What are the factors that affect the profitability of a business? As a business owner, profit is likely top of mind and is obviously important to monitor as your business moves forward. We are talking about the four factors that determine the profit that you can control, changes you can make to positively impact your profit, and what you can do to accurately monitor them.
What we cover in this episode:
- 01:34 – What is profit?
- 02:21 – 4 factors that determine profit that you can control
- 04:47 – Price
- 07:28 – Quantity
- 10:25 – Variable costs
- 12:25 – Fixed costs
- 13:00 – What do you do next with these factors?
- 16:43 – How often should you monitor these factors to improve profitability?
- 18:00 – Bringing this back to strategic plan
What is profit?
Profit is what’s left over once all expenses have been paid out. There are quite a few factors that affect the profit of your company. Some factors are things you can control and others are a little harder to control. You want to be focused on the things you can control to improve profit! As you gain control of those factors, you have to analyze them regularly, so you can make changes as needed in order to maximize your efforts.
4 factors that determine profit that you can control
Price, quantity, variable, and fixed costs are the main factors that go into determining your profit. We cover each of these factors in further detail below, but first, we want to address a few important things to remember if your goal is to boost your profitability.
Remember your why and don’t get lost in the money. Yes, we want profits to be healthy in the business, but we also don’t want to lose ourselves in the almighty dollar. It’s so crucial to always stay focused on your vision and long-term goals, be true to yourself, what you’re trying to accomplish, and the lifestyle you’re trying to live.
Another great tool you should consider using as you go into this exercise about profit is the SWOT analysis. We talk about that in episode #15 SWOT analysis. This analysis is helpful because it provides internal and external factors that will give you important insight and will allow you to then shift your focus to profit.
Price
Price, what we’re charging for products or services, is the first factor that determines profit. There is quite a bit that goes into developing your price point. The goal is to charge as much as you can for what you’re producing, as long as you’re still competitive, so there are two perspectives you have to consider in setting your price.
First, you have to look at your building-up method. How much is it costing you to be in business? How much is it costing you to deliver the service? Have you considered increasing your pricing? You must understand all of the costs associated with doing business (raw materials, time, etc.) to ensure your price covers your cost.
Second, you have the current market rates. What’s going on in your industry? What are your competitors charging? There is a tension between your internal costs and the market rates and you must find a happy medium that yields the highest profit for your company while also remaining competitive. Marketing research can be quite helpful in determining what the landscape of your industry is and you can stay in the loop.
What is your pricing strategy? Are you establishing yourself as a low price leader or are you choosing to charge a premium? You have to differentiate yourself. Your Unique Core Differentiator, or UCD, is important, in addition to well-executed storytelling to highlight how that can impact your customers. Effectively communicating your UCD can then help you set and justify the price you’ve established.
Quantity
Quantity is the volume of services or products you’re selling. There are two ways to look at quantity as well that can help improve your business profitability.
The first is by looking at the number of clients you have currently. You could potentially increase your profit by choosing to increase sales, growing the total number of clients you serve.
Alternatively, you have the number of services per client. Another way to increase profit is by integrating upselling or increasing the number of services you provide to each of your current clients. To implement this strategy will require that you recognize where there may be a need or complimentary service and communicate the benefits well so they can take advantage of that.
Now, this is where some business owners get caught up in the “sales” side of the business and don’t want to become that pushy salesperson we have all encountered at one point in time. There is a better way to approach offering services. If we truly care about our clients, we are looking out for their best interests.
We are the experts in our field so we know what they need. We don’t want to push things on our clients that they don’t need and there is no need to be pushy at all. It is simply a conversation to discuss options available and explain the benefits of implementing your recommendations. Part of serving clients is providing education and you must always strive to come from a place of service.
Variable costs
Variable costs are those that change with revenue. Costs like labor and materials will increase as revenue increases. It is crucial to have a good understanding of the relationship of those things. Having awareness of your costs, how they move and what things drive them, help in making decisions about what we’re going to do when it comes to profit.
We have to understand the effects on the cost side with every action we take in business. If a change is made to the top (revenue) without considering the effects of the bottom (costs), we may not get the intended results.
For example, if we’re choosing to add a large number of clients to increase profit, we have to consider the costs associated with taking that action. How many more team members or administrative staff do we need to serve those new clients? What’s the cost to obtain those new clients? There’s no sense in getting 100 more clients if the bottom line isn’t going to increase the way we want it to. It’s just creating more havoc without results.
By fully understanding your variable costs, you can then consider other ways to increase your profit if increasing the number of clients will not ultimately have the impact you want on your bottom line. Maybe you consider cross-selling to current clients or think of other solutions without the cost variance difference.
Fixed Costs
Fixed costs are things like rent and other overhead items that will stay pretty stable regardless of your revenue. Again, you want to be very familiar with these costs because they will play into price points and you want to make sure you’re including enough to cover those costs. By considering these costs and understanding if those are going to be increasing, you can usually foresee changes in these fixed costs and make any necessary changes as needed.
What do we do next with these factors?
Once you’ve analyzed the four factors above, the next step is to look at your budget. As a part of the strategic plan, you should have a budget already established. If you’d like to learn more about a strategic budget, please listen to episode #04: Strategic Planning – Digging Deeper – Budgeting.
Your budget should estimate your costs for at least the next year. By regularly monitoring, you can ensure they stay in line with what you’re expecting. This is an important step to see if you’re on track or not as you go forward. Are your costs going up? This allows you to notice it quickly and make adjustments as necessary.
You should be performing a budget to actual analysis on a monthly basis. If you’re expecting a certain profit margin, you can compare your budget to actual to ensure you stay on track. This also allows you to keep tabs on all areas of your business, providing improved awareness so you know about any challenges before they become major issues.
In looking at variable costs, managing by percentages is crucial. For example, when you pull your profit and loss (P&L) statement, you look at the actual numbers, but you also want to look at things like the percentage of your overall revenues you paying the team.
Make sure those percentages are staying in line from year to year. If you’re going through a growth phase, your dollar amounts will be very different, but by looking at percentages, you can establish certain tolerances that allow you to see if those numbers start to skew. Are you producing more to the top line, but it’s all going out the door? Then you’re not hitting your profit on the bottom. Watching these percentages, especially during a growth phase, provides much more meaningful insights than just the dollar figures alone.
Industry analysis can help you set the percentages and tolerances mentioned above. Historical information from your own company, alongside industry analysis, can help you gauge where you should be and where you’d like to set your tolerances.
How often should you monitor these factors to improve profitability?
The frequency of how often these factors should be monitored depends on the factor you’re analyzing. In general, you should be looking at your budget to actual expenses, which are line items on your P&L, on a monthly basis. There are ebbs and flows in these, so you should also be analyzing your year to date to get a better sense of the overall situation, see if you’re on track, and find any adjustments that may be needed.
The next step, breaking this down further is to monitor your KPIs, which are more specific drivers for these things. If you’d like to learn more about Key Performance Indicators (KPIs), we talk about those in further detail in episode #08: Strategic Planning – Digging Deeper – KPIs.
Bringing this back to your strategic plan
We need a roadmap. Profit is crucial to keep your business moving forward, give back and pay yourself as the owner! You need a road map to get there. You can’t expect you’re going to make a profit if you don’t have a plan. A budget and plan must be in place so you can reach the goals you have set. Then, with regular analysis, you can make sure you’re on track.
If you’re interested in more ways you can grow your business, you can find our free webinar, 4 Ways to Grow Your Business, here!
Conclusion
We start out this discussion about taking control of profit by defining the term. Profit is what’s leftover once all expenses have been paid. We then discuss 4 factors you can control to improve the profitability of your business.
Price, quantity, variable, and fixed costs are good places to start when considering how to improve profitability. Once you’ve analyzed these factors within your business, it’s time to take a look at your budget. Not only should you have a budget in place, but you should be comparing your budget to actuals to ensure your estimates are accurate and that you’re staying on course.
It’s important to monitor these factors regularly and set meaningful KPIs that will help you stay on track. In addition, linking any growth plans back to your strategy is key in making sure you’re always coming back to your bigger vision and constantly working in the right direction.
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