Get your calculator warmed up. Business is a game of numbers.
CASH FLOW AND PRICING – how to improve your bottom line with a few key strokes.
Most business owners focus on price and margins forgetting an important element in running a successful business – cash flow. What does this mean and how does it work?
Let us consider for a moment that you are selling loose tea. You pay 1 dollar per kilo for the tea. You sell the tea for $1.50 per kilo giving you a margin of 33%. Monthly you can sell 100 kilos to 100 different customers. So every time you sell one kilo of tea you profit by 50 cents.
At $1.50 per kilo you can sell 100 kilos per month but experiments have shown that by dropping the price to $1.29 per kilo you sell 150 kilos per month to 150 different customers. That generates a margin of 22%. So every time you sell one kilo of tea you profit by 29 cents.
These are the typical areas of focus for business owners. But will they help your profits?
In the first example the cash flow is $50 per month. In the second the cash flow is $43.50. So dropping the price and selling even more tea has damaged the bottom line. In terms of cash flow, increasing the sales has not been a good decision.
But if you focus on the cash flow figure, you can also improve profits, as follows. Suppose that you are now selling tea for the sale price of $1.29 per kilo. But instead of selling one kilo at a time, now the buyer must buy a minimum of 2 kilos. As before 150 customers come in and buy tea and the margin remains the same at 29 cents per kilo. But this time the contribution to the bottom line is $87. And you did not have to work any harder for that profit.
What this example tells us, is to focus on the dollar contribution and not margins or even the price. Dollars pay the rent, employees and taxes.
This technique I have used in bakeries, hardware stores and even truck repair facilities. We focused on the dollars per invoice, assuming that the amount of effort and cost to write one invoice for $5 was the same as for $500. By finding the means to up-sell or add additional lines to an invoice or sales slip, we increased the cash flow. By not adding to indirect costs, and taking into account only the direct cost of materials or ingredients or direct labour, the extra money free falls all the way to the bottom line.