Becoming profitable is what transforms your business from ‘just coasting’ to ‘driving at full speed’. And as we said in our last blog post, the first step in improving your profitability is stopping to ask Where am I now, and how healthy is my business?.
That health check process tells you how effectively the business is working, and gives you a normalized profit number and acceptable level of profit (ALP) figure that tell you whether your enterprise is:
- Vulnerable to failure
- Treading water and in need of change
- Meeting its profit goals and ready to grow
But whichever category you fall into, there’s always something to be done to improve your profit level, increase your efficiency and make you a more streamlined, cash-generating venture.
Where could I be losing profits?
There are many reasons why your business may not be achieving its profit goals.
- Your pricing may be wrong – either too high or too low.
- Your costs and overheads could be too high – and eating into your margins.
- You may not be using your team and resources effectively.
- You might not be bringing in enough customers, so sales are too low.
- You could be working with unprofitable customers who eat into your time.
The key here is to identify the specific problems you’re facing (remember the importance of that initial health check) and to then work towards resolving those issues as quickly as possible.
Working with a professional accountant is going to help here – after all, it’s our job to help you spot those bugs in your financial systems and to flush them out. And that’s why we think you’ll get more from your profit improvement initiative by working in partnership with an experienced advisor.
With the right combination of industry knowledge and accounting experience, we can work together to flag up the holes in your profits and start plugging those gaps in a way that has your long-term business interests at heart.
The impact of labor costs
The single biggest cost for many service-driven businesses is their labor costs.
Unlike manufacturing or construction businesses, that will have big spends on raw materials, a service business’s biggest overhead is its people.
Your salaries, your reward packages and your bonus scheme all eat into your profits. And if you’re the owner of the business, your own compensation and remuneration can also start affecting your profit number.
So getting your compensation and payroll costs right is one way to have a significant impact on boosting your profit numbers.
Setting a reasonable compensation number
Reasonable compensation is about knowing how much to pay yourself, as the owner-manager of your business.
The ideal situation to balance your own remuneration needs against the profit needs (and tax efficiency) of the business.
- Pay yourself too much and you increase your own tax bill and take cash out of the business that could be invested in growth plans or in buying new assets
- Pay yourself too little and the business is left on ‘life support’, ticking over and functioning but not evolving.
- Get your compensation right, though, and you can reduce your tax bill, release more profits and have the liquidity in the business to thrive and grow.
The same applies to what you pay your team members. If they’re chronically under or overpaid that impacts on your profit numbers too, so working to get your compensation on point should be a real focus for any business owner.
Finding your labor efficiency ratio
Compensation isn’t the only element of your team’s labor that can affect profits.
How efficiently the team work together, how much time they take to complete a task and how well they deliver on your core priorities all impact on your end numbers.
Tracking labour time and getting an understanding of your efficiency levels is critical to your profit improvement drive. And one way to do this is by figuring out the labour efficiency ratio (LER) for the business and then monitoring it over time.
Anyone who’s more than 50% involved in the rendering of services is counted as contributing to your LER. And the different roles in the business are broken down into three key categories:
- Direct labor – the people who perform the core service or labor.
- Administrative or management labor – the people who support the delivery of direct labor.
- Sales and selling – the people in your sales and business development teams.
For each of the three main areas, you can then break down the best-case-scenario hours you expect to be delivered by each role, the cost of delivering those hours – and then measure that against the actual hours the team log on your systems.
As a general rule, it’s the direct labor that you’re interested in. The formula to work out your Direct LER is as follows:
(Actual hours – Standard hours) x Standard rate = Labor efficiency variance
Reviewing your LER metric as part of your regular reporting means you can measure the efficiency of everyone in the team. Over time, you can see if people are effective at what they do – and if they’re helping you deliver your goods and services in an efficient and profitable way.
And that can help you to pinpoint the resourcing areas that need to improve – and how the team progress over time one a new goal has been set.
A razor-sharp focus on efficiency
At the base level, if you’re going to improve the profitability of your business then you need to have a constant focus on efficiency.
Wastage – whether it’s overspending on compensation, inefficient working practices, or spending too much on your direct overheads – is going to impact on your numbers. So it’s vital to track, review and analyze every element of the business, and to look for a way to lose the waste, improve the efficiency and boost your profits.
If you want to generate better profits, please do come and talk to us – our Awesome 8 approach to profit improvement will help you to spot those key efficiencies and deliver more from your business.
Get in touch with your local Holden Moss office to book a session with one of the team – we’d love to talk to you about your financial improvements.
In the next part of this series we’ll ask ‘How do I have better ideas?’ and will explain the importance of great execution to an effectively run company.