As sales pour in, it’s easy to become so focused on top-line growth that costs and expenses go unchecked. For small business owners, it’s important to keep a close eye on both in order to determine true profit margins. This ensures that the extra resources companies invest to grow revenue will reflect positively on their bottom line.
To effectively track sales and costs as a small business owner, consider using the seven tips below. First, let’s explore the key distinctions between gross profit and net profit.
1. What is the difference between gross profit and net profit?
Gross profit calculates revenue minus cost of goods sold.
Net profit goes beyond that to calculate revenue minus all business expenses, including cost of goods sold, operational costs, legal fees, marketing spend, and so on.
Take a vending machine as an example.
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In a week, the vending machine sells $500 in drinks, which is revenue.
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The wholesale cost of those drinks, or Cost of Goods Sold (COGS), totals $100.
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Other expenses may total $350, which include rent paid to park your vending machine, weekly maintenance costs, and labor to collect the cash and restock the machine.
This makes the calculations for gross profit and net profit simple.
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Revenue ($500) minus COGS ($100) = Gross Profit ($400)
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Revenue ($500) minus Total Expenses ($100 plus $350) = Net Profit ($50)
While it’s nice to see a large gross profit (equal to 80 per cent of sales), net profit (equal to just 10 per cent of sales) is the most important metric a business owner should focus on. Of course, there’s more to it than just these summarized numbers. Another thing SMBs need to do is an in-depth analysis of their sales and expenses.
2. Break down sales and costs by product lines.
Smart leaders know how their sales are divided up between product lines. Even better, they also have a deep understanding of their product line costs. These figures give them further insight into their true cash cows.
To add on to the vending machine example, we might see:
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$200 worth of cola sold each week
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$150 worth of bottled water
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$100 worth of seltzer
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$50 worth of juice
The costs and gross profits for each may be:
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Cola: $70 in costs and $130 in gross profit
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Bottled water: $10 in costs and $140 in gross profit
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Seltzer: $10 in costs and $90 in gross profit
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Juice: $10 in costs and $40 in gross profit
This reveals that although cola drives the most revenue, it’s bottled water that generates the highest gross profits.
By knowing which products have the strongest gross margins (the difference between the sale price and the cost of goods sold), small business owners can make better decisions about the products they should market and promote.
3. Keep your sales team in the know.
Generally, vending machines run on autopilot, absent sales staff and complicated marketing campaigns. Most small businesses, on the other hand, have a sales team that is responsible for maintaining and tracking a strong sales pipeline. Often, they work to sell whatever they can to customers to keep up with their quotas and revenue goals.
In a different sales approach, managers can encourage sales reps to focus their pitch on products or services that have higher gross margins. In doing so, businesses typically see downstream improvements in their net profits and bottom line. That way, reps can focus more of their efforts on closing sales that generate more profit for the company.
To empower sales reps to make smarter sales decisions, business owners can even disclose their cost of goods sold across product lines. Armed with this information, salespeople can apply discounts more selectively and strategically when acquiring new customers in order to keep profits healthy.
Ask your sales team to regularly log in to their CRM platform to report their revenues along with their gross profits. This keeps margins top-of-mind as they reflect upon their contracts won, clients pending, and potential cross-sells and upsells with existing customers.
4. Evaluate customer acquisition costs and identify retention opportunities.
Before new customers enter the pipeline, small businesses invest in various advertising, marketing, and public relations initiatives to build brand awareness and generate exposure. Those costs get factored into net profits, but are often undisclosed to salespeople. As such, owners need to develop their own formulas to calculate customer acquisition costs from discovery all the way through the sales pipeline until the contract is won — because salespeople may not have every data point, their metrics may not reflect reality.
In some cases, you may find the total cost to acquire a customer is more than their gross profit to the business. A rational response may be to set contract minimums to offset acquisition costs, or to disqualify those leads early in the sales funnel. A wise alternative, in this instance, is to place a higher emphasis on client retention since renewals, cross-sells, upsells, and even positive word of mouth marketing (leading to customer referrals) can significantly impact your long-term bottom line. Research from management consultancy Bain & Company supports this, suggesting that a 5 per cent increase in retention can boost profits by as much as 95 per cent.
Use your CRM platform to determine current retention rates and set quarterly goals to steadily improve those numbers.
5. Balance growth and profitability.
More sales mean more work. Whether you manufacture a product or fulfill a service, your team’s administrative and operational workload tends to increase in lockstep with sales. Of course, if orders for low-margin products grow, you run the risk of working harder for fewer profits.
Data found in your CRM platform can tell you which types of accounts generate bigger profits versus those that stretch company resources thin. Before entering into a new contract, consider whether the extra effort is worth the potential short- and long-term profits. Perhaps it would be best to decline or eliminate certain sales opportunities during busier periods in order to ensure you have adequate resources to support higher-margin accounts.
6. Consider cash flow and payment delinquency.
As businesses grow, some customers may ask for delayed payment terms. While agreeing to this request may be simple and a good business practice, the impact it could have on your finances may put you in a precarious situation.
Beyond simply tracking sales and costs, management also needs to work with their financial analyst or bookkeeper to closely monitor cash flow and to account for payment plans, potential delinquencies, or defaults.
On a rolling basis, smart leaders understand their upcoming accounts receivables, payables, and late payments owed to their company. You can use your CRM system to send automated, gentle reminders to customers with outstanding balances, but you should also use it to estimate your average defaults each quarter and year. Deduct lost revenue due to defaults when looking at net profit calculations to get a more holistic look at your company’s financial health.
7. Establish budgets and create measures for accountability.
Cost of goods sold aside, your sales budget is complex. Quality advertising is expensive, salespeople need allowances for building relationships with clients, and paid software licenses are required to automate tasks and streamline workflows. Many of these expenses are necessary to run a successful business, but it is, of course, important that these costs don’t get out of hand.
The best way to keep expenses in check is by providing different departments and functions with a pre-set budget that leaves the overall business with plenty of room for profits. Though with budgets, accountability measures are important, too, so ensure everyone keeps accurate records of the amounts spent, the rationale behind the cost, and any management approvals for additional budgets.
Assuming there are only rare instances when teams spend more than they’re allocated (while others spend less), then you ensure costs don’t exceed sales projections and you protect your net profits.
Final tips for small businesses tracking sales and costs.
It goes without saying, but companies need to track everything, from items sold to discounts applied, advertising expenses to legal fees, salaries and commissions paid, and anything else that breaks down revenues and costs.
Taking this a step further, leaders can plan to do a quarterly review with their teams to remind them of how sales (and their respective costs) impact the company’s bottom line. It’s even more helpful when businesses upload that data into their CRM platform, either manually or by syncing vendor costs and other bookkeeping data sources, to provide more transparency to their employees. That way, employees can then decide on smarter strategies to drive better profits instead of just increasing sales.
When businesses also align employee incentives with profits, most salespeople forgo lavish expense budgets and focus heavily on selling high-margin products.
The more you track sales and costs and communicate them to your team, the more they’ll adopt a profit-oriented mindset that’ll ensure your bottom line grows just as fast as top-line revenue — or even faster.
