Every entrepreneur starts a business for the most important purpose. To make a profit and to improve her personal life. Profitability is something that is the most wanted thing in the life of every entrepreneur. If you have $5,000.00 this year, you will want $7,000.00 next year. If you have $10,000.00 profit this year, you will want $15,000.00 for next year. If you have $150,000.00 profit this year, you will want $200,000.00 for the next year. You will always want more profit.
You must permanently do two things about your profitability:
- Analyze from time to time the profitability and
- Improve the profitability.
How you can analyze and improve your profitability?
The first thing is to see how you make a profit and what impact on your profit results. When you already know your numbers and important factors, the second thing is to develop a profit improvement strategy.
Start with the analysis of your profitability?
If you want to analyze your profitability you will need to start with your history data related to your past year. For example, you will need sales records and costs records in order to find your profitability, average sale from a customer, and average profit margin. You will also need to analyze your sales funnel to find the real numbers about conversion rates from the last year.
When you finish with the collection and analysis of these data, the first thing you need to do is to answer these questions:
- How many leads you generate annually? You will need a number. For example, 3000 leads, or 10.000 leads. You can find this number from your sales funnel.
- What is the conversion rate from leads into the customers? This is a percent. Again, this information will be based on the analysis of your sales funnel process. For example, if you have generated 50.000 leads, and you have 2.500 customers who start buying from you, the conversion rate will be 5%.
- What is your average sale per customer annually? You can calculate this easily this from your sales records. For example, if you have the records with customers, and amount paid, you can collect all amounts paid and divide with the number of customers. Let’s say that the last year you have generated $50.000 from sales. This number was generated by 2500 different customers. When you divide $50.000 with 2500 customers, you will get that the average sale per customers is $200.
- How much is your average profit margin? To calculate this number you will need to use data from your sales records and cost records. If you sell only one product and service, it is easier, because you already know this number. But, if you sell different products and services, with different profit margins you will need to calculate the average profit margin. The simplest way to do this is to collect your whole income from sales and subtract all your costs. If you divide the number you get with the total costs, you will get your profit margin expressed in percent.
Now, you will need to put those answers on the table as in the example below:
|Number of Leads||50,000.00|
|Conversion Rate (%)||5%|
|Annual Average Sale per Customer ($)||$200.00|
|Average Profit Margin (%)||10%|
|Profit (50,000.00 x 0.05 x $200.00 x 0.1)||$50,000.00|
As you can see these are 4 most important elements that have direct impact on the profitability of your business.
What you will improve to increase your profitability?
As you can already note, you can easily make improvements if you increase one or all of these factors:
- Number of leads and/or
- Conversion rate and/or
- Annual average sale per customer and/or
- Average profit margin.
Let’s say that you want to improve all 4 elements for 10%, then your profitability will be:
|Number of Leads||55,000.00|
|Conversion Rate (%)||5.5%|
|Annual Average Sale per Customer ($)||$220.00|
|Average Profit Margin (%)||11%|
|Profit (55,000.00 x 0.055 x $220.00 x 0.11)||$73,205.00|
As you can see the 10% improvement for all 4 elements that impact on the profitability can bring you a profit of $73,205.00. That is a 46% improvement in profitability. This effect is called the butterfly effect.
Also, if you succeed to improve any single element, you will improve your profitability. For example, if you increase prices and profit margin your profit will be larger.