Profitability Improvement Strategies for Small Businesses
Chasing profitability can feel like a losing battle for many businesses. What I see most in clients and potential clients is that they haven’t built a long-term financial strategy for their businesses. Instead they’re just trying to make it the next closest milestone by doing so they are in a constant state of barely getting their head above water. In this post, I’ll walk you through why most businesses struggle with profitability and what you can consider in your business to get you on track to be a profitable & thriving business.
Why Most Small Businesses Struggle with Profitability
Defining “profit” is elusive because it isn’t a single number on your financial statements. I wrote a whole blog post about this- you can read it here.
When you’re looking at your business, define profit in terms of your long term goals.
It could be:
EBITDA (earnings before interest, taxes, depreciation, and amortization),
free cash flows,
owner’s distributions and owner’s compensation or Seller Discretionary earnings
net income.
All of these can be “profit”. And they are usually all different numbers. Be sure to define what success looks like to you before trying to maximize a specific number.
At the end of the day- cash in the bank is the real metric of success. And speaking of cash in the bank - a good note to remember is that net income on your P&L does not equal cash in the bank.
Quick personal story of my own business:
In 2022 & 2023 I started to grow my firm with people. I was on track to hire a CFO, I had an analyst and 2 administrative folks work behind the scenes. But then Mid-2023, my personal income started to drop and I started having to trade off between keeping the business running or paying myself. I realized (while going through burnout) that I hadn’t taken the right steps to keep my profit up while scaling. I stopped trying to grow revenue at the cost of my income and started optimizing and tracking my personal income and total compensation from the business. 18 months later, my revenue has increased and my personal take-home pay is the highest it’s been. But it took me breaking the business back down, resetting my goals, setting the right KPIs (key performance indicators), and staying focused to get back on track. What’s crazy is I have caught this trap with numerous clients and helped them receive it, but couldn’t take my own advice until I felt the pain myself. So if you’re in this situation - just know even finance professionals are not immune to this very common business situation.
Key Drivers of Small Business Profitability
Based on our data from working with small businesses across industries, here are the four main factors that impact profitability:
1. Cost Management
I’ve been slowly winding down my work with venture backed - high growth start-ups over the past 2 years, but they make the best examples of how not to manage costs and how to get them under control. There are 2 main clients that stand out who raised $11M and $4M respectively and 9 months later were down to 2 months of cash (runway). In each of these scenarios, the CEOs were overly confident in their ability to return to current investors at any second and close another round of funding. This overconfidence made them disregard cost management until it was too late.
Each had similar experiences of basically overnight having to cut major expenses. Don’t let this be you, instead- be like 2 of my other clients that when they were down to 12 months of runway - asked for advice and we worked together to review each business expense, cut wasn't driving revenue, and optimize what we could.
There are so many dollars wasted in small areas that business owners can’t see. One example I see in most businesses is operational software expenses (think Slack, Google, ChatGPT, Notion, etc…) - software is shiny and new and sounds like it will save you $1000’s, but the trick is they hire good marketers so a business owner will pay for 10 different software at $6/per person/month and suddenly they’re software expenses are through the roof. I recommend everyone review their software usage on a quarterly basis. Use it if it helps increase productivity, and cut if no one isusing. If you’re committed, sign up for annual, if not then keep it monthly until you decide.
Other areas to look for cost management:
Office supplies & equipment
Memberships & dues
Meals & miscellaneous sales expenses
2. Strategic Pricing
Pricing is tricky and likely the trickiest of all aspects of running a business.
Check out my other blog all about pricing.
To keep this blog short, I’ll say this - when you’re looking for profitability and margin - look at BOTH gross margin and contribution margin
Gross Margin = Revenue - COSGS
Contribution Margin = Revenue - all the variable costs of the business
This is what is left to cover the fixed costs of running the business
Every business needs to measure both of these margins because it’s pretty easy to have an 80% gross margin, but never be able to cover your fixed costs. (hint, this is one way start-ups fail)
Just one of my favorite client stories:
One of my favorite client stories is this: a gym owner wasn’t paying herself and by increasing her gym membership she was able to create enough margin to finally give herself a salary. Pricing is one of those things that you don’t always know if it’s the cause of low margins, but if it is and you increase you can finally breathe as a business owner.
3. Revenue Optimization
A GOOD CFO is going to push you hard on driving revenue. My biggest ask when I onboard a client is “how do you get customers?" or “what's your sales strategy?” and we work hard to define the metrics for knowing how every $ spend in sales & marketing is going to increase revenue.
A few areas we look to optimize revenue are:
- Sales volume > do you know how many leads you need to hit your revenue target?
- Customer mix > Is any particular customer/ client accounting for a significant % of revenue?
- Product/service portfolio > are your products the right mix to serve your target client? Any products generating less than 10% of revenue?
Revenue optimization isn’t a quick process. It takes time to get the right mix of strategy in place to drive revenue to your business. Be patient, work with your CFO to gain insights and use those insights to tweak your strategy along the way.
While working with one of our clients, we dug into their sales pipeline and learned that their sales team was inefficient at getting sales calls to be closed. In order to meet their revenue goals, they needed to either double the sales team or increase their sales calls to closed deals conversion rates by a significant amount.
4. Operational Efficiency
Last, margin can be created by improving internal operations. This includes things like: writing SOP’s so you’re not recreating the wheel, using automation software to do small tasks for $0 instead of paying someone $15 to do it, and looking for other ways to optimize your employees time. The key thing to note here is, you can only do this when you’re pushing hard for revenue. If you’re just starting out - don’t optimize your operations because your one goal is to bring in new revenue and I often see clients wasting so much time managing their bookkeeper and EA they’re not focused on going out and selling.
One client in particular has been stuck in a look of trying to figuring out the best way to bill clients that she wasn’t focusing on sales and then lost 2 clients and now has to go back and fill that revenue gap, but doesn’t have the pipeline built as strong as it needed to be to fill that quickly. Always focus on Sales First and operational efficiency second.
Long-term Financial Planning for Sustainable Profitability
Build your cash reserves! A client said this to me on a call recently: “I am so glad you told me to put away that $90K, I lost two clients and I’m not stressed about money right now”. Let this be you. When business owners don’t have this buffer, they often have to 1) have to shut down, 2) stop paying themselves 3) rush to take on financing from a bad partner.
Sustainable Small Business equals Profitability
Improving your small business's financial health isn't about dramatic changes - it's about making strategic decisions consistently over time. The key is having the right long-term financial planning framework in place.
Ready to transform your business's profitability? Join Finance Fight Club for monthly support in implementing these strategies and improving your small business's financial health.