This is a guest blog post from Howard Polansky of Cash Flow Coach.
While it’s important to raise your prices as you go because your value and expertise will continue to improve over time, This isn’t the area that creates the greatest impact to your business.
As Mike Michalowicz mentioned in his book, Profit First¸ he had a 7-figure business that was losing money. The average person would think to themselves, how could that be? It’s because the top line has nothing to do with what’s left in the pocketbook. If the million dollars of revenue costs you $1,000,001 to generate, you are not running a profitable business.
An audit of your expenses should be a required task every year, at a minimum. I know Profit First professionals (PFP) will help you with an audit of profitable/neutral/destructive expenses when a new client onboards. Why? Because they are guiding you into an operating expense budget your business needs to fit in.
At the start, it almost feels like those pants you haven’t worn since you put on the COVID-15. It’s tight, you don’t know where to cut, but your PFP is your guide to realize what tools are must-haves to your business vs nice-to-have. However, there’s a deeper reason that most PFPs may not even realize on why this should be done annually.
I credit Tim Francis of Profit Factory for making this concept simple to understand. Tim calls this the BLOAT of the business. Most people understand the concept of the profit margin of the business. If my business generates $100,000 of revenue and my expenses are $90,000, my profit is $10,000, or 10%. To generate an extra $2,500 of profit, I need to sell another $25,000 of goods and services. That may feel intimidating just thinking how much more you have to sell to barely create a bump in profit.
But have you stopped to think: If I can save $X from my expenses, how much less do I have to sell? This goes back to the BLOAT. If I can cut a one-time expense of $100 and my business has a profit of 10%, I won’t have to sell $1,000. If that $100 was a recurring monthly expense, I won’t have to sell $12,000!! It doesn’t sound real, but the math is the math. So let’s take this step by step.
First, figure out your profit margin. It’s simply revenue – expenses = profit. Divide the profit into your revenue to get your profit margin.
Next, we figure out the BLOAT. Divide 100 into the profit margin to get there. If your profit margin is 18%, we calculate 100/18 = 5.56.
Now we come to the justification. Let’s say the one-time expense is $200. We multiply the BLOAT number of 5.56 by $200 to equal $1,112. The question we ask ourselves is this:
To justify this $X (recurring/one-time) expense, I have to sell $Y of goods and services. Is it worth it?
With this example, to justify this $200 expense, I have to sell $1,112 of goods and services. Is it worth it?
If it is a monthly recurring of $69, we multiply the expense by BLOAT and by 12. In other words:
$69/month x 12 months x 5.56 BLOAT = $4,603
To justify this $69 monthly expense, I have to sell $4,603 of goods and services. Is it worth it?
I’m not here to judge what you need to run your business. I’m here to help you truly analyze, by the numbers, how you justify each and every expense and understand how much in sales each expense really costs.
The added benefit of scrutinizing and justifying each expense is that when you can cut an expense permanently, the profit margin of the business increases and the BLOAT decreases. Playing defense is how sports team wins championships and how you create a championship business.