True story: a good client sold his business last year. The new owners put a manager in and the profit figures, for the moment, are looking good. The problem is, the profits are being achieved by downsizing, reducing the number of employees, and in doing so, reducing their competitive advantage, the value they provide to customers. Inevitably, sales are starting to fall.
You’re cruising along in your business, sort of comfortable, but do you have a little query at the back of your mind that occasionally turns into an itch? Could you do better? Just maybe it’s worth taking a look.
But what should you be checking? You’ve probably heard the term “benchmarking”, and a very useful tool it is. Benchmarking enables you to compare a range of measures for your industry. In fact, it does more than that; it can compare by the size of businesses in your industry, and by location.
Naturally Wikapedia has a definition, one that encompasses (with my emphasis) the full range of benchmarking practices:
“Benchmarking is the process of comparing the business processes and performance metrics including cost, cycle time, productivity, or quality to another that is widely considered to be an industry standard benchmark or best practice. Essentially, benchmarking provides a snapshot of the performance of your business and helps you understand where you are in relation to a particular standard. The result is often a business case and "Burning Platform" for making changes in order to make improvements.
Benchmarking is most used to measure performance using a specific indicator (cost per unit of measure, productivity per unit of measure, cycle time of x per unit of measure or defects per unit of measure) resulting in a metric of performance that is then compared to others.”
Note the reference to “industry standard”. Knowing how your performance compares to your own industry is important. Finding that you are behind the average is a great spur to improving your performance, as is the desire to compare to the best in your industry. I regularly benchmark my clients to help them improve their profitability, productivity and the value they provide to customers – i.e their competitive advantage.
I’ve written about benchmarking a number of times.
In fact the quotation above comes from one of those posts.
There is one aspect of benchmarking that is not always looked at, but can give you real insight into the opportunities for improving your cashflow, and profitability. That is what I’m examining in this blog.
Profitability per employee is not just a measure of profitability, it is also a measure of productivity; how much value does each employee generate for your business, and your customers? It is also a measure of your competitive advantage.
As I discuss in “Do you know why good businesses keep getting better?” good managers look ahead and benchmark their business against their industry peers. They are looking at profitability, productivity and seeking to create competitive advantage, and scoring their performance through benchmarking.
The first thing you must do is to establish your base; the number of employees. Different businesses may employ a different mix of full-time, part-time and casual employees. To ensure a consistent base it is necessary to convert the number of employees to Full-Time Equivalents (FTEs). This should include working owners or Principals.
The easiest and most common measure is Sales per Person. You can also measure this in terms of Sales per $ Wages, but for the purposes of this blog I will stick to ‘per person’.
The problem with this measure is that a good year in Sales (Income) does not always flow through to the bottom line. Nasties like low margins, high Cost of Sales or high Overheads may leach away your profits. Sales don’t always equal success, particularly if they have been achieved at the expense of margins. Not charging the right price for your product or service leaves money on the table; a profit leak.
Gross Profit per Employee is a much better measure of profitability, productivity, and competitive advantage. My well-known mantra is that it is not the volume of sales that is important, but the volume of Gross Profits.
If you can maintain a higher GP/Employee than your industry average, then you be reaping the rewards of creating a competitive advantage. People are willing to pay more because your product/service is better, there is a point of difference which they perceive is of higher value.
However, there can still be profit leaks from your Overheads, as I discussed in “Is there Flab in your Overheads?”
So the final measure you may wish to take is Nett Profit per employee. While different businesses in the same industry may have different financial structures, ultimately that Nett Profit figure is the key to your future, and the ultimate measure of profitability, productivity, and competitive advantage.
That’s why benchmarking is important. Once you see your peers doing better, you know improvement is achievable. You have a target. Planning becomes easier when you know the target is achievable. Improve, and then pass your peers.
When clients approach me for coaching, clients with businesses that are underperforming despite the crippling hours and effort the owner is putting into them, they are sometimes held back by lack of knowledge of what is possible. A lack of focus of potential improvements leads to a lack of control over their business, and eight times out of ten that lack of control comes down to a lack of knowledge of what is happening in the business, and what their peers are achieving.
For more than 28 years I’ve been helping small business owners plug the profit leaks in their business and restoring their cash flows by assisting them understand where and how they may change their business to be a leader in profitability, productivity, and competitive advantage.
If you would like to discuss with me how you might do that, book a Strategy Consult here.
© Copyright 2017 Adam Gordon, The Profits Leak Detective
Some profit losses are pretty obvious - so you fix them.
BUT, what if you don't know profits are leaking, cash out the door?
Possible leaks could be anywhere.
Are there some clues or symptoms that are tell-tales?