Profit mistakes you need to avoid

By Jonathan Amponsah is founder and CEO of The Tax Guys

When you’re working hard and money is coming in, it is easy to assume that you must be making a reasonable profit. However, I often find business owners are making mistakes and not achieving the profits which they deserve. Let’s look at some common profit mistakes and how to handle them.

Not knowing your numbers

The biggest mistake is not knowing the profit numbers that matter in your business. Your gross profit margin, profit per staff, profit per client or project, net profit margin, breakeven number, monthly costs and prices are all-important to track and focus on. 

If you speak to your accountant once a year only to be told how much tax to pay with no access to your key numbers, it is unlikely you will be able to improve on your results. The good news is that there are many online accounting apps on the market, such as FreeAgent, QuickBooks and Xero, to help you with this. 

Unplanned undercutting

It’s tempting to look at your competitors’ prices and undercut them in order to win business, but this is a problem without any long or even short-term plan. Over time, when you win more business, you find yourself not making profits because your costs have gone up and it becomes hard to raise your prices as you’ve attracted price-sensitive customers. You need a plan for your pricing.

Confused by cash

Too many business owners rely on judging the profitability of their business based on their bank balance. However, you might be making a loss despite the cash in your bank. This may be because:

• You have received advance cash from your customers
• Payroll expenses have not been reflected in the accounts
• You have not paid your suppliers or other creditors
• You are not paying yourself a reasonable salary
• You haven’t made adjustments for all expenses

Have a conversation with your accountant and go through the above list together with other factors specific to your business. 

Wrong calculation of price

Having ascertained your profit margins of 30 per cent, a common and huge mistake I see is as follows. You go to see a new prospect. You take your costs. Let’s say £1,000. What do you do next? You apply 30 per cent to the costs. You then quote £1,300 for the job. It makes sense, right? 

Well not quite. If you take your £1,000 costs from the £1,300 revenue (price) you get £300. Now divide that by £1,300. You now get 23 per cent. You’ve just lost 7 per cent profit margin without even blinking. 

And this mistake will make its way down to the net profit figure, causing you to be less profitable year after year.

Cutting the wrong expenses

You realise the cash at bank is not yours and that you are not making profit. So panic sets in and you’re determined to cut costs to make profits. Here’s the thing though: Not all expenses will have a greater impact on your profits. 

A study by McKinsey and Co (global consulting firm) revealed that while a 1 per cent reduction in fixed costs can lead to around 2 per cent increase in profits, the same reduction in variable costs has a bigger 7 per cent increase in profits. So instead of going for cost-cutting at all cost (no pun intended), conduct a cost/benefit analysis and focus on variable or direct costs first.

Not going for 1 per cent

The same study shows that increasing pricing has a bigger influence over your profits than reducing costs or increasing sales volumes.

Most business owners do not consider assessing the power of a mere 1 per cent increase in price, 1 per cent increase in sales, 1 per cent decrease in variable costs and 1 per cent decrease in fixed costs. 

Next time you sit down with your accountant, ask him or her to run these numbers and show you the impact it will have on your profits. Would you lose a lot of customers due to a mere 1 per cent increase in price? 

Lastly...

I like the idea Mike Michalowicz has in his book Profit First. He suggests opening another bank account and transferring your profits before you make payments to anyone. If you’ve calculated your net profit as 10 per cent, transfer that right away. Then manage with the remaining 90 per cent.