We’ve all known businesses that appear to be doing well, but end up going out of business because they’ve made major mistakes in pricing, cost control or financial management. Here are some of the areas where these problems arise and some suggestions for how to avoid making the same mistakes.
1. Pricing Strategy
Pricing is probably the most important decision you make every day. If your prices are too high, you won’t get enough volume. If you set them too low, you might get a lot of sales, but you will lose money. So how do you find the right price?
If you’re in a business where your prices can be directly compared to your competitors’ (shoes, for example), your flexibility is limited. You can always run specials and have sales, but your competitors may follow. You’re better off trying to create a sense of immediacy so that your customers buy as much as possible at full price. This is where good marketing makes all the difference. Try different approaches, track customer behavior, and make adjustments as you learn what works.
On the other hand, many non-retail businesses and businesses with patented products have more flexibility in their pricing. It’s common here for entrepreneurs to actually under-price their products. Most advisors recommend starting a little high and monitoring the response — it’s easier to lower a price than to increase it.
2. Accounting for Cost of Goods Sold and Tracking Gross Profit
Many small businesses do not correctly account for the full cost of their products or services. It’s much more complex than many realize. For example, if you are a clothing retailer, the cost of the freight to your store is part of the cost of the clothes. You also need to track and factor in shrinkage, damages, and unsalable returns — all of those costs that can eat up your profit margin.
If you’re a service provider, the wages that you pay the employees providing the service — including payroll taxes, insurances, and benefits — should be considered “cost of services provided.”
Accurately accounting for cost of goods sold is important so that you can control those costs and also so that you can easily monitor gross profit, which is the difference between sales dollars and the cost of goods or services sold. It’s not enough to just monitor sales volume — what matters is the profitability of those sales.
If your gross profit percentage starts to slip, you need to immediately find out why and fix it. It could be caused by a cost issue, a pricing problem, or both. Don’t wait until the end of the month to look at your gross profit numbers — put a system in place where you can monitor them weekly or even daily.
3. Credit and Collections
Many small businesses do a poor job of credit and collections. In many industries, customers expect to buy on credit, and in many service businesses, fees are billed after services are performed. This means that your business is making an investment in your customer or client’s company. Treat this with the seriousness it deserves! Use a solid credit-checking process, set realistic credit limits, be very clear about what your credit terms are, and stick to those terms. You can also ask for a deposit up front, or a retainer if you are providing services. You may lose a sale or two, but it’s better than never getting paid.
4. Budgetary Controls
Every business has overhead expenses, which can get out of control. These are things like rent, utilities, administrative employees, insurance, and office supplies. You should prepare an annual budget for these. Have your accountant load it into your accounting software and then run a “budget vs. actual” report each month. This will show you where spending is creeping up.
5. Necessary Business Infrastructure
Small businesses often skimp on the personnel, resources, and infrastructure needed to run a business effectively. You need top-notch accounting help to track your day-to-day activity as well as a good CPA. You also need a robust accounting system, a great attorney and insurance broker, good computer systems and a responsive IT firm to keep your systems running, Make sure these are in your budget.
You need to be informed on tax issues in order to make good business decisions. These taxes include income taxes, sales and use taxes, payroll taxes, and business property taxes. Don’t be afraid to ask questions of your tax advisor when you need to. The cost of non-compliance, especially with payroll taxes, can be staggering, and knowing how to manage your business decisions with income taxes in mind can leave more money in your pocket.
Even if you’re already doing a good job in these six areas, you may be able to enhance your profitability by making small improvements to your current procedures. If you’re not doing these things, I encourage you to start implementing them. You’ll be amazed at the results.
JoAnne Berg, CPA is the founder/CEO of Peer Coaching Network, Inc. in Carlsbad, California. She is a trusted business advisor with over 30 years of experience as an entrepreneur, CFO/COO, and CPA/advisor to closely held businesses. Read her blogs at The Art of Small Business. You can follow her on Twitter @JoAnneBerg and on Facebook.