit, then there’s no issue. Unfortunately, that was not the case. Her cupcakes broke even, and some of her secondary products lost money. The least advertised products were the ones keeping the business alive. We found all this out by investing the time to understand her product’s cost. 

For this example, we need to calculate the cost of the ingredients that go into the cupcakes and the amount of ingredients needed to bake each individual cupcake. Sugar costs the bakery $9.89 for 23 cups, and our cupcake recipe calls for 2 cups. Thus, we are spending $0.86 for the sugar in the cupcakes, or $0.43 per cup. Our recipe makes a total of 24 cupcakes, which gives us a total sugar cost of $0.04 a cupcake. 

After completing the same exercise for all the ingredients in the recipe, we found that the total ingredient cost for each cupcake was $1.10. We also need to consider: 

• The cost of labor to produce a cupcake
• The error rate of the product
• And the overhead rate of fixed costs

In this case, our product cost before overhead was $2.47, which was previously unknown to the owner. The bakery was selling each cupcake for $2.50. 

This gap in cost meant that the bakery owner could sell a million cupcakes and only have $30,000 left over for rent, equipment, utilities, and a fancy baker hat. (Admittedly, I did purchase one such hat for myself when working with this client.) Now that we have the details of the business costs associated with baking the cupcakes, we can begin to scrutinize our cupcake costs. 

Cost of the Cupcakes

We conducted a price elasticity check by raising the price to $3.50 to see if it would affect sales. It did not. That takes the profit from $0.03 to $1.03 per cupcake. This change was a significant improvement, considering that this bakery also sold bulk cupcakes at $1.75 each based on what the owner deemed a reasonable price. This “reasonable price” came before the known costs. As we now know, that pricing would cause the business to lose $0.72 per cupcake. 

Once we felt secure in the pricing, we went on to see what ingredients drove the cost up the most. Some ingredients were available to order by the pallet and could be used in time to remain fresh. Discovering this brought our cupcake price down from $2.47 to $1.96, saving us $0.51 a cupcake. 

A Cupcake Cost Savings Conclusion

After understanding all these pricing factors, selling a million cupcakes would yield a profit of $1,540,000 to pay overhead and invest in the business. Understanding your pricing structure drives profitability for your small business, allowing for more opportunities to thrive! 

As a small to medium-size business owner, experiencing a period of revenue loss can happen anytime. Revenue loss can be caused by various factors, such as market fluctuations, unexpected events, economic downturns, or changes in consumer behavior. Regardless of the size of your company or the industry in which you operate, Cogent Analytics will assist you to be prepared and have a plan for navigating through these times successfully. For engineering-driven businesses, this often means being strategic, adaptable, and innovative in your approach. With our team of in-house experts, we at Cogent will explore some key engineering strategies and survival techniques that can help your company overcome periods of revenue loss and come out stronger on the other side.

Diversification of Product/Service Offerings:

To survive difficult times, engineering companies can improve their position by broadening their product or service range. This diversification can help you reach new markets and client groups, offsetting any loss of revenue. At Cogent, we provide a Market Discovery service that allows engineering firms to assess their market strategy and tools and adapt them to utilize their expertise to create innovative solutions or adjust existing ones to meet varied market demands. By staying in tune with the market, companies can remain relevant and adaptable.

Embracing Innovation and Research and Development (R&D):

Incorporating R&D in engineering businesses is essential to overcome revenue loss. By embracing innovation, your company can create unique products or processes that give you a competitive advantage or disrupt the market. Investing in R&D enables engineering firms to develop cost-effective solutions, enhance existing products, take advantage of tax credits, or even transition to new industries. The ability to adapt and innovate is crucial for long-term prosperity.

Focus on Operational Efficiency:

To effectively manage revenue loss, engineering companies must focus on operational efficiency. Operational efficiency involves continuous process evaluation to identify improvement and cost-reduction areas. Cogent’s extensive operational experience focuses on optimizing workflows, eliminating waste, and automating repetitive tasks. We at Cogent hold ourselves accountable for the opportunities identified and the return on investment generated for our clients. Our experience has shown that this approach can lead to increased productivity, reduced overheads, and better financial stability for companies.

Client-Centric Approach:

Maintaining strong relationships with existing clients becomes paramount during challenging times. A client-centric approach involves understanding their needs, providing exceptional service, and delivering value beyond expectations. Satisfied clients are likelier to remain loyal and refer others to your company. Additionally, seeking client feedback can help identify improvement areas and guide product development efforts.

Strategic Partnerships and Collaborations:

Collaboration between companies, where they share resources, technology, and expertise, is an effective way to expand the reach of each company and capitalize on new opportunities. Businesses can overcome obstacles and achieve mutual growth by leveraging each other’s strengths. At Cogent, our mergers and acquisitions (M&A) expertise allows us to assist you in identifying and capitalizing on said synergies that can significantly increase the likelihood of your company’s success and survival.

Cost Management and Financial Planning:

Effective cost management and financial planning are crucial for companies to maintain financial stability during periods of revenue loss. At Cogent, we provide tools that help assess financial situations, prioritize expenses, and implement cost-saving measures while maintaining the quality of products and customer satisfaction. Our Basic Management Tool (BMT) provides a Cash Management System [1] (CMS), a Current Financial Summary [2] (CFS), and Key Performance Indicators [3] (KPIs) that analyze cash flow, financials, sales, and general key performance indicators. We also explore alternative funding options and treasury optimization that can provide stability during difficult times.

Invest in Employee Development:

Employee development can be an invaluable asset for any engineering firm. At Cogent, we help you identify and evaluate your employees’ skills and abilities, determine organizational gaps, and create a training plan to close those gaps. This plan enhances employee capabilities, fosters a positive work culture, and can lead to higher job satisfaction. A motivated workforce is more likely to weather any challenges together and contribute to the company’s resilience and recovery.

To survive a loss of revenue, businesses in engineering must be adaptable, innovative, and efficient. This process involves diversifying offerings, focusing on research and development, optimizing operations, and maintaining strong client relationships. Cogent Analytics has shifted its focus to helping business owners prepare for and survive economic downturns. We facilitate strategic partnerships, financial planning, and employee development. By proactively implementing these strategies, engineering companies can navigate challenging times and emerge stronger and more competitive in the ever-changing market.

1. The Cash Management System (CMS) measures cash inflows and outflows over 12 weeks (4 weeks in the past and eight weeks in the future), factoring in tax obligations, debt management, working capital needs, funding growth initiatives, and planned owner distributions.  
2. The Current Financial Summary (CFS) is a financial snapshot or overview of the business with a mix of inputs from Operations, the Profit, and the Lost and Balance Sheet.
3. The Key Performance Indicators (KPI) is an operational KPI plan and review of the four pillars in the profit platform.

Procurement savings encompass more than just securing a lower price. 

The Impact of Procurement on Profitability 

In various industries, the cost of purchasing goods and services accounts for 40% to 70% of total revenue. Thus, reducing the cost of goods sold (COGS) can have a significantly larger impact on profit than either increasing sales or cutting overhead expenses. Consider this example: a 5% reduction in COGS can result in a 50% increase in profit. To achieve a similar increase through sales, revenues would need to be boosted by 50%. 

The Focus on Strategic Procurement 

Businesses, regardless of size, aim to enhance their profits. However, in the procurement realm, the focus often narrows to negotiating lower prices with vendors. By shifting towards a strategic perspective of the source-to-pay business processes, companies could realize greater benefits without affecting their vendors’ profit margins. 

Achieving Strategic Benefits 

Achieving these benefits requires companies to create visibility and a comprehensive understanding of their key vendors, establish appropriate processes and metrics for the procurement department that promote a holistic approach to purchasing, and implement processes and metrics that sustain these savings through timely feedback and discussions with key vendors. 

The goal is to integrate strategic sourcing and supply management with supportive technologies, efficient procurement infrastructure, operations, and metrics. 

For large companies, this strategy can lead to savings in the millions of dollars; for smaller companies, the savings potential is also significant. 

Steps to Achieve Procurement Benefits  

Step 1: Understand Spending and Vendor Participation 

Step 1 involves understanding your company’s spending and vendor participation. This includes knowing how much you spend with key vendors, what products and services are purchased, reviewing existing contracts to understand terms and conditions, understanding your market and the market for essential COGS items, establishing relationships with major vendors open to negotiation, and identifying opportunities for savings. 

The aim of Step 1 is to comprehensively understand spending patterns and procurement practices. Once the data is gathered, the company can identify opportunities to reduce costs. For instance, a small classic auto import company achieved cost reductions by consolidating its suppliers and negotiating prices based on the supplier’s full annual capacity. Similarly, a small contractor enhanced their contractors’ productivity by pre-packaging materials needed for daily tasks, reducing morning preparation time. 

Identifying quantifiable savings and highlighting these opportunities on the “Opportunity Wall” concludes this step. 

Step 2: Modify Source-to-Pay Processes 

Step 2 focuses on identifying business requirements, determining key suppliers for the program, evaluating your market participation, establishing clear supplier management expectations, developing a supplier report card, and incorporating your actions into this evaluation. 

This step involves modifying the source-to-pay processes and infrastructure. It’s crucial to understand the true cost of purchasing, including the item’s price and the additional costs associated with sourcing, purchasing, and paying for it. Factors affecting overall purchasing costs include the volume of spending, current contractual agreements, product or service complexity, the supplier’s competitive position, and product quality, among others. Streamlining these processes can lead to significant cost reductions. 

Step 3: Improve Procurement Organization and Culture 

Step 3 is about improving the procurement organization’s skills, creating compliance mechanisms, streamlining business processes, and realigning the company culture. 

Viewing procurement improvement as a one-off event leads to the loss of savings over time. Continuous improvement and change creation processes are essential to maintaining benefits. Savings can evaporate due to changes in product lines, technologies, management focus, the vendor pool, and market conditions. 

Key Areas of Focus for Effective Procurement 

To create an effective procurement organization, the management team must focus on five key areas: 

• Strategy: Develop a vision and strategy for procurement, differentiating between strategic and commodity products and services. 

• Process: Measure and simplify processes, considering the specific needs of different commodities. 

• Technology: Integrate technology with business processes for a comprehensive solution. 

• Organization Structure: Design an appropriate organizational structure and measurement system to capture savings opportunities efficiently. 

• People: Ensure management support, provide holistic training, and establish metrics that drive desired changes, moving beyond mere price reduction to include total acquisition cost. 

This process is applicable to companies of all sizes and across both manufacturing and service industries. Planning, acting, measuring, and enhancing your bottom line through these steps can unlock substantial savings. 

When your revenue is flowing easily, finding profit is not a problem. In these times of success, morale is at its highest, and everyone is feeling safe. Salaries and commissions are at an all-time high, and spending doesn’t seem like a big deal anymore. Many companies have experienced this “high” at some point and continue to stay in that world year after year. For the businesses that face profit and revenue challenges daily, it’s time to focus on what’s critically important and be ready to make challenging decisions. 

To weather the profit and revenue storm, consider what you would do revenue slows because of an unforeseen and uncontrollable circumstance. For example, governmental or political influence, another pandemic, or a major vendor or customer shutting down their operation could all have a massive impact on your business. Will your business be able to survive it? Or would you be forced to react by making a permanent decision based on a temporary situation? Use the following three phrases to reframe this scenario and make sound business decisions:  

1. Make Money

So how are you supposed to make money when your revenue has noticeably slowed? First, you must understand your business transactions and the profit a dollar should be generating. Don’t fall into the trap of waiting until the end of the month to analyze P&Ls, balance sheets, and bank accounts. Instead, pay attention to how every dollar should return a percentage of profit.  

When you know your ROI for every dollar spent, you should also know that every transaction has a cost. Are you making your planned ROI per dollar? Is the decision you are making today generating the desired profit? If the answer is anything other than yes for these questions, consider getting to know your business’s financials more intimately so you can make the right decisions to yield the profit and revenue you expect. Below are some challenges that can get in the way: 

• Conducting business with friends and family (either as customers or co-workers) 

• Long-term relationships with vendors/ customers who are your “cash cow” or biggest revenue generator (you have become afraid of losing their business, revenue, and relationship) 

• Lack of understanding and awareness of the expected profit goals 

• Being blinded by monthly cash flow instead of having a clear understanding of daily ROI per dollar 

2. Save Money

When companies are easily making profit, all stakeholders should reap those benefits. In the same way, when things aren’t going well, and a company struggles to make payroll or pay vendors, everyone in the business should “feel the pinch.” This doesn’t always have to result in layoffs or furloughs. It could mean managing the luxuries and the status quo with a fine-tooth comb. Sometimes tough decisions must be made immediately to save the company. Yes, company functions may be limited or suspended until further notice. Travel and expenditures may be halted indefinitely. Saving money is an instant game changer to profit as it flows immediately to the bottom line and doesn’t cost anything to generate an ROI! 

3. Solve Problems

Solving problems is key to employment security.  

Solving problems takes a bit more insight, fortitude, and emotional intelligence than making money or saving money, often because of the human element of business problems. Task your middle management team to solve the problems they can. This practice frees other leaders to think more clearly about introducing different revenue streams, ROI, growing EBITDA, or retained earnings. In other words, when middle management and their support team in operations can solve problems, they allow you as the business owner to “work on your business instead of working in your business.” What a luxury to have employees who can identify and solve problems so you, as the business leader, can focus on leading. Companies with many problem solvers will weather any profit and revenue challenge that may come their way. 

When you’re in a tight spot with revenue loss, keep making money in whatever ways you can, save money wherever you can, and trust your team to help you solve problems.  

What is Cash Flow?  

At its core, cash flow is the total amount of money coming into and going out of a business. It plays a crucial role in maintaining the viability of a business, enabling it to pay workers, suppliers, and manage short-term debts. Without positive cash flow, a business faces the risk of liquidation to meet its financial obligations. 

The Importance of Cash Flow 

Is Cash Really King?  

You’ve likely heard the phrase “Cash is King,” but how true is this in the business world? While having a large volume of cash is beneficial, the true measure of a company’s financial health is how effectively it manages its cash outflows. Proper control and utilization of cash resources are what really determine a company’s success. 

Case Study: Cash Flow in Action 

Comparing Two Companies  

Consider two hypothetical companies: Company A and Company B. Company A generates $10 million in cash inflow but spends $10.3 million, resulting in a negative cash flow. Company B, on the other hand, has an $8.5 million inflow and spends $6.5 million, achieving a positive cash flow of $2 million. Despite having less cash coming in, Company B is more financially healthy due to its effective cash management. 

The Mechanics of Cash Flow 

Cash Inflow and Outflow  

Cash inflow includes revenues from sales, loans, and investor contributions. Cash outflow refers to expenditures such as the cost of goods sold (COGS), salaries, wages, and capital expenditures (capex). Balancing inflow and outflow is key to maintaining a healthy business. 

Cash Flow Forecasting 

Why Forecast Cash Flow?  

Forecasting cash flow provides a clear view of what’s ahead, enabling businesses to plan and make informed decisions. Regular cash flow forecasting helps anticipate upcoming expenses and revenues, guiding strategic and operational planning. 

Managing Negative Cash Flow 

Strategies for Addressing Cash Shortfalls  

When faced with a negative cash flow forecast, options include increasing bank loans, extending accounts payable terms, or requesting faster payment from accounts receivables. Each choice comes with potential downsides, such as interest costs with loans or strained relationships with vendors or customers. 

Understanding Different Types of Cash Flow 

Operational, Investment, and Financing Cash Flows 

Operational Cash Flow: This is cash generated directly from a company’s primary business activities. 

Investment Cash Flow: Includes cash flows from the sale or purchase of assets, which affects the company’s net worth. 

Financing Cash Flow: Involves cash received or paid related to debt and equity financing. 

Improve Cash Flow, Improve Your Company 

Managing cash flow effectively allows businesses to navigate financial challenges and opportunities. By understanding and managing different types of cash flow, companies can maintain financial health and direct their future strategically. Remember, managing your cash flow allows you to effectively navigate the future of your business and drive success. 

Managing cash flow is a cornerstone of financial health for businesses across all sectors. A robust cash flow enables a company to meet its obligations, foster growth, and maintain stability. This article delves into effective cash flow management, drawing insights from the experience of a burgeoning plumbing company. 

The Importance of Cash Flow in Business 

Cash flow stands as a pivotal element in the financial management of any enterprise, large or small. It is the lifeline that allows businesses to settle bills, reinvest in operations, and secure financial equilibrium. Our journey through cash flow management begins with a plumbing company on the cusp of growth, facing unexpected financial hurdles despite apparent success. 

Exploring Cash Flow Challenges 

Consulting with a plumber who epitomized success—boasting a stellar market reputation, a loyal workforce, continuous work, and record profits—uncovered a perplexing issue. Despite his profit margins, there was a disconcerting gap between expected revenues and actual cash on hand, especially noticeable during payroll periods. This discrepancy highlighted a critical need for understanding and addressing the underlying causes of cash flow disruptions. 

Identifying the Core Issue 

A thorough examination of the plumber’s financials pinpointed delayed receivables as the primary cause of cash flow issues. Engaging in subcontracted projects with extended payment terms meant waiting longer for payment, significantly straining cash flow despite ongoing profitability. 

Conducting a Cash Flow Analysis 

To address these challenges, a detailed analysis of the company’s cash flow was undertaken. This examination laid bare the discrepancies between profit and cash availability, emphasizing the urgent need for strategic interventions. 

Implementing Solutions for Cash Flow Improvement  

Introducing Milestone Payments 

Adopting milestone payments emerged as a critical strategy. By securing partial payments at predefined project stages, the company could ensure a more consistent cash inflow, alleviating the pressure of extended payment waits and mitigating the risks associated with non-payment. 

Transitioning to Shorter Payment Terms 

The plumber’s acceptance of Net 60 payment terms was revised to Net 30, aiming to accelerate receivables and enhance cash flow. This change meant quicker access to earned revenues, crucial for covering immediate expenses and reducing financial strain. 

Enhancing Accounts Receivable Management 

Active management of accounts receivable was advised, involving prompt invoicing, diligent follow-ups on overdue payments, and, when necessary, engaging a collections agency. While potentially diverting focus from other business areas, this proactive approach was deemed essential for maintaining healthy cash flow and avoiding detrimental delays in payment. 

Achieving Positive Cash Flow 

The implementation of these strategies marked a turning point. The plumbing company not only addressed its cash flow issues but also set a course towards becoming one of the market’s most profitable small businesses. By ensuring a steady and reliable cash inflow, the company could now reliably cover its operational costs and pursue growth opportunities. 

Conclusion: The Vital Role of Cash Flow Management 

Effective cash flow management is paramount for any business’s success. It transcends mere survival, enabling companies to thrive and compete. The plumber’s tale underscores the significance of a keen understanding of cash flow dynamics, thorough analysis, and strategic action to overcome financial obstacles. 

By prioritizing cash flow analysis and adopting targeted management techniques, businesses of any size can navigate the challenges of cash flow management. Ultimately, the essence of financial management lies not just in weathering the storm but in steering towards prosperity in the competitive landscape of business. 

You’ve heard the catchy phrase: “Cash is King!” And it’s true, cash is the most important thing for a small business. Unfortunately, success is extremely difficult for small businesses to achieve.  

Carter (2021) wrote, “Approximately 20% of small businesses fail within the first year. By the end of the second year, 30% of businesses will have failed. By the end of the fifth year, about half will have failed. And by the end of the decade, only 30% of businesses will remain — a 70% failure rate.”  

There are several reasons why a small business can fail, but we will focus on the importance cash flow plays in the success of a small business. The number one survival tip for small businesses is to protect your cash (Martin, 2002). Cash flow is king. 

What is Cash Flow? 

Cash flow is the cycle of cash through the business. Cash enters as revenue from sales or proceeds from a loan or cash infusion then moves to the purchase of goods or services to generate sales to continue the cash flow cycle (Thompson, 2001). A business cannot function without cash. Cash is needed for payroll, supplies, overhead, inventory, fixed and variable expenses, and to purchase raw materials or goods used to produce the company’s product or service.  

Cash Flow Process 

This diagram shows the cash flow process (Worrell, 2018). The first step is purchasing to create an inventory to sell. Notice this also opens accounts payable (AP). The inventory is then held until it is sold. At this point, accounts receivable (AR) is opened. Then the cash is collected on the AR and the cycle starts over. The management of cash is what differentiates a successful business from an unsuccessful business. 

Cash Flow Management 

Effective cash flow management is critical to any business, regardless of size (Isle et al., 2018). Cash flow management is a critical indicator of the health of the business. A company’s success is measured by the amount of cash flow it has to cover its operations, pay debts, increase its credit rating, and maximize shareholder value (Scott, 2007).  

Business operations are the most significant source of cash in and out of the business (Isle et al., 2014). Small business owners are usually operational experts in whatever field in which they operate but lack the financial literacy to manage their cash flow effectively (Isle et al., 2018). This causes a problem and contributes to the failure rate of new small businesses. To manage cash flow, the business owner needs to understand the components and measurements needed to manage the cash effectively. This requires an analysis of different business areas to obtain cash flow information. 

Cash Flow Information 

According to Haron et al. (2014), there are two dimensions of cash flow information. The first dimension includes cash ratio analysis, inventory, cash flow budget, bank balance, and cash flow statement. The second dimension includes accounts receivable and accounts payable. This requires the small business owner to track these aspects of the business from reports, which are pulled from their accounting software.  

Once the information is pulled, it needs to be evaluated to determine necessary changes. For example, the inventory turn ratio will show how many days it takes to sell the current inventory. The sales cycle will show how many days it will take to receive the cash from a sale on credit. This information will help align the account payable with the cash receipt (Papmehl, 2018).  

The business owner must know how many days of cash the company has to cover operations. A business should have 60 – 90 days of cash to cover unexpected expenses or take advantage of opportunities (Papmehl, 2018). There are several way business owners can avoid cash flow problems. 

Cash Conversion Cycle – Amazon 

The chart above shows the cash conversion cycle for Amazon (Cuafano, 2022). This shows how Amazon uses the cash flow cycle to its benefit and maximizes the cash to increase the business. When cash comes in, and they buy inventory, the item is sold within 36 days; they then have 82 days to pay the supplier for the inventory. That leaves them 46 days. That is enough time to order more inventory and sell it before the first order is due. For the accounts receivable, they collect their payment within 20 days. That gives Amazon 26 days to use that cash to make more money.  

Most small businesses cannot negotiate terms like Amazon, but this gives an example that the cash flow cycle can benefit the company. If the components are monitored to be as short in duration as possible, cash will be received around the same time the payable is due. That will minimize the amount of cash being paid out without corresponding sales. 

Solutions  

One of the best ways to avoid cash flow problems is to be proactive and forecast potential issues. Consistency in billing and payable activities is key. (Sansone, 2016) This includes establishing an SOP to handle accounts receivable and accounts payable. Avoid deviating from the procedures unless necessary.  

Another way to avoid cash flow problems is to set a budget and ensure strict adherence to it. Additionally, a forecasting tool will help identify potential cash flow problems so adjustments can be made early. This proactive approach will help avoid dramatic impacts on operations from last-minute decisions.  

A consistent review of the cash flow management reports is also critical to avoid surprises. The most important thing when relying on financial reports is to ensure the accuracy of the data entered. A strong understanding of the financial data points that need to be entered into any accounting software is critical to accurate reporting. The saying, “garbage in, garbage out”, applies well to this scenario. You cannot expect to have accurate results when you enter inaccurate data, regardless of how good the software advertises it is. If you do not have financial literacy, seek the help of an outside entity to guide you through the process until you are comfortable. This may cost some money, but the savings will significantly exceed this through increased cash flow.  

Conclusion 

Cash is the lifeblood of a company. Without cash, the company dies. Small businesses are especially susceptible to failure due to a lack of cash flow control. Cash flow management will determine the overall health of the company. This is based on the results from the cash flow analysis, and reports pulled on cash flow activities. The information from the reports will help the business owner make informed decisions to prevent or avoid cash flow problems before they become too large and negatively impact operations. An effective cash flow management plan could be the difference in going under and making it past the 5th anniversary. 

References 

Carter, T. (2021). The actual failure rate of small businesses. Entrepreneur. Retrieved from https://www.entrepreneur.com/starting-a-business/the-true-failure-rate-of-small-businesses/361350. 

Cuafano, G., (2022). Amazon’s cash conversion cycle. Four Weeks MBA. Retrieved from https://fourweekmba.com/cash-conversion-cycle-amazon/. 

Haron, N., Yahya, S., & Haron, H. (2014). Cash Flow Information and Small Enterprises’ Performance. International Journal of Organizational Innovation, 7, 7–17. 

Isle, M. B., Freudenberg, B., & Sarker, T. (2018). Is the literacy of small business owners important for cash flow management?: The experts’ perspective. Journal of the Australasian Tax Teachers Association, 13(1), 31–67. 

Isle, M. B., & Freudenberg, B. (2015). Calm waters: GST and cash flow stability for small businesses in Australia. EJournal of Tax Research, 13(2), 492–532. 

Martin, K. (2002). Survival tips for small business. Fairfield County Business Journal, 41(2), 4. 

O’Brien, A. (2015). Cash flow is king. Money (Australia Edition), 183, 44. 

Papmehl, A. (2018). New ways to help small business improve cash flow. Maclean’s, 131(9), 62. 

Sansone, B. (2016). What to do when your cash flow dries up. GP Solo, 33(1), 28. 

Scott, S. (2007). The importance of cash flow analysis for small businesses. Commercial Lending Review, 22(2), 37–48. 

Thompson, M. (2001). Cash flow management and the small business. Enterprise/Salt Lake City, 31(21), 13. 

Worrell, D. (2018). Optimizing cash flow: The cash flow cycle explained. Fuse CFO. Retrieved from https://fusecfo.com/blog/blog-optimizing-cash-flow-for-small-business-the-cash-flow-cycle-explained/. 

In the journey of measuring marketing effectiveness for small businesses, we’ve explored the realms of Return on Investment (ROI) and the strategic interplay between Lifetime Revenue and Customer Acquisition Cost. Now, let’s delve into the intricate world of branding—a crucial element that goes beyond immediate revenue figures and leaves an enduring mark on a business’s identity and perceived value. 

The Power of Branding 

Think about Coca Cola. It’s not just sugar water; it’s an iconic brand that can charge double the price of a store-brand cola. Or consider Delta Airlines—they have a logo but can’t command a premium and often compete on price and convenience rather than brand recognition.  

The power of branding lies in the difference between what you can charge as a commodity versus what you can charge because customers perceive you as more valuable than a commodity. 

For small businesses, branding extends beyond logos and slogans. It encompasses every touchpoint with customers, from physical signage and online presence to the appearance of your team and the content on your website. 

Elements of Small Business Branding 

Physical Signage: 

• Invest in clear and attractive signage for your storefronts, trucks, or any physical presence you have. This creates a lasting visual impression on potential customers.

Online Presence: 

• Optimize your organic Google rankings, maintain an informative website, and actively engage with your audience on social media platforms. Consistency across online channels builds trust and reinforces your brand. 

Content Creation: 

• Regularly publish blog posts relevant to your industry. Share your expertise and provide valuable information to your audience. This not only establishes authority but also contributes to your brand narrative. 

Uniforms and Appearance Standards: 

• The way your team presents itself speaks volumes about your brand. Uniforms and appearance standards contribute to a professional and cohesive brand image. 

Social Media: 

• Leverage social media to humanize your brand. Share behind-the-scenes glimpses, customer testimonials, and relevant industry updates. Engaging content builds a connection with your audience. 

Small Business Branding and Customer Sensitivity 

It’s essential to understand that the impact of branding varies across different customer segments. For example, business clients might be less price-sensitive, allowing for more emphasis on added value and brand reputation. On the other hand, individual consumers might prioritize price and convenience, making branding a secondary consideration. 

Measuring the Impact of Branding 

In our last two articles, we explored the ROI of direct marketing efforts. These were fairly easy to measure and determine if they were worth our investment. But measuring the effectiveness of branding is inherently challenging. It’s an investment in the long-term perception of your business, and its impact often extends beyond immediate financial returns. 

Brand Value 

One way to gauge the effectiveness of branding is by considering the brand value of your product or service. This is the difference between what you can charge versus what a similar unbranded product or service can charge. 

Brand value = (Price with Branding−Price without Branding) 

Consider a scenario where an unbranded product might sell for $100, but due to strong branding, you can sell a similar product for $150. The branding value in this case would be 50% and an ROI might attempt to capture some sort of total revenue in excess of commodity revenue divided by the amount spent on branding.   

But how long of a period would you include for your cost of branding?  After all, some companies like Coca Cola started branding a century ago and even relatively new companies may have a decade of marketing spend. That’s one of the biggest challenges that companies small and large face. Here are a few metrics that you can measure to determine if your marketing dollars spent towards branding are effective.   

Customer Loyalty and Repeat Business 

A strong brand often translates into customer loyalty. Track repeat business and customer retention rates. If customers are returning because of your brand, it’s a sign that your branding efforts are resonating. 

Brand Perception Surveys 

Conducting surveys among your target audience can provide insights into how your brand is perceived. Ask questions about brand attributes, values, and associations to gauge the effectiveness of your branding efforts. 

Social Media Engagement 

Monitor engagement metrics on social media platforms. Likes, shares, and comments reflect the level of connection your audience feels with your brand. High engagement suggests a strong and positive brand impact.  Be careful as some marketing firms tend to focus on this metric, because these types of metrics can be easy to pay for but not that effective at driving brand.  But for some companies, like fashion brands, this can be a very effective metric. 

Case Study: A Local Café’s Branding Journey 

Let’s consider a local café that decided to invest in branding. They redesigned their logo, revamped their online presence, and trained their staff to embody the brand’s values of warmth and community. Over the next year, they observed an increase in customer loyalty and positive online reviews. Between hiring a design firm, hiring a marketing firm, and training their staff, the owner spent $50,000 on his branding efforts. 

Branding ROI 

Before the rebrand, the café could charge $3 for a cup of coffee. Post-rebrand, they increased the price to $4, and customers willingly paid the premium due to the enhanced brand experience. They also increased their total purchases from 200,000 cups of coffee to 250,000 cups of coffee.   

To determine an ROI for the cafe’s branding efforts, we must first determine the additional revenue received as a result of the branding effort.   

To calculate the ROI, we use the same formula as we used in our previous articles for direct marketing.  The branding ROI in this case would be: 

A 700% ROI in this case would be a very effective marketing campaign. Of course this is a very simple hypothetical example. In the real world, attributing revenue to a particular branding campaign vs other marketing efforts or unrelated factors like a new gym opening up next to the cafe can be very difficult.  

On the other hand, branding efforts can last much longer than the time period measured. Even though we calculated the benefits and costs for one year, the price increase and the additional foot traffic may well hold for years to come increase the ROI of our branding campaign. 

Conclusion: The Art and Science of Branding 

While ROI and financial metrics provide a clear numerical picture, branding introduces an element of art to the science of marketing. It’s an investment in perception, emotion, and long-term customer relationships. Small businesses should approach branding as a strategic asset, understanding that its impact may not manifest in immediate revenue but holds the potential for sustained growth and customer loyalty. 

In our exploration of measuring marketing effectiveness for small businesses, we’ve measured ROI in several different ways and delved into the nuanced world of branding. Each element contributes to a comprehensive understanding of a business’s marketing impact. By navigating this landscape, businesses can make informed decisions, optimize their marketing strategies, and build a resilient brand that stands the test of time. 

In the world of marketing effectiveness, understanding the long-term impact of your efforts is crucial. For small businesses, especially those that offer a subscription service or rely heavily on repeat business, this becomes even more significant.  

In this article, we’ll explore how calculating Lifetime Revenue and Customer Acquisition Cost (CAC) plays a pivotal role in determining the Return on Investment (ROI), using a SaaS vendor as our case study. 

The SaaS Landscape 

Imagine a SaaS vendor offering project management software to businesses. They operate on a subscription model, generating revenue through monthly or annual subscriptions. Additionally, they provide training sessions for an additional fee, contributing to their overall revenue stream. 

Customer Acquisition Cost (CAC) 

The first step in this strategic approach is to delve into the Customer Acquisition Cost. CAC is the cost associated with acquiring a new customer and is a critical metric for subscription-based businesses. For our SaaS vendor, the CAC includes marketing and advertising expenses, sales team costs, and any other expenditures directly related to acquiring new customers. 

Let’s break down the CAC formula: 

​ For our SaaS vendor, if they spent $10,000 on marketing and sales efforts and acquired 50 new customers, the CAC would be $200. 

Lifetime Revenue 

Now, let’s shift our focus to Lifetime Revenue. This metric involves calculating the total revenue a customer is expected to generate over their entire lifespan as a paying subscriber. In the case of our SaaS vendor, it includes not just the subscription fees but also revenue from additional services like training. 

The Lifetime Revenue formula is as follows: 

If the SaaS vendor charges $50 per month per subscriber and the average customer stays subscribed for 24 months, the Lifetime Revenue would be $1200. 

Calculating ROI 

With both CAC and Lifetime Revenue in hand, we can now calculate the Return on Investment. The modified ROI equation for this approach is: 

In this scenario, the ROI is approximately 500%, indicating a solid return on investment. This means that for every dollar spent on the marketing campaign, the contractor gained about $5 in return. 

Determining ROI Strength 

So, what constitutes a good ROI in marketing? A general guideline suggests a range of 400% to 600%, with anything below 200% considered poor and results exceeding 1000% deemed exceptional. This range depends on the profit margins of the business. High-profit margin businesses can afford lower ROI campaigns, while those with narrower margins need higher returns for the effort to be worthwhile. 

In our example, 500% would be a successful marketing campaign.  If feasible and if we have the capacity to support more sales, we should invest more money in the marketing campaign to expand it and capture more revenue. 

Additional Revenue Sources 

Firms should measure all revenue sources when calculating lifetime revenue. Training and service contracts are common sources of additional revenue that should be added into the lifetime revenue formula. 

For our SaaS vendor, offering training sessions provides an additional revenue stream.  Let’s say they charge $2000 for each training session, and on average, 20% of their customers opt for training. This adds an extra layer to the Lifetime Revenue calculation: 

Training Revenue per Customer = $2000 × 0.2 

This means an additional $400 per customer for training. 

Now, the updated Lifetime Revenue formula becomes: 

With this inclusion, the Lifetime Revenue increases, positively impacting the ROI. 

Our new ROI when including the additional revenue source is 700% which is an exceptional marketing campaign.   

Conclusion: A Holistic Approach to ROI 

In the ever-evolving landscape of subscription-based businesses, a holistic approach to calculating ROI is crucial. By considering both Lifetime Revenue and Customer Acquisition Cost, businesses gain a more comprehensive understanding of the impact of their marketing efforts. 

For our SaaS vendor, offering additional services like training further enhances their revenue potential and contributes significantly to the overall ROI. This strategic approach enables businesses to make informed decisions about their marketing strategies, ensuring that the cost of acquiring customers aligns with the long-term value these customers bring.  

In the final part of this series, we’ll explore the intricate world of branding and how it factors into the measurement of marketing effectiveness for small businesses. 

Next article:  The value of branding for small businesses 

When we talk about a business, we’re referring to a team of people who come together with the goal of making something valuable. This could be a product or a service that people need and are willing to pay for. But the big question is, how do we make sure our business is as valuable as possible to everyone involved?  

It all starts with setting a clear goal. We need to ask ourselves: What unique value does our business offer? Whether it’s through the hard work of our team, the services we provide, or the products we sell, our aim is to offer something that people see as valuable enough to spend their money on. 

The Essence of Value Creation 

Identifying Your Business’s Value Proposition 

Understanding the core value your business offers is crucial. This value can manifest in various forms – be it a product, service, or a blend of both. Identifying what sets your offering apart is the first step in crafting a compelling value proposition that resonates with your target audience. 

Aligning Value with Customer Expectations 

The alignment of the value you provide with what your customers are willing to pay for is a delicate balance. It requires a deep understanding of your market and the needs of your customers, ensuring that the value you deliver meets or exceeds their expectations. 

Strategic Pricing and Cost Management 

The Pitfalls of Traditional Costing Methods 

Many businesses set prices based on experience or market standards without a thorough understanding of the actual costs involved. This oversight can lead to pricing strategies that do not accurately reflect the value provided or the costs incurred, potentially harming profitability. 

Understanding True Costs 

A comprehensive approach to understanding the true costs of providing your value proposition is essential. This includes direct costs like labor and materials, as well as indirect costs such as benefits, taxes, insurance, and overhead expenses. Accurately accounting for all these factors is critical in setting prices that are both competitive and profitable. 

Advanced Costing Strategies 

The Role of Job Costing 

Job costing plays a pivotal role in refining your understanding of project costs. By comparing actual job costs to estimates, you can identify discrepancies and adjust your pricing strategies accordingly. This process is vital for maintaining profitability on a per-project basis. 

Addressing Variances in Estimates and Actuals 

Variances between estimated and actual costs can happen for several reasons, including inaccurate estimates, execution challenges, and unforeseen changes in scope. Understanding and addressing these variances is crucial for improving cost management and pricing accuracy. 

Improving Estimation Accuracy 

The Importance of Detailed Estimates 

Creating detailed and accurate estimates is the foundation of effective cost management. This involves a thorough understanding of the project scope, realistic labor and material cost assessments, and anticipation of potential challenges. 

Learning from Past Projects 

Each project provides valuable insights that can improve future estimations. By analyzing the variances between estimated and actual costs, businesses can refine their estimating processes, leading to more accurate pricing and better profitability. 

Managing Project Execution and Scope 

Execution Efficiency 

Efficient project execution is critical for maintaining profitability. Identifying areas where time or resources are wasted and implementing strategies to mitigate these issues can significantly improve overall project efficiency. 

Scope Management 

Effectively managing project scope and changes is another key aspect of profitability. Establishing clear criteria for what constitutes a significant change and how these changes are priced can help maintain project budgets and profitability. 

The Path to Enhanced Profitability 

Profitability is not merely a result of strategic pricing but also of accurate cost estimation, efficient project execution, and effective scope management. By starting with a solid foundation of understanding your true costs and overhead, and continuously refining your processes based on actual performance, your business can achieve a sustainable and profitable operation. The journey to profitability is ongoing, but with the right strategies in place, businesses can unlock their full potential and create lasting value for their customers and themselves. 

Beyond Sales and Marketing  

In the dynamic world of small businesses, the focus often lies heavily on sales and marketing. While these areas are crucial for generating revenue, there’s another vital aspect often overlooked: product and service development. This post aims to explore how small business owners can leverage product and service development to significantly boost their company revenues. 

The Importance of Expanding Your Offerings 

Adding Value to Your Business 

One key strategy for growth is the addition of complementary, ancillary, and replacement products and services. By expanding your offerings, you not only meet the evolving needs of your customers but also add to your company’s value proposition. Take the example of a popular food chain adding sophisticated drinks to their menu – this move not only increased average customer spending but also brought in significant revenue from the new offerings. 

Developing New Products: A Strategic Approach  

The product development process involves market research, competitive analysis, and trial runs. This method focuses on increasing customer spending through complementary and ancillary offerings, thereby boosting overall revenue. 

Enhancing Existing Products and Services

Responding to Customer Needs 

 A crucial part of product and service development is enhancing what you already offer. Listen to your customers – what features do they request? How can you differentiate your offerings to boost sales? Incorporating customer feedback and competitive analysis into your development process is key to improving and refining your existing products and services. 

Selecting the Right Products for Development 

Analyzing Potential Returns 

 Deciding which products to develop requires careful consideration of the market, options, and return on investment. Tools like customer feedback, competitive comparison, and Ansoff Analysis can help in identifying the most promising opportunities for development. 

The Business Development Process: From Idea to Market  

Starting Small, Thinking Big  

Even without a large budget or dedicated staff, small businesses can excel in product development. What’s essential is a keen market awareness and the ability to identify and respond to ongoing needs. Methods like customer feedback systems and user focus groups can be invaluable in evaluating potential development opportunities. 

Conducting Competitive Analysis  

Understanding what your competitors offer and how they meet customer needs can provide valuable insights for your own development efforts. Are there features or experiences they provide that you don’t? A thorough competitive analysis can guide your business development strategy. 

Implementing the MVP Approach  

Testing and Refining Your Ideas 

Before fully developing a new product, consider creating a Minimally Viable Product (MVP) – a prototype that can be tested with customers to gather feedback and gauge market interest. This stage is crucial for avoiding the pitfall of creating a product that doesn’t meet user needs or is overly complex. 

Learning from Trials  

Trials allow you to understand customer reactions and refine your offering accordingly. This phase is about optimizing interest and revenue potential with minimal initial investment. 

Finalizing and Launching Your Product

From Concept to Completion 

Once your MVP has been tested and validated, it’s time to complete the development. This stage involves planning, budgeting, safety testing (if necessary), and considering the marketing and sales strategies for the new offering. 

Seizing Opportunities for Growth  

Adding complementary and ancillary products and services is a practical way for small businesses to diversify their revenue streams. This approach doesn’t require large budgets or polished offerings; start with a few ideas, conduct research, develop an MVP, and test your concepts. Remember, the key to success is a willingness to pivot based on what you learn and the courage to abandon ideas that don’t yield results. Start brainstorming, conduct preliminary research, and embark on the exciting journey of product and service development! 

Have you ever heard of starting your budget from the bottom up? The traditional way of setting your budget usually starts with a fixed set of expenses and then calculates the resulting net profit. With profit-driven budgeting, you begin with the desired net profit as the goal and work backward to determine what expenses and revenues are needed to achieve that goal.  

A Valuable Mindset Shift 

Profit-driven budgeting sounds unorthodox, but with the simple shift from our goals to our costs, we enter abundance, not scarcity. An abundant mindset is invaluable when fostering a productive team and work environment, as it keeps your team focused on profitability. This article will give you a step-by-step guide on how to accomplish this bottom-up or profit-driven budgeting and provide answers to some of your burning questions. 

Step-by-Step Profit-Driven Budgeting 

The first thing you must do in profit-driven budgeting is set your desired net profit. What kind of money do you want to have at the end of the year to put into your retained earnings, and how much do you want as a distribution to yourself as company owner? Start by determining the level of net profit you want to achieve within a set amount of time. That set amount of time is usually a year, but it could be broken down into quarters based on your preference. Stick with a yearly budget if it is your first time building this type of budget. 

Your next task is estimating revenues. Using your knowledge of your business and current market conditions, estimate the total revenues required to reach your desired net profit. This could be your sales income from all sources, among other things. After that, determine the associated variable costs that generated those revenues. The variable costs are expenses that fluctuate with the level of production or sales, such as the costs of goods sold or direct labor. Then determine your fixed costs, which are costs that do not vary with production or sales. These are items like your rent, salaries, and utilities, which are fixed or independent of production and don’t change often. 

Now you are ready to calculate the total expenses for your budget. Allocate resources and expenses to different categories or departments within your organization based on your specific business needs and goals. It’s best practice to review your allocations with the department lead or director so that expectations and needs are adequately met. Don’t simply assign a budget or determine your needs in a silo unless you know all the ins and outs.  

Implementing Your New Budget 

At this stage you have a solid budget to monitor against your actual performance. Your teams should review the numbers in regular meetings in the middle and at the end of each month to catch any variances with the expected budget. Differences in the red that are caught early can help adjust your strategy to ensure you meet the expectations by the end of the month. On the other hand, if you have an uptick and are performing better than your expected budget, you can analyze what you did well and work to recreate it.  

Using this approach keeps the focus on profitability as the primary goal and makes sure that your budget aligns with your financial objectives. It requires your team to understand your business’s cost structure, revenue drivers, and market dynamics, enabling you to set realistic targets. Doubling your target net profit is unrealistic in almost all cases. Instead, start by increasing your target net profit by 20-25% in the first year. Profit-driven budgeting applies to various types of businesses, including manufacturing, service, retail, and many others. It’s a versatile budgeting strategy, but it requires knowing your financial dynamics. 

Avoiding Profit-Driven Pitfalls 

As with any budgeting process, this method comes with a few challenges. One of the major challenges is estimating revenue projections. If you don’t have historical data on your performance, it’s hard to set proper objectives. The rest of the budget will not be accurate if your revenue estimates are out of proportion. Incorrect revenue projections often come from setting unrealistic expectations on the set net profit. Be reasonable and remember that you should be basing that net profit number on historical data or average expectation for a company of your size and capacity level.  

Another common pitfall that will throw off any budget is the inability to adjust to the changes in the business environment. Stay versatile and monitor your budget versus actual frequently, as recommended above, to stay ahead of problems and manage your business and budget effectively. Action-based metrics should also be measured from the bottom to the top. This way, you can find the areas in which your business is lacking and focus your efforts there. 

Use Tools to Better Your Business 

As you can tell, proper prior and future data collection is essential to executing and maintaining a profit-driven budget. If you do not perform sound metrics captures regularly and do not have a handle on your financial drivers, cost structure, and market dynamics, the profit-driven budget strategy is not for you. Make sure those items are in order before implementing profit-driven budgeting and you will have success.  There are also various profit planning software tools available that can help you streamline the profit-driven budgeting process. Reputable budgeting software will enable you to set targets, monitor progress, and analyze variances with ease. With the outline in this article and the right software in place, your budget will become a tool to help you drive profitability.  

As a business owner, you likely did not open your business to be an accountant. You understand revenues, costs, and profit, but how can you go a step further to obtain valuable information to improve your business? An accounting system comprises various ‘accounts’ that collect information. How you structure these accounts is the key to gleaning valuable intelligence on how your business operates and where you can improve.

How do you know which revenue streams are the most profitable? What costs are driving your profitability? If you alter one area of your business, how will it impact others? These are all questions that you should be asking of your accounting systems and data.

In accounting, this structure is called the Chart of Accounts (CoA) and should be structured to match your business. Most accounting systems offer standard CoAs for common types of businesses. To optimize the information you receive, however, you must tailor your CoA to give you actionable information, enabling you to make better decisions. Business owners tend to create too many accounts instead of not enough, making their CoAs cluttered and difficult to navigate. The components that drive your business success are often buried in numbers that do not provide you with an accurate assessment of your situation. There are four main categories that you must organize to make your CoA work for you: revenues, costs, expenses, and investments.

Revenue

Starting with revenue, you want you CoA to accurately identify what products, services, or divisions generate revenue for your business. Identifying your various revenue streams allows you to take control of your business in a new way. You can assess what sales efforts should be given the highest priority. You can invest in growing revenue streams with good profit margins in emerging markets. You can see the decline in your legacy revenue streams and evaluate why. You can evaluate what actions to take to bolster your market share, adjust your pricing, improve upon your offerings, or pivot into new products, services, and markets. These actions produce measurable results that can be used to improve your overall business financial performance. 

Costs

The costs of your business are things that are directly related to generating revenues. The most common breakdown of these costs is material, labor, and other costs associated directly with these revenues. As your revenues grow, these costs usually grow in proportion. For example, the more widgets you make, the more material is used, and the more people and supplies are needed to make them. The more installation or service work you perform, the more materials, people, and vehicles we need to accomplish these activities. Your organization’s productivity can be measured by the revenue generated divided by your costs. Your output (revenue) is divided by your input (costs). If you can find ways to increase your output or decrease the amount of input needed, you can improve your productivity. If you can do both, your Gross Profit or Gross Margin will improve even more. Gross Profit is your revenue minus your costs to produce it in dollars. Our Gross Margin is a percentage of these costs divided by your revenues. If your revenue increases, your Gross Profit increases if your Gross Margin remains the same.  

Expenses

Expenses, often referred to as overhead, are essential elements for sustaining your business, regardless of its revenue levels. Examples of expense items include rent, utilities, technology, advertising, insurance, and administrative resources. As your business expands, certain expenses may increase, but they usually do not scale in direct proportion to your revenues and costs.  

In the initial stages of your business, you might find that these functions, like accounting, bill payments, payroll processing, hiring, and phone services, demand relatively fewer resources. However, as your business grows, these tasks can absorb valuable time from key personnel who are pivotal for fueling continued growth. Even if you decide to outsource functions like payroll, accounting, or other administrative tasks, they remain categorized as expenses. 

When you subtract your expenses from your revenue, you derive your Gross Profit. Gross Profit signifies the revenue remaining after the costs of production. This figure is quantified in dollars. Gross Margin, on the other hand, is represented as a percentage, with costs divided by revenues. If your revenue increases while your Gross Margin remains constant, your Gross Profit improves. 

Expenses are undeniably necessary, but the power of controlling or minimizing them should not be underestimated. Accountants have consistently emphasized that Net Profit, the sum left for you as a business owner after costs and expenses are deducted from revenues, can be engineered through the astute management of expenses. The actions you take to enhance profitability will hinge upon the insights gleaned from your CoA. If your CoA fails to provide the necessary information, it might necessitate a restructuring. 

Another valuable tool for recognizing significant revenues, costs, and expenses is to introduce a column in your Profit and Loss statements that compares each account as a percentage of your revenues. This practice will show you which accounts have negligible impact on your end results, and which select few have a substantial impact. 

One area where you often have significant control is in your direct labor costs. Even a minor enhancement in productivity can yield a substantial boost in profitability. By assessing and understanding which accounts significantly affect your business, you can focus your efforts on those with the most profound impact. By thoughtfully organizing your accounts to measure, track, and enhance them, your accounting data transforms from a mere tax-keeping system into a powerful management tool. 

Effective communication of financial information, while some business owners are hesitant to do so, is vital for assessing current performance, setting targets, and gauging improvement. Using percentages instead of dollar values can be a helpful approach. One commonly employed technique is the use of ratios, such as the effective multiplier, which signifies the ratio of revenues to direct labor costs for billed work. The intention is to empower individuals in your business who are best positioned to influence the data.  

The most promising avenues for improvement often emerge from those engaged in the day-to-day operations. Achieving optimization necessitates the active involvement of the entire organization. For instance, some smaller organizations employ the company’s gross margin percentage as a performance gauge for their incentive plans. The underlying rationale is that the most controllable cost, both at the company and individual levels, is often the cost of efforts. Incentivizing this aspect encourages higher productivity and can eventually become the standard or ‘best practice’ for similar roles. By aligning incentives with the most controllable elements, businesses can maximize their output for the efforts invested. 

To attain optimal results, it is imperative to identify, evaluate, and control the items or accounts that have the most substantial impact on financial outcomes. This necessitates a meticulous organization of your accounts that provides this information without clutter. Focus on what truly matters, and concentrate your efforts on those areas where you can make the most significant impact. 

Investments

When it comes to optimizing your accounting system for better decision-making, investments play a crucial role. While revenues, costs, and expenses are essential components to track, investments are the fuel that can propel your business to new heights.  

Investments, in this context, encompass the allocation of resources, both financial and non-financial, in areas that can generate future returns. A well-structured CoA should include an organized framework to track your investments, helping you understand where you’ve committed capital and resources, and more importantly, what returns you can expect from them. 

Tracking investments within your accounting system is essential for making informed decisions. Investments can take various forms, such as capital expenditures, research and development, marketing campaigns, or even hiring top talent. By categorizing these investments in your CoA, you can assess their impact on your business. Are certain investments leading to substantial growth in revenues? Or are some investments not delivering the expected returns? With this information, you can adjust your investment strategy to focus on areas that are driving profitability. 

Every investment carries a level of risk. By closely monitoring your investments within your accounting system, you can evaluate the risk associated with each one. This allows you to make more informed decisions about whether to continue or modify your investment strategy, balancing the pursuit of opportunities with prudent risk management. 

Investments often involve the allocation of resources, both human and financial. By tracking these allocations, you can better manage your resources. For instance, if you realize that a particular project or division is not delivering the expected returns, you can reallocate resources to more promising areas of your business, improving efficiency and profitability. 

Investments are not just about immediate gains; they are also about building for the future. A well-organized CoA that includes investments enables you to engage in long-term planning. You can set aside funds for research and development, expansion into new markets, or the acquisition of new technology, all with a clear understanding of how these investments contribute to your business’s growth. 

Some investments may offer tax benefits or incentives. By tracking investments in your CoA, you can identify potential tax advantages that can help you manage your tax liability more effectively. 

Make Your CoA Work for You

In the realm of business, knowledge is power. Your CoA is more than just a ledger; it’s a compass that can guide you towards better decision-making. By thoughtfully organizing your CoA to encompass revenues, costs, expenses, and investments, you transform it into a dynamic management tool. The path to profitability is not just about increasing revenues; it’s about optimizing costs, managing expenses, and nurturing investments that yield returns. As you embark on this journey, remember that true success comes from identifying what truly matters and concentrating your efforts there. Your CoA can be your ally, helping you navigate the intricate landscape of your business’s financial health and enabling you to make decisions that lead to lasting prosperity. So, make your CoA work for you, and watch as it becomes a beacon illuminating your path to financial success. 

Guest post about using technology to increase productivity and profitability in a business.

Technology has greatly evolved in almost all aspects of life, and workplaces have not been left out. The office environment has changed a lot, allowing businesses to reach a global market, thanks to improved tech. Without a doubt, technology has enhanced efficiency and convenience in handling business.

As such, small and large businesses alike have always been on the hunt to new and useful technology for more significant benefits. That has made the business world competitive than ever before, but this has a desirable effect on productivity. If you have been wondering how technology increases productivity and profits, have a look at the following points

1. Efficiency and increase productivity

A few years ago, one of the main challenges that most businesses faced was gaining access to information while on the road. This had unwanted effects, such as delayed results when serving customers.

Limited information accessibility means a business cannot reach the maximum potential in terms of performance. However, this has changed with improved technology, such as cloud storage, fast internet access, and more. Businesses can serve their customers more efficiently than ever before.

2. Reduced marketing costs

Print marketing was associated with a high overall cost. The advent of the internet has brought severe change with the introduction of LED and LCD screens in digital signage and marketing. Businesses can also use social media platforms and other platforms for cheaper yet effective marketing. Besides, it easier to create more targeted ad campaigns, and such approaches do contribute a lot to reduced marketing costs.

3. Easier to identify challenges

Before improved and efficient technology, businesses had a tough time trying to establish the reasons why they were not doing well. This has changed with time, allowing businesses to carefully analyze their strategies and know what does not work for them. By identifying their weak points, companies can come up with better plans to achieve their objectives.

4. Better organization and time tracking

When members of a team want to achieve a common purpose, they have to collaborate and be organized. Online productivity tracking has made this possible, with functions like goal progress tracking, time tracking, and project management. The ability to track the progress of a project makes it possible to avoid nasty surprises when the time comes to deliver results.

5. It’s easier to reach experts

With the different outsourcing tools available, a business does not have to rely on their employees for all expert advice and service. It’s easier to hire renowned experts who can help a company get the best results. Hiring experts allows the employees in a company to concentrate on their expertise as the experts do their thing.

6. Improved business safety

With manual records, it was quite challenging to ensure the safety and integrity of information. This was mainly as a result of how the data was being stored, accessed, and maintained. Modern technology has eliminated this challenge by allowing controlled storage and access of data. It’s possible to ensure business data security, as only the authorized people get their hands on the data.

7. Reduced overall costs

One of the best ways to maximize business profits is to reduce costs where possible. With things like cheaper and more secure storage options, reduced labor costs, and others, businesses can reduce the overall operation costs. Companies can also invest in LED and LCD screens for digital signage, allowing them to interact better with customers and save money in the long run. That way, more cash is channeled to the profits account.

The above are some of the main ways through which technology is enhancing productivity and profits in businesses. Both small and large companies can now use technology to improve their performance and get better returns. The main benefit of technology is that it always evolves to become more efficient and has never-ending benefits.

Mia Clarke is part of the content and community team at Userful.com, experts in all things video wall and display solutions. When Mia is not spreading the word about video walls she is often found discovering the great outdoors, walking or cycling.

At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. To learn more ways to enhance your business, check out this post for helpful business information:

Cogent Analytics, LLC is a business management consulting firm, with a primary focus to help small to medium size, privately held businesses achieve success and long term profitability. Cogent provides powerful solutions with integrity and transparency to privately-held businesses throughout the United States.

Business owners who do not know their break-even point will eventually find themselves asking,

“I’m making money, so how come I don’t have any?”

The answer for most owners is simple – because you are not doing the math. Making money is not making a profit, and you cannot make a profit if you do not know your break-even point. A lot of business owners do not understand how to read their financials or use them as a management tool. These are usually the same people who ask the above question. Just bringing in money does not guarantee solvency, you also need to make a profit on the money. 

Let’s look at how profit, loss, and break-even works. 

If you earn $1.00 and have expenses of $.90, your profit is $.10. You have a profit margin of plus 10%. When your margin is positive, you are getting paid to provide your goods or services. If you earn $1.00 and have expenses of $1.10, your loss is $.10. You have a loss margin of minus 10%. When your margin is negative, you are paying for providing your products to the customer. If you earn $1.00 and have expenses of $1.00, you are at break-even or zero. You have no profit or loss, neither making nor losing money. 

To understand the importance of knowing your break-even point look at this example. In 2014 ABC company had a net income (money they got to keep) of $500,000 from sales of $5 million, this is a profit margin of 10% ($500,000 divided by $5 million). In 2015 they got a new customer. But, instead of doing a break-even analysis they estimated the costs and miscalculated the increased expenses (i.e., labor, supplies, overhead). They made $500,000 again, only it was on sales of $5.5 million, resulting in a 9% margin. They were making less money on a higher volume. In 2016 the client offered ABC more business, which they accepted without running the break-even numbers. Increased expenses (i.e., new machinery, overtime, warehouse space) produced the same net income of $500,000. Only it was on $6 million, which was an 8.3% profit. The company increased its volume by a million dollars over two years but made less profit. The owner could not understand why he had a smaller bonus in 2016 than he had in 2014, especially when he was working longer, more difficult hours. Math is non-negotiable – your product cannot cost more to make than what you charge for it. The only way to know how to make a profit is to figure out the break-even point. So, in spite of  what you thought, you do need some of your high school math in the real world. It can mean finally having enough money in your pocket. 

At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:

A one page business plan is a document that in a short form format identifies what the business is about and how it will succeed.  In today’s business environment, the need for concise and direct information is of utmost essence for an SMB/SME to succeed.  

Many times brevity is the best way forward while presentation with 50 power point slides is most often a turn off for many investors.    

As Winston Churchill once said, “If I can speak for four hours I can start now; if I only have 15 minutes I need three months to prepare.”       

As to making a one page business plan, the first stage is to create an actual business plan outline; it need not be perfect or completed though it does need to have enough information to cover the various aspects of the business such as:  

• • Describe The Business Model  

• • Who is the business team    

• • What are the ownership and the legal formations of the business  

• • Why is the business going to succeed – Additional analysis for proof of concept   

• • Sources of Revenue and the operational costs of providing the products/services  

• • Marketing Plan Overview  

• • Operational Plan overview  

• Capital investments needed and how funding will be achieved  

Using this information, the One Page Business Plan can be created by including the following:   

• • Business Model  

• • Business team – Brief formation of the business  

• • Success Factors – Reasons for  

• • Sources of Revenue   

• • Marketing Plan – Brief  

• Operational Plan – Brief  

At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:

Despite what you hear on the news, small business owners are thriving in very real ways. This article details three client case studies on how these small business owners have successfully delivered more Net Profit to their pocket.

Most small business owners have never read a Jim Collins book.  That is a real shame, because a fundamental business principle is to face the facts (both good and bad) head-on.  We saw this in the energy bust in 2015.  Several companies that had planned very conservatively from the 2007 drop had built up large cash reserves.  The only guarantee when you have a boom is that you will have a bust.  The question for business owners should not be, what will happen to your business, but rather, what are you planning to do to prepare for it?  So, for those that were prepared, they swept in and bought up a number of assets that were on a fire sale, from those other companies that were highly leveraged, had failed to plan, and were simply trying to ride the wave to fortune and riches.

This article details three privately owned, small businesses that operate in larger metro areas.  Company Alpha is a commercial service company; Company Bravo is a design/manufacturing company; and Company Charlie is a professional services firm.  Each has their own unique value proposition, and as you will read, has figured out a way to either raise their prices and/or raise their net profit.

Alpha has been around for about 15 years.  The owner is a technician and started the company by himself.  He shortly found himself with an abundance of service calls, and so he started to hire more technicians and the necessary support staff to support his early stage company.  The demand for his service is so great, a typical service call goes like this:

Client:  I have a broken piece of equipment, how soon can you get here to fix it?

Alpha:  Mr. Client, we are happy to help you but it looks like all our techs are scheduled thru the next five days.

Client:  5 days is unacceptable.  Isn’t there any way you can get here quicker?

Alpha:  We do have our after-hours program, but you pay a premium since we are paying our staff overtime.

Client:  That’s fine, when can they get here?

Alpha:  Did I mention that there is an after-hours service charge in addition to the wage premium?

Client:  That’s fine, when can they get here?

Alpha:  There is also a 15% markup on their mileage for these after hour calls.

Client:  That’s fine, when can they get here?

You get the point.  Alpha’s work is in such high demand that time is much more important than price.  Alpha has worked hard to cross-train its field technicians to be able to repair any piece of equipment in the field, giving them ultimate flexibility with their logistics and being able to maximize their gross profit on a daily basis.  Alpha keeps adding additional “service fees” or bumping up its hourly rate until customers not only complain about it, but when they start to see a decrease in the number of service calls by that particular client.  Then they go back and negotiate a “standard rate” for that client, which is still a 25% increase over the base rate, because they will provide priority scheduling for that client.  This is an excellent example of the business principle, “the price you are willing to pay for something is directly proportional to your need of it.”

Bravo is a really neat design/manufacturing firm.  They make custom engineering applications for various companies.  Whenever you see the word “custom” your mind should immediately register “higher net profit.”  Whenever the economy tightens up and clients look for ways to increase efficiencies/output, they call on Bravo.  Bravo’s best years since 2001 were 2007-2010 and also 2015-2017.  Since he has now successfully expanded his client base during two past downturns, he now has more recurring maintenance revenue than ever before, which provides great cash flow, and also increases their project work, because now they are the first call for a larger number of clients.  Bravo’s clients are able to get quotes from other vendors, but the other vendors have much more overhead than Bravo does, and so even with the very healthy gross profit margins that Bravo uses in its estimates, it is still generally the lowest bidder.  They had been working with one large Fortune 500 client for about three years, and they finally figured out the purchasing game.  The Operations Department would contract with them to provide a custom application.  The Operations Department Manager would then beat them up a little bit, trying to play the bids against each other, and generally was able to get a 2-4% bid price reduction.  The Engineering Department Manager would then beat them up a little more on price and try to get another 1-2% reduction in the bid.  Then the Purchasing Department would beat them up a little more and try to get another 5-10% reduction.  Bravo figured this out after a while and simply added another 25% to the initial bid estimate, so that even if they “agree” to a 16% price reduction, they are still 9% higher than they were before.  The old line of “be careful what you wish for because you might just get it” comes to mind for their client here.  This is on top of Bravo’s standard practice of adding 25%-50% contingency (internal) into their initial estimate, since many times they have no idea how many design hours will be needed or how difficult it will be to manufacture a particular piece.  They also have a clause in their contract that states, if there is more than a 15% variance in our bid estimate to actual, then client will pay for all additional fees and expenses at market rate.  If you customize something for someone, then you should absolutely get paid for it.

Charlie is a professional service company that now operates like a well-oiled machine.  They provide a service that is required by law.  As with many of these types of services, the client is not concerned with value because he is forced to contract this service.  What the client is interested in is price and speed.  Charlie decided to build a company that is the lowest cost provider, will be able to take a significant portion of market share, and then he will reverse engineer how to drive a significant net profit from the low price.  He invested heavily in technology, and so where his competitors use two field technicians, he can use one.  His competitors still enjoy driving around very large trucks, and he has put his people into fuel-efficient cars and smaller SUV’s.  He has streamlined the back-office processing to where they can produce the necessary client documents to the cloud or email within 1 business day of the site inspection.  Charlie started the company in 2003 and waited for the economy to take a dive.  In 2006 he had about 30% of the market share.  By 2010 he has over 60% of the market share.  By leveraging technology and investing in training, he has been able to drive his gross profit to above 70% and his net profit to about 32%.  I don’t know any company that would sneeze at 32% net profit margins!  He aligns all his employees with the company direction by providing real-time data on their performance to them, as well as paying large bonuses for gains in their productivity.  The faster and more efficiently they work, the more money they make.  Charlie’s theory is that he can “perfect” this business model in Houston and then replicate it in all the large metropolitan areas that have the economic indicators that show it would be a great location for his particular service.

These three companies provide a small snapshot into the world of small business.  According to the US Census Bureau, there are 27.9 million small businesses in the US.  If we assume Pareto’s law of 80/20, that means that about 5 million of these businesses are the rock-stars, like the companies we have read about above.  Until you go and listen to their stories, dig a little into their business models, and understand how they are functioning, you would have no idea just how profitable these little businesses are.  If you are an employee for one of these companies, you are extremely happy because they are providing great work environments, as much work as you want to do, good benefits, a family environment, and an opportunity to develop and take on as much responsibility as you want.

The trick is that on average, only 1 in 6 of the companies you interview at will be in this category.  Choose wisely…

At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:

According to Road Scholar Transport, “Nearly 70 percent of the freight shipped throughout the United States travels by truck at some point in its journey.” It’s the middle of 2018, and it’s time to look at the trucking industry, it’s performance, and gain insight about where the industry is forecasted to go.
We would like to take a closer look and offer some insight as to where the trucking industry is headed for the remainder of 2018 and into the future. As the economy grows, it is placing an incredible demand on freight transport, especially considering the shortage of drivers available in the U.S. today. ” Freight shipping will boom in the U.S. over the next ten years, with the volume rising from 15.18 billion tons moved in 2017 to 20.73 billion tons in 2028 – an increase of nearly 37 percent,” this is according to a Forecast provided by the American Trucking Association.
According to the American Trucking Associations(ATA); freight loads are beginning to trend upward, however, ‘less than loads’ (LTL) freight loads are trending even higher as many companies explore ways to transport and receive their smaller shipments. Need will continue to produce higher demand and revenue in the trucking industry.

Expected Diesel Fuel Costs –
As stated in a 2018 Kiplinger Energy Prices Forecast, fuel costs across the board are expected to continue rising. As the upset in Saudi Arabia continues to escalate, oil prices will rise leading to price increases for

diesel and gasoline in the U.S. With the uncertainty about the troubles in Saudi Arabia; business persons globally are likely concerned with the possibility of an oil supply interruption. For the trucking industry, this could increase fuel prices significantly for the remainder of 2018.

Should American Consumers Expect Increases in Trucking Rates? –
Yes. Some of the big players, FedEx and UPS at the beginning of 2018 had implemented their 4.9% increases. We all know that eventually prices must rise on nearly everything and these costs must be passed on to the consumer. It’s certainly not something that any company wants to do, but in most cases have no other options.
These increases will not only affect the big players, but small business trucking companies will have to follow suit if they haven’t already. Owning a small trucking business is expensive.
Literally, every aspect of owning a trucking business is expensive. The labor is intensive as well. If the owners don’t raise their rates to increase profitability, they could face having to close their businesses.
As of March 22, 2018, FTR reports ” Tight motor carrier capacity and rate gains continue to remain two of the dominant themes in freight transportation, according to the most recent edition of the Trucking Conditions Index (TCI)…” This is a positive for companies as it indicates an increased level of opportunity to serve more clients/customers in the long run.

Adjustments to Capacity Due to Lack of Trucks and Driver Availability –
Even if there were no shortage at all, there is still the serious concern regarding the industry’s ability to handle the capacity imposed. There are only so many drivers and therefore only so many freight carriers available. With increasing demand, some consumers may have to consider other modes of transporting goods.
The other options would be acceptable; however, these additional options won’t carry directly to the needed locations. This will require additional local transportation and there again, costs rise. A lack of truck capacity could cause a lack of inventory for consumer’s shelves.

How Is Revenue Being Affected in 2018? –
As always revenue will continue to change as it does annually. However, revenue will likely be affected by demand combined with the new EDL restrictions for truckers’ hours, and the continued price increased as well, the desperate need for long-haul carriers.
As more consumers continue to demand more merchandise, more work and increased expenses will be expected from those truckers who will need to ship them. If consumers want these things, they will have to face the fact that they should no longer expect transporters to ‘split the difference’ to get the business. Long haul companies will be forced to increase trucker’s salaries. Although many organizations which closely monitor the trucking industry feel that 2018 will bring positive changes to the industry, adjustments may be needed along the way to keep the positive changes on track.

Driver Shortages –
In 2017 the ATA reported that the trucking industry is currently suffering a shortage of approximately 30 to 35 thousand professional truck operators and states that by 2022, it could reach a shortage of approximately 245,000.
Also, according to the ATA, it’s over the road professionals that are so desperately needed. This appears to be an area of the industry that few people want to work since the pay rates are low and time away from home and family are significant. To recruit long-haul drivers, the salaries for those positions must increase to balance this area of the industry.

At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:

Understanding how to calculate cash flow is of high value to an SMB/E.
Operating cash flow Formula for an SMB/E provides a measure of the amount of cash generated by a company’s normal business operations.
The output from the Operating cash flow formula will indicate whether a company can generate enough positive cash flow to maintain and grow its operations. Otherwise, it may require external financing for capital expansion.

It is essential to avoid confusion when talking about the Operating Cash Flow Formula; cash flow metrics need to be clear and useful.
This includes the net margin after, e.g., cost of goods sold and operational expenses have been taken out.
It does not typically include non-operational fund additions such as capital grants, loans, interests from investments and such.
Formula:
Generally, the Operating cash flow formula is calculated in two different ways. The first way, or the direct method, subtracts operating expenses from total revenues.

This calculation is accurate and straightforward but does not give investors much information about the company, its operations, or the sources of cash. That’s why GAAP (Generally Accepted Accounting Principles, your accountant knows more about this) requires businesses to use the indirect method of discovering the cash flows from operations. This method is an indirect, roundabout, way to calculate it.
The operating cash flow equation for the indirect method adjusts net income for changes in all non-cash accounts on the balance sheet. Depreciation and amortization are added back to net income while it is adjusted for changes in accounts receivable and inventory.

Net Income +/- Changes in Assets & Liabilities + Non-Cash Expenses = Operating Cash Flow

Changes in assets and liabilities are, e.g., accounts payables and receivables. Non-cash expenses are, e.g., credits due to poor quality.
This Operating Cash Flow formula version is a bit more complicated but gives much more information about the SMB/E’s operations for banks and SMB/E lending associations.
Knowing how to calculate cash flow allows you to present the operating section of the accrual income statement to a cash basis statement.

At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information: