As a busy entrepreneur, keeping track of where your money goes can be difficult. Your efforts are on sales; marketing for them, making them, billing for them. Our bookkeeping firm deals with many different types of businesses, however most businesses share common issues where even small tweaks can make a difference in your bottom line. We also know that most business owners look at the monthly P&L, and when you do, your eye naturally goes first to these three numbers: sales, cost of sales, and net income.
If you are at all disappointed in your net income, the tendency is to blame sales, but would you be surprised to know that you have the most control over cost of sales and other items that you probably don’t even focus on? While building sales is important to increasing income, we’ll table that conversation for now. Let’s explore your expenses. (This article, Part 1, is for those of you who sell products in inventory. If you provide a service, you may skip ahead to Parts 2 and 3.)
Cost of Sales: Generating income depends on many factors, but you have much more control over your gross profit through your costs. Let’s say that you purchase medications, vaccinations, supplies, etc. These are, by definition, your cost of sales. How can you lower your cost of sales in order to increase your profits? Here are some ways you should consider:
- Negotiate with your vendors on price. Yes – ask for better prices! You have sales reps who are paid commission on what they sell you; there is wiggle room in the prices, built into their commission. Try this: “we’ve been working with you for a number of years now, and I’m looking to consolidate our purchases and have them come from fewer sources. What can you do for me if I start buying prescription dog food from you rather than Vendor X?” You need to have this conversation at least once a year, as prices are always changing and your sales rep wants to keep you happy. If they don’t provide you with what you want, move on.
At the bottom of this article, I demonstrate how lowering costs, while not changing your sales price, adds to your profits. Caveat: I go a little overboard on the math and charts, but if you like that sort of thing, I invite you to review it.
- Negotiate with your vendors on terms. If your suppliers offer you 30 or 60 days for terms, this is fantastic for your cash flow, but what about asking for a discount if you pay at the time of sale? 2%10 net 30 is still common (you get a 2% discount if you pay within 10 days, rather than waiting the allotted 30), but if you have the means to not wait the 30 or 60 days, you should be able to take a discount. Again, ask!
- Watch your inventory. Like a hawk. I’m not just talking about locking it up and only giving the keys to your most trusted employee (we can’t be naive about how common it is for inventory to go missing.) Inventory control is an acquired skill that is now, fortunately, aided by efficient practice management software that will let you know what you have, what you need, and when you’ll need it. If you over-order, you run the risk of shelving obsolete or expired supplies. If you under-order, you can’t make the sale. Inventory tracking is probably included in your management software, so use it!
- Use your Practice Software to analyze your gross margins. I can’t stress enough how important it is for you to utilize your CRM / inventory software. Your subscription cost hits you every month, so use it! If you set up the inventory properly, as I mentioned above, the program will track costs, as you enter new purchases into the system. If you run monthly inventory reports on sales and cost of sales, you will have a clear analysis of not only how much you sell, but how profitable each item is. So if, for example, your profit margin on one item is 50%, but the profit margin on another is only 5%, you may want to take this up with your vendor, or find a new source.
To adopt all of these procedures takes time, and to analyze them takes learning and discipline. Naturally, I recommend the services of a reliable bookkeeping firm to set them up for you and train you and your staff to utilize them. In my experience with business owners, most of you are happily busy taking care of your sales. You find yourself with a successful, growing enterprise, with little time to take care of all of the financial intricacies. Whether you reach for consulting help or take care of the details yourself, let’s not leave money on the table – let’s start with an easy step and open a price negotiation with your vendors.
In Part 2, I will talk about a cost center that is most likely your biggest and most painful expense: Payroll.
As promised, here are some examples that demonstrate the power of lowering your costs:
Let’s say you sell an item for $50, and its cost to you is $35 Let’s also say that you sell, on average, 60 of these per month, or 720 per year
Now, let’s negotiate a discount with our vendor. Can you get 5%? How about 10%? Let’s see how those two scenarios increase your gross profit (still selling 720 units per year):
So, with a 5% discount you will increase your profit by $1,260 per year, and with a 10% discount, your gain is $2,520. That’s just for one item – imagine the possibilities.
Now, to completely belabor this issue, I want to show you the other side of it: how many more units would you need to sell, at the $60 price with the original $35 cost (no discount negotiated) to reach the same gross profits realized with negotiations?
And finally, if you’re thinking “why don’t I just raise the sales price?”, check this out:
WHAT PRICE WOULD I NEED TO SELL ORIGINAL 720 UNITS FOR TO REALIZE GAINS OF: (Cost remains at $35):
At this point, you should be thinking:
- What works best for my business: raising my prices, or negotiating a discount?
- What if I do both?
Moving on, we will address other expenses in the next two articles; expenses affecting service industries as well.