How a Shop Owner Turned Her Business Around (And the Numbers You Need to Know)May 13, 2022
Have you ever thought that you might be holding back your business's profitability? Here's what you need to know to make better financial decisions.
One of the reasons businesses aren't making enough money is a bad pricing strategy. But why does it happen?
Often, it’s because of fear.
There's a fear in some business owners’ minds that customers won't pay more and won't come back if their prices go up.
This is the fear that Sarah, one of my clients, faced.
Sarah ran a retail business and decided to include a coffee shop as an add-on. She wanted to create a new revenue stream for her existing business.
Unfortunately, she was in a very competitive market. And the expenses of the coffee shop – equipment, employment, etc. – weren't covered by her revenue.
The experience was a nice perk for her customers, but it also started driving Sarah's business down.
In our discussions, Sarah made it clear that attracting new customers wasn't really an option. But she also wasn't open to adjusting the pricing strategy.
She feared that her customers would leave and never come back. But since her situation was urgent, she agreed to increase her prices by 10%.
It was really Sarah’s only option to get her business back to cash flow neutral without borrowing money.
I reached out two weeks after, and Sarah said that everything went great. The only customer who said anything was someone who always carried the fixed amount for their coffee.
When it happened, Sarah's employees explained the situation. And they didn't charge that customer the additional 10%. But the next time the customer came back, they already had the full amount.
Sarah kept adding value to the customer experience and addressed her initial underpricing strategy.
In doing so, she eliminated the cash drainage.
What's the lesson here?
Perceived fear can prevent you from creating the revenue your business deserves. It can force you to make uninformed decisions, especially around pricing.
With that in mind, let's look at what really drives profit in your business.
The Numbers You Need to Know
Even when advised, Sarah was initially reluctant to alter her pricing strategy.
That was her perceived fear speaking. And it’s something that she and many other business owners share.
But I would argue that a better understanding of the numbers can help you avoid having to alter your pricing strategy in the first place.
If you know the business's figures, you'll have an easier time understanding what you need to do to stay cash-flow positive.
So, what are the numbers that are important to your business?
#1. Fixed Expenses
These are costs inside your business that don't change. They might fluctuate slightly monthly, but they're not necessarily dependent on the revenue.
For example, rent and insurance are often fixed costs inside a business. The subscription to your CRM platform is another type of expense that tends to stay fixed.
If we look at Sarah's story, her pricing strategy didn't allow her to cover fixed costs like employment and equipment rentals. A better understanding of those expenses could've prevented her from underpricing the goods and services in the coffee shop.
Monitoring and analyzing fixed expenses is one of the key ways to increase your financial performance. To do that, you can eliminate non-essential costs and create a pricing strategy that ensures you can sustain a cash flow positive business.
#2. Variable Costs
These are incurred expenses directly related to delivering your revenue. And they are a crucial driver of profitability in your business.
Let’s say you're selling books. It costs you $4 to get a book, and you're selling it for $10. That leaves you with a $6 gross profit.
However, manufacturing and vendor costs can fluctuate. That means the same book can suddenly cost $8, which would cut your profit down to $2.
What do you do then? Do you stop selling it, raise the price tag, or find a new supplier?
Monitoring your variable costs on a monthly basis will help you review your financial performance. It will then give you the information you need to make better business decisions regarding pricing, selecting suppliers and vendors, putting items on sale, etc.
However, not all businesses have wildly fluctuating variable costs. This is more common if you're delivering products as opposed to services.
But that doesn't mean that your variable costs don't need close monitoring.
This is a key area to check whenever your profitability starts going down. It's also worth investigating if you notice an upward trend in revenue and profit.
Figure out what's working and do your best to maintain or improve upon it, if possible.
#3. Breakeven Point
This is the volume of revenue you need to hit for your bottom line income to be zero. It's the target you must hit before you can start making money.
Let’s say you're selling a computer for $1,000 that costs you $500 to manufacture. And your business expenses for the year equal $10,000.
This means you'd have to sell $20,000 worth of computers, or 20 computers annually, to hit your breakeven point. When you sell 21 computers onward, you start being profitable.
Using this information, you could work out realistic revenue targets, marketing budgets, pricing strategies, and everything else you need to build a sustainable business.
Knowing your breakeven point will help you understand how many sales you need to make to cover all your fixed expenses.
Numbers Drive Your Business
As a business owner, there's a lot you need to know to create sustainable profitability. Your decisions are vital, and you can't make good ones without information.
So, what will give you the necessary information?
Understanding your fixed costs, variable expenses, breakeven point, and other numbers are important for creating a good pricing strategy. They're required to set sales targets, figure out budgets, and everything else that drives revenue and profit into your business.
Without knowing your numbers, you could easily underprice or overprice your products and services and see your profits driven down.
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