In this four-part series, I want to share four areas where your business may be leaking valuable dollars. I’ll call them profit leaks. Many business owners operate with a “leaky bucket” and don’t even know it.
I don’t know of any business that sets out to be unprofitable or to burn through more cash than they generate. Unfortunately, not monitoring your business for these leaks could have a devastating effect on your business results.
Or maybe you’re doing okay, but you know it could be better. Who wants their business to just be “okay”?
One of biggest offenders of profit leaks is your employees. In this four-part series we’ll look at how profit can leak out of the following four areas.
- COGS (cost of goods sold)
- Admin (or G&A)
Each of these categories, has the potential to either enhance your ability to generate profit OR drain your business of cash.
Now let’s talk about the first leak, COGS (costs of good sold).
What Employees Are Part COGS?
According to Accountingtools.com COGS is defined as “the accumulated total of all costs used to create a product or service, which has been sold. These costs fall into the general sub-categories of direct labor, materials, and overhead. In a service business, the cost of goods sold is considered to be the labor, payroll taxes, and benefits of those people who generate billable hours (though the term may be changed to “cost of services”). In a retail or wholesale business, the cost of goods sold is likely to be merchandise that was bought from a manufacturer.”
For our discussion, I want to focus on the employees or labor part of the COGS equation. The employees which are responsible for delivering your product, should be placed in the COGS bucket.
If you are spending more than the ideal on labor to deliver your product or service, you have a profit leak that could be significant.
You see this happen often when businesses fail to monitor their Gross Margin or the billable dollar goal of the employees, which are part of product delivery.
What is gross margin? – Gross margin is the difference between revenue and cost of goods sold, or COGS, divided by revenue, expressed as a percentage. Generally, it is calculated as the selling price of an item, less the cost of goods sold (production or acquisition costs, essentially).
- Do you know the gross margin (GM) of each of your products?
- Do you have a target GM?
- Do each of your employees have billable dollar goals?
If you are not tracking these KPIs, there is a strong chance, you are leaking profits.
Let’s do some simple math and look at the revenue generating side of things…
Say you have 10 employees who are responsible for product delivery. Each is paid $50k per year and the are billable at $100 per hour.
Let’s assume there is 2000 hours available to work per year (40/wk * 50 weeks). I’ve assumed two weeks of vacation.
Let’s also assume they really only work seven out eight hours per day or the are 87.5% utilized. That one hour gets eaten up with meetings or other time that is not dedicated to delivering your product.
In theory, those 10 employees should generate 10*2000*87.5%=$1.75M in revenue
How much revenue is lost if the are only 80% billable? (10*2000*80%=$1.60M in revenue)
That’s a $150k loss in revenue. If you business has a 10% net income, that $15k.
So, clearly is very important that each employee knows the gross margin goal and their billable goal.
What Does A 10% Drop In Gross Margin Do To Your Business?
Let’s look at it another way by comparing three different scenarios:
In the super-simplified P&L, you can see what a dramatic effect a 10% drop in gross margin has on a business.
What Can You Do To Avoid This Profit Leak?
There are a number of things that can be done to improve your gross margins, however the starting point is understand what they are. If you do not have solid financials or a financial model, chances are you will spend more than you need to on the labor component of COGS.
There are a number of things that can be done to improve your gross margins, however the starting point is understand what they are. If you do not have solid financials or a financial model, chances are you will spend more than you need to on the labor component of COGS. Business don’t magically drift into profitability. You must have a target that you are shooting for and monitor it relentlessly.
Think you may have a problem with this profit leak? Need some help solving this issue? Contact us today for a free 15 minute discovery call.
Stay tuned for our next blog where we’ll discuss another profit leak.