What does your business need most? Turnover or Profitability?
It’s the start of a new year and so lots of businesses are busy setting goals. I’m no exception to that. For me it’s a straight forward process. I’m the only person in my business so I only have to test whether my goals align with each other and with my values. I’m the only one that has to make them happen. I’m the only one who owns those goals.
But what if your business comprises more than yourself? If you have staff, how do you make sure that everyone knows:
a. What the goals are, and
b. What they need to do to help achieve them?
Turnover and Profitability
Two common goals that are frequent sources of conflict are:
• Increasing sales – be it through getting more clients or selling more to existing clients.
• Increasing profitability
At first glance, you would think this is a perfect alignment. To increase profits you need to increase sales right? So direct all efforts to the former and the latter will happen as a natural by-product – yes?
Well – ummm – no actually. Or rather, it’s not as straightforward as all that.
Profit and profitability
There’s a difference between profit and profitability. Profit is the amount of money you have left from your sales after paying all your expenses. Profitability, on the other hand, is a measure of the efficiency of the business. This article from Investopedia, explains it in more detail than I can here.
The Sales/Credit Conflict
If you put all your focus on sales growth it would make perfect sense to sell to anyone who wants to buy from you. More sales means moving ever closer to that sales target. But there’s a danger here: focusing on increasing sales alone puts you at a greater risk of late payments and bad debts.
Yet, an exclusive credit risk focus makes it logical to only trade with business that you know will either:
• Pay you up front or
• Pay you on time – every time
And that certainty is rare. Adopt this tactic then and you restrict your pool of potential customers.
Sales personnel often joke that credit management is ‘sales prevention’. They say that it creates barriers towards the sales effort. In truth though, good credit management can contribute to increased sales and profitability. The role of credit management is to find ways to do business at every opportunity while looking for ways to mitigate the risks of not getting paid.
Now let’s return to the goal of profitability. Late payment for a sale erodes the profit margin for that sale. Why? Because it costs you time and effort, which have a monetary value, to try and collect it. It may also cost you in interest if you’ve had to borrow because you didn’t have that cash available to you when you had budgeted to.
Even worse is a sale that is not paid at all. This is a torpedo hit straight to your bottom line. In simple terms: imagine you had made a sale worth £1000, of which 20% is your profit margin, i.e. £200. If you had to write off that £1000 you would need to make four more sales of £1000 to recover the cost of that one original sale.
It’s logical then, that the goal should be to increase profitable sales, i.e. sales with a decent profit margin that get paid for either on, or as close to, their due date as possible.
The role of Credit Management
As I’ve said before, the role of credit management is to find ways to accept the sale wherever possible. To do this it is vital to assess the creditworthiness of the prospect BEFORE you agree any sale with a prospective client. This then determines the terms you will offer to that prospect. If there’s a high risk of default, potential for a sale remains on cash with order terms. The key is to find a solution that allows the sale to take place with minimal risk to the business. If the prospect doesn’t like the terms offered you need to be clear that the risk is unacceptable to you and you walk away.
There will be times where the level of risk is simply unacceptable because the risk to profitability outweighs any benefit to sales growth.
For more on due diligence on prospective customers see our article Are you selling your stuff or giving it away?
Whether there are two or 200 of you in the business it’s critical to the success of the businesses goals that everyone understands both what you want to achieve and how you intend to achieve it.
When it comes to credit risk you should make sure everyone is aware of what the rules are. They need to know the criteria for determining that risk for each prospect. They need to know too who, if anyone, has the authority to break the rules – and is accountable for the consequences.
The greater the risk you’re willing to accept, the more controls you need to have in your credit management toolkit. Higher risk clients will come with associated costs. You’ll need to factor in to your profit margin such things as monitoring and payment chasing.
You also need to be able to bear any losses that may arise from a more liberal risk appetite.
It’s clear there’s a lot more to profitability than merely working with the right customers and getting paid on time. This article about increasing profitability by HSBC explains more on that.
To find out more about the role of credit management in increasing sales and profitability get in touch to book your FREE, no-obligation consultation.