When your business is just getting off the ground, or fighting for territory, any sale feels like a good sale. When you sell something to a client or customer, that means money is coming in to your business, right? And money coming into your business is what pays your employees, covers your payables, and keeps the lights on.
My firm often works with business owners who can’t quite figure out why the money that their salespeople are bringing in is barely enough to keep the business afloat – if that. When I look over their books, I can usually quickly identify one, if not several, reasons a business is struggling. And a lot of it has to do with how a business looks at sales.
Too many business owners chase revenue without regard for margin. Don’t get me wrong, sales are great but you have to be just as (if not more) focused on your margins. In the business world, there are several different kinds of margins, but when I work with my clients the one I focus on is gross margin. Gross margin is what is leftover from your sales once you deduct what it cost you to make those sales. It does not take in to account your overhead expenses (rent/utilities/insurance, et cetera).
If you’re a reseller, this could be called markup. If you are in a services business, like I am, your gross margins must take into consideration your people costs, including salaries and benefits.
Operating with low margins may seem like a smart move if your business plan is to beat your competition on price. And if you sell a large volume of product or services, this can work. But there’s a flip side – low margins can seriously affect cash flow if customers are slow to pay. Here’s a simple example:
Suppose you sell books and give your customers five days to pay. You, however, must pay for the books immediately. You buy a book for $9 and you resell it for $10. So your gross margin is $1 per book sold. Remember, that’s your profit before you pay overhead. Now suppose that a customer does not pay you (or pays very late). You now need to sell nine extra books just to pay for the one you were stiffed on, and those nine sales don’t count at all toward your bottom line.
Use the same scenario, but now suppose you bought the books for $5, so you had a $5 gross margin. Now it only takes one extra sale to cover the $5 your customer has not paid on time. Not nearly as damaging.
Taking on even more low-margin business in an effort to improve your cash flow can compound your problems. Now you have more sales, which means you need to hire more salespeople or technicians or installers or whatever the term is in your field. You may need a larger facility that requires more insurance and electricity and telephones. All of these costs add to your overhead. If these new customers are slow to pay, you can find yourself out of cash very quickly.
So are all sales good for your business? Absolutely not.
All business owners must have a minimum gross margin that they are willing to accept. If a potential sale does not meet that margin, you must be willing to turn it down. It may be tempting to bend your rules just this once, but know this: selling too much and growing too rapidly can bankrupt a company just as fast as not selling enough. That means all your hard work to get those low-margin sales and satisfy your customers will mean nothing in the end. Nothing.
So know your gross margins. Set your minimums. And don’t look back.
Robert J. Rickert CPA, PC focuses on giving its clients timely, accurate and relevant financial information to help them make informed decisions about their businesses. The firm provides customized solutions to meet the specific needs of its clients. Services offered by the firm include CFO and controller services, crisis management, interim financial management, acquisitions and business buying, divestitures and business selling, litigation support, business tax services, and tax dispute assistance for individuals. For more information, visit rickertcpa.com, call 910-319-9127 or email [email protected].
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