The formula to drive profits 61 per cent
Conventional business reporting usually looks at three variables, namely sales, expenses and profits: Sales – Expenses = Profits.
This simple formula offers valuable information, but presents a narrow view. Each variable depends on the other, forcing businesses to look at either increasing sales or decreasing expenses in order to influence profitability.
Tracking and reviewing additional statistics using the Five Ways formula breaks the sales variable into five separate components.
Testing, measuring and recording activity in each of the five key areas — lead generation, conversion rate, average dollar sale, average number of transactions and profit margins — reveals significantly more data.
Calculating and tracking in each of the five variables in the following formula quickly shows how an increase in any or all of them can increase sales and profits, while keeping expenses constant.
Lead Generation x Conversion Rate = No. of Customers
No. of Customers x Average Dollar Sale x Average Number of Transactions = Revenues
Revenues x Profit Margins = $ Profits
Understanding lead generation, conversion rates and average dollar amounts
Generating leads and getting more of those leads to make purchases is the direct cost of client acquisition.
This is the most expensive function of your business.
The conversion rate is the actual number of people who did buy versus those who could have.
Ten people walked through the door, three people purchased something — using this example, the conversion rate was three out of 10, or 30 per cent.
The average number of transactions is the number of purchases each customer will make over a specific time frame, normally over a fiscal year. This area is directly related to effective customer service/relationships.
Finding ways to reach the people who need/want what you have to offer and getting them to act — to pick up the phone, visit your website or walk into your business — is what the majority of marketing strategies are designed to do.
Discovering revenues and working on margins
Revenue is computed by multiplying the total number of customers by the number of times each purchased from you, multiplied by the average amount they spent. The resulting number is the total value of overall sales for the business.
Regardless of how many customers you have, how often they buy from you, or how much they spend, if your margins are too low, revenue will perpetually go back into your business to cover costs.
Margin is the profit percentage of each and every sale. Simply put, if a business sells something for $100, and $25 was profit, the profit margin is 25 per cent.
The primary business strategy to improve margins is to manage and reduce costs. However, one of the simplest ways to increase your margins is to increase your prices.
The normal reaction to this option is the fear of loosing customers. The fact is, if your margins are 25 per cent and you increase prices 10 per cent, you could afford to lose 29 per cent of revenue and still make the same profit.
The final step in the formula takes the resulting revenue number and multiplies it by a company’s profit margin percentage to reach bottom-line profit.
The Five Ways formula can be used to leverage one or all of the variables in the equation. Any business can work with the variables to improve the bottom line, even those that offer products or services with a long-term buying cycle or a limited number of transactions.
When used consistently, this business tool will highlight the areas that should be included in future planning.
Information may indicate that more marketing is required to capture more qualified leads, or more initiatives developed to increase conversion rates, or upgrading profit margins.
The five-part formula is challenging, but so effective because it touches on each and every area of your business.
If you could increase the value of each of the five parts by just 10 per cent, you would increase you bottom line profits by 61 per cent. In future columns I will be discussing strategies you can use to realize these gains.
In addition, I will be presenting this topic at the Success 4 Business Expo at the Westerner Park Harvest Centre this Thursday.
ActionCoach is written by John MacKenzie of ActionCoach, which helps small- to medium-sized businesses and other organizations. He can be contacted at firstname.lastname@example.org or by phone at 403-340-0880.