It’s no surprise that the most critical element when looking at profitability is knowing your numbers. And this is the first area we cover off with templates and fact sheets to help you capture all the information needed to help you make informed decisions around the key elements that will determine your profitability.
Pricing is a key element when considering how to make a business profitable, but it isn’t the only factor. Other critical elements include your product, the physical environment your product is delivered in, the processes that are in place to help you deliver the product efficiently and effectively, the place where your customers can buy your product from and the people who will deliver it.
All these elements are covered off in this section and there is a check list to help you to see which areas you are already on top of and which you may need to focus on.
Find out exactly what marketing is as well as what it isn't. Explore the seven P's of marketing: price, product promotion, place, people, process and physical evidence. Look at your business in a holistic fashion.
What are the options available for your business and how can these be personally beneficial? Access helpful bite-size sessions to watch when you are ready. Learn all about pricing for profitability so you can come up with a pricing strategy to maximise your profitability.
In simple terms, the definition of a profitable business is that once you have added up all your sales and then deducted all your costs you will have money left over.
It sounds straightforward, and many businesses think that because they are still trading, and are not in the red at the bank, they are profitable. However, this may not be the case and unfortunately the truth only emerges when the business shows signs of difficulty.
The main problem is often that the businesses don’t know their numbers well enough. They haven’t taken the time to create a budget forecast that shows every item of potential expenditure throughout the year and allocate it a realistic cost.
Income or sales figures, we can’t hide. There will be receipts that back up the money we have earned. But there is a phrase ‘turnover is vanity’, which means that it doesn’t matter how much you have sold – if it has cost you more to produce the product or service then your business isn’t profitable and won’t survive.
By having a thoughtful and detailed budget and reviewing this throughout the year, it’s possible to quickly assess where any adjustments might be necessary. Without this any problems could pass unnoticed, and the problem will compound year on year.
Budgets reveal other things too, for example: –
- Where you might be over reliant on some products or services
- Which products or services (or even people) generate the most profit
- Whether you have any blind spots in your spending (for example – is all that tech necessary for the business or are you indulging your own interests?)
How to create a budget forecast
We’ve included a template that you can tailor for your business. You don’t have to use this, but it will help to highlight areas that you might not be budgeting for, and it will help you keep an eye on your cash flow.
- The first, and potentially easiest, area for you to complete if you are an existing business – are your sales as you will have receipts from the previous year.
- If you offer different products and services try and split the sales out across these, this will help you analyse whether the whole of your business is profitable or just some elements.
- It’s not unheard of to find a business that offers a service and then finds that it costs more to run than they earn, but because it’s all rolled into the total sales, the problem is masked.
- Equally there may be an area of the business that makes a big profit per unit sold, but which has a small number of sales. By identifying this, you have a potential opportunity to refocus your marketing and potentially increase sales for this high profit element.
Cost of Sales (direct variable costs that only apply when a sale takes place)
Some businesses include all costs in one section, and this is fine to do – the main thing is capturing all costs, but it’s often helpful to be able to see ‘at a glance’ either whether you are paying too much for your materials or charging too little for your items once you can see the directly related costs with overhead stripped out.
For example if you offer yoga sessions at a supplement for your bed and breakfast guests, you may charge £15 per session for these (which you will include as a line item under yoga) but you may have to pay a qualified teacher to come a deliver the sessions @ £50 per session of up to 10 people and you may provide a healthy juice drink afterwards at a real cost to you of £2.00 per person. It will be helpful for you to see, at a glance which months are your most profitable for this activity (i.e., you fill the classes, have £150 in sales for each session and incur costs of only £70 making a profit of £80) and which months you ought to consider having a different offer for guests – perhaps you only manage 4 people per session which earns you just £2).
Overheads (or fixed and variable running costs)
This is everything you ultimately need to provide your product or service to your customers. In broad terms (but you will need to split these down) it will include: –
- rent or mortgage, rates, and insurance
- heat, light, water, waste collection
Insurances and licences
- public liability and any other insurances you may need for the services you provide
- if you serve alcohol or have entertainment on your premises, including playing a radio you will need licences
- ICO registration
- including your time – even if you only pay yourself minimum wage, consider what would happen if you fell ill, couldn’t provide the service, and had to bring someone in to provide it on your behalf. You would have to pay them!
- include training – even if it’s just you. What can you learn each year that would help improve your service and offer?
- uniforms – even a branded apron goes a long way to show customers that you are proud of your brand
- staff welfare – we all know how difficult it is to attract staff right now. So, make sure you hold onto yours by remembering their birthday with a card and a cake or a small gift (it all costs money – so budget for it!)
- pension – you are not obliged to run a pension scheme if you don’t employ anyone else to help you run your business, but if you employ just 1 person you must set up a scheme.
- even if you run a bed and breakfast there is a bare minimum in equipment you will need to take care of the business administration, and these include: a computer or laptop; a printer; a mobile phone; a card payment machine.
- even if you use a booking agent, you should be actively marketing your business via – your own website; social media sites; cards and leaflets; advertisements
- if you don’t have the time or knowledge to do this yourself you will need to factor in support from third parties
- Loan repayment costs
- Accountancy fees, including any accounting software
- Booking agents commission fees
Wear & Tear
- Things get broken and things wear out. If you are to continue to provide a first-class service, you’ll need to make sure you are able to fix things as soon as they go wrong. This may mean factoring in
- labour costs
- physical equipment replacement
- replacement of soft furnishings, linen, and crockery
- It pays to have an emergency fund, to cover you for unexpected circumstances, unpaid bills etc. so budget for this monthly
- And to make sure you can continue to improve your service; you’ll want to ensure you can try and develop it year on year. This is likely to take money…so budget for this monthly
Analysing the results of your forecast
The template that we’ve included has formulas that will automatically give you the results as you update the cells with your figures. Areas to check include: –
- If the cost of sales line shows a higher figure than the actual sales made in that month (or at the yearend)
- Then you are selling an unprofitable service – full stop I know what you mean, but maybe doesn’t work – replace with warning sign?
- If the shaded Total Gross Profit line shows a negative figure
- Then you are selling unprofitable services – full stop
- If the bottom shaded line – titled net/profit loss shows a negative figure
- If there is a negative figure in any of the cells on this line it means that you will have a cash flow problem during this month.
- If there is a negative figure in the final column R of this line it means you will have made a loss
If any of the above happens, we promise you it is all fixable and is not a disaster and we’ll show you steps to take to rectify things. What we don’t want you to do at this stage is just randomly reduce allowances you have included in your costs or decide you won’t pay yourself or that you don’t need an emergency allowance. We also don’t want you to increase your sales without first thinking through a strategy.
If the bottom shaded line – titled net profit/loss shows a big profit, then we need to consider: –
- Whether you are paying yourself sufficiently
- Whether you could be investing more in your business this year (this will also help to reduce your tax bill)
- Whether you could be investing your profits elsewhere for even better returns
Rectifying any negative figures
The first thing to say is that none of the below areas can be viewed in isolation. Each impact on the other. For example, any tweaks you make to your product, or your processes may need to be reflected in your prices or your buying.
The way to make sure you get it right is to always ask the question. “How does this benefit my target customer?”
If you haven’t done so yet, we recommend that you head across to the Market Research section and check out the resources that will guide you through identifying your ‘ideal’ customer. This is the key to everything else you will do for your business.
Once you’ve done that, let’s get cracking on the areas below.
Sometimes we have blind spots when it comes to our product or service. We become so caught up in the day-to-day production or delivery that we default to what we know (our likes and preferences), and this can subconsciously affect the decisions we take and the costs they incur.
There is a simple question to ask here. Is there any part of your product or service that doesn’t add value to your target customer?
- For example – you have a four-page menu.
The more items you have on the menu, the harder it is to produce the food unless you have more staff. Any bulk purchasing discounts will likely be reduced because you’re likely to be purchasing from more than one supplier. And you’re likely to have more waste from any pre-prepped food that isn’t ordered.
If you know your customer as well as we’d like you to, then you’ll know exactly what food they like best and you can pare your menu down accordingly. Yes, give choice, but a selection of 4 or 5 options for starter, main and desert is sufficient for most people. And if you’re worried about them coming back for more, change the menu regularly. This is one of the best and easiest ways to save money and improve your service if you are a B&B Owner, Hotel with room service menu; Restaurant; Café.
- Or perhaps, when you last renewed your linens, you couldn’t resist and went all out for luxury Egyptian cotton.
This might be fine if your target market furnishes their own homes with something similar but if the reality is that most families that stay with you are happy with a good cotton blend, then does this really add value?
Whilst striving to provide a quality service and adding extra value, make sure it adds value to your customer. One of the questions we often ask businesses when they are working out where they sit in terms of brand perception for their customer, is what supermarket do they visit? Harrods or Harvey Nichols food store sits at the top end (and would mean they’d probably go the whole hog and have silk sheets); Waitrose and Sainsbury’s will probably capture the Egyptian Cotton market, Tesco, Morrisons and Asda will have a good solid cotton sheet and Lidl and Aldi would be at the basic end.
This exercise isn’t about cost cutting at the expense of your customer. It’s about checking that everything you do adds value to your customer and in turn this will drive waste and unnecessary expense out of the business. As you’ll see in the next section, if you are adding value for your customer this can be reflected in your price.
Price remains one of the most important elements that determines a business’s market share and profitability. Unlike product features, prices can be changed quickly, and they can have a direct impact on your bottom line. A small percentage improvement in price can generate a large percentage increase in profitability. More importantly, as part of a company’s overall value proposition, price plays a key role in creating customer value and building customer relationships.
The sweet spot is somewhere between your customer’s perception of value and the cost of the product. There will be a ceiling price, above which there will be no demand for the product and a base price which you can’t go below without losing money.
Finding that sweet spot however isn’t straight forward and it’s important to consider not just your brand positioning (see supermarket analogy above), what your target customers want, need and are willing to pay for; who you competition is and what they are doing; but also, what’s happening in the environment.
- The very first thing you need to ask when looking at pricing is – what is your objective? Is it to attract new customers? Is it to retain existing, loyal customers? Is it to create excitement for your brand? Or does having a premium price position you in the premium bracket and serve you well?
- For example, you may decide to have a promotion if you are new to the market (second person eats for free) or alter your price temporarily if you’re re-opening (half price), or you might even have different price points for repeat customers (discount loyalty card).
- You’ll then need to assess your competition. What are they charging? How are you different to them? What is that difference worth to your target customers in price terms? We’ve created some templates to guide you through competitor research that will help with this, and these can be found in the Market Research section on this website.
- For example, if you run a bar in the centre of town and there are bars on every corner, what value do you offer that the other bars don’t which may enable you to charge a premium price? Perhaps you specialise in artisan craft beers. Maybe your staff are knowledgeable about all these beers and can talk about the ingredients and their production. Perhaps you offer a craft beer tasting hour with accompanying nibbles.
- Or perhaps you only use sustainable materials to produce your product or service. People are often willing to pay more for what they believe in and for products and services that meet their ethical values.
- Next see what’s happening in the wider world that may affect your customer’s ability and willingness to spend. Or have trends changed?
- For example, the pandemic has changed how and where many people are choosing to spend their leisure time. How will this affect the value you offer?
- At the same time, the cost of living is rising, and this might affect your target customers disposable income. How will this affect their willingness to pay for your product or service?
- And wages and raw material costs are going up. How does this affect your profit margins and are these sustainable without an increase in price?
- Perhaps there is an option for you to upsell your product or service so that from a base product price perspective it appears unaffected by inflation and still adds value. You still offer a 3-course menu perhaps for £25pp. But perhaps you could charge a supplement for an extra special dish or extra sides.
- Initiating a change in your pricing needs to be done with care and should have some form of positive messaging to accompany it. Customers are a savvy bunch of people, and they recognise that price changes happen for a reason. Price cuts for example can be seen as the business being in difficulty, having excess capacity, no demand or having quality issues. And price rises can be seen as greed. If you do need to adjust your prices, be clear and transparent. Let customers know exactly what they are receiving, what’s changed about your product or service and then focus on what value they will receive by purchasing with you.
Whatever product or service you provide, especially in the visitor economy sector, you will be reliant upon several supply chain partners to help you provide this service. The amount of reliance depends on the size of your business, and often the supplier partners are not known to your customers, but they do have a large impact on them. So it’s critical therefore that you make sure your supply partners align with your product or service and your target customers. They will impact on: –
- The cost of your product
- The reliability of your product
- The quality of your product
- It doesn’t matter which end of the scale your customers sit – whether it’s Harrods or Aldi, there will be an acceptable level of quality for the product or service you provide which you cannot go below. However, there will also be a point above which it will be difficult for them to notice the quality difference and it’s important to recognise this because this is where profits can be made and lost.
- Think about where you purchase your products from. Is the quality going to be lost on your target customer? You may pride yourself on providing only produce from the local farm, or buying your towels from Harvey Nichols – but does your customer value the additional cost? Or would they feel they’ve received just as much value from supermarket sausage or linen from Dunelm?
- The reliability of your suppliers is also very important. If you advertise that you include picnic hampers for the beach and your supplier runs out of stock meaning that you must run around and create your own hampers at double the price you have a problem.
- Most reliability problems occur when negotiations focus heavily on price rather than developing a mutually beneficial relationship. Price is important, it affects your profitability, but hammering a price so low that a supply partner doesn’t value your business is nearly always a false economy. The additional time it takes in rectifying unreliable service and/or absorbing additional costs can be crippling for low margin businesses. Finding a supply partner that values your customers as much as you do is the key.
When you are assessing the costs you incur, can you identify which costs are directly related to the service you provide, which are indirectly related, and which have no relation? And then can you interrogate the necessity for each level of expenditure?
For example, the cost for breakfast items or even laundry services are directly related to the service a customer receives. The cost for marketing and administration is only indirectly related – but still necessary for the business. Membership fees and subscriptions are totally unrelated – i.e., your business can still operate without them.
- We’ve covered how you assess the relevance of the costs directly related to the product or service above.
- When it comes to indirect costs, assuming reliability can be assured, are there other products or suppliers that could provide the same or a similar product or service of the same quality for less? Do you need to have a top spec laptop when you only use it to do the books once a week?
- When it comes to the totally unrelated costs unless they add value to your customer in some way – why do you have them, how often do you use or refer to them?
The phrase ‘time is money’ says it all. How you deliver the products and services will have a massive impact on profitability – especially where you have people costs involved in the delivery. And mostly it’s down to poor or unnecessary processes being in place that don’t add value to the customer’s experience.
- If you have a team working for you, you can bet your life they will have a list as long as your arm of things that get in the way of them doing their jobs well. This is the best place to start. Ask for and listen to their feedback and remove those obstacles.
- Assess how much time different parts of the service take and see whether technology can save you time and improve your customer service. For example, by investing in an EPOS system in your restaurant can you improve the flow between the person taking the order and chef having the food ready? Can it help you manage stock? Can it help speed up the restaurant reconciliation each day, week, month?
- What things consistently go wrong. Where it feels like Groundhog Day. If you can fix these – how much time would you save?
It doesn’t matter how effective your pricing is, or how well you manage your costs, or how slick your processes are, if you don’t ensure you are paid on time and have clear cancellation terms and conditions in place to protect you, you will still have a cash flow problem.
One of the biggest problems for business is cash flow. Where possible you want to limit the amount of money you have to pay out to suppliers before you receive the funds from your customers. You can do this through: –
- Asking for extended credit terms with suppliers
- Asking for deposits and stage payments from customers
Ultimately profitability is reliant on several factors and each needs to be assessed in turn. But unless you know your numbers, it’s unlikely you’ll be able to confidently claim that you’re running a profitable business.
In this first of three masterclasses on marketing planning, Deborah explains the importance of having a marketing plan in place. By the end of this video you will understand the elements that you will need to include in your marketing plan.
In this first of three masterclass videos about pricing, Jo discusses the variables you need to consider when coming up with a pricing strategy to maximise your profitability. By the end of this video, you will understand how to assess the value of your product or service to create a price point that your customer is happy to pay and that is profitable for your business.