Running a small business can mean long hours, steady sales and a constant stream of customers. Yet, at the end of the month, the money left in the bank may not reflect all that effort. Supplier prices have increased, wages need to be paid, rent is due and everyday operating expenses continue to add up.
For so many NZ business owners the issue isn't just about making more money. It's about ensuring that the business retains a reasonable proportion of what it does make.
Knowing how to improve your profit margins in a small business begins with understanding where your money is going. It's all about looking at your prices and your costs, controlling your costs, improving your productivity and managing your cash flow. A few well-informed changes can make a real difference.
Here are seven practical strategies to help improve business profitability without necessarily requiring higher sales.
1. Understand Your Current Profit Margins Before Making Changes
Before you go about deciding what to cut and/or how much to charge you need to take a good hard look at your current financial position. You need to establish whether the problem is one of the cost of delivering your product or service, your operating expenses or both.
Two figures are particularly useful:
Gross profit margin: this is the amount of revenue that remains after the direct costs of producing the goods or delivering the services have been deducted.
Net profit margin: This shows you how much of your revenue is left as profit after all of the business expenses have been deducted.
The formulas are:
Gross Profit Margin = (Revenue − Cost of Goods Sold) ÷ Revenue × 100
Net Profit Margin = Net Profit ÷ Revenue × 100
For instance a small NZ retailer might generate $100k in sales and spend $60k on the goods that it sells.
Gross profit is $40k (40% gross profit margin).
However after paying rent, wages, insurance, utilities and all the other operating expenses, suppose its net profit is $10,000. Its net profit margin is therefore 10%.
The difference between those figures is important. A healthy gross margin doesn't necessarily equate to the business making sufficient profit overall.
Always review your P&Ls regularly. Look out for any expenses that have gone up, any change in gross profit and any unexplained dip in net profit. That will give you a much clearer baseline from which to work in order to improve your profitability.
2. Review Your Pricing and Make Adjustments Where Necessary
Pricing has a direct bearing on your profit margins. Some business owners will be reluctant to raise prices for fear of losing customers.
Prices can be kept the same while supplier costs, wages and all the other expenses go up and you'll gradually erode your profitability. A price that was perfectly adequate two years ago may well no longer cover the cost of delivering the same product or service.
Begin by looking at the total cost of what you're selling. That's materials, labour, packaging, delivery and all the other direct costs. Then look at what your competitors are charging and what the customer is actually getting in return.
For instance, if a product costs $50 to buy and sells for $80 the gross profit is $30. If the purchase cost goes up to $55 and the selling price stays at $80 the gross profit is now $25.
A small price increase might go some way to making up that difference.
This doesn't mean just going in and increasing prices without any regard to what the customer would expect. You could also look at product bundles, service packages and discounts. Frequent discounting may well lead to increased volume, but can leave you with very little profit per transaction.
The objective is to set prices which reflect your costs, the value you are delivering and what your customers are willing to pay.
3. Identify Unnecessary Expenses and Reduce Business Costs
Business expenses don't always go through the roof. They can accumulate over time through a series of small, regular payments which are very easy to miss.
Review your regular spending and work out where the money is going that isn't providing sufficient value.
Some areas worth checking include:
Subscriptions and software: cancel any tools that you're no longer using and where possible replace overlapping subscriptions with a single, appropriate solution.
Supplier agreements: compare prices, negotiate better terms and check whether buying in bulk is actually going to be financially viable.
Inventory: Don't order any more stock than you can realistically sell. Bad stock control can result in cash being tied up and increased waste.
Utilities and overheads: review your electricity, your internet, your insurance and all your other recurring costs.
Operating expenses: look for duplicate services, unnecessary purchases and processes which create avoidable costs.
A small hospitality business might find itself regularly buying ingredients which are then very rarely used and end up being discarded. Adjusting order quantities and monitoring stock levels will reduce this waste without in any way impacting the menu or the customer experience.
Effective business cost reduction strategies are not about cutting every cost. You can actually create bigger problems down the track by removing costs which support product quality, employee performance and customer satisfaction.
Focus on spending more thoughtfully rather than just spending less.
4. Focus on Your Most Profitable Products, Services and Customers
Not every product a business sells is going to be equally profitable.
A product may sell a lot and yet leave a very slim margin on purchase, packing and delivery. The same applies to a service which may generate a lot of revenue but which will take so many staff hours that the real return is very poor.
This is why looking at total revenue on its own can be very misleading.
Think of a small professional services firm with three services. One of the services sees the most enquiries but is by far the most labour intensive, requiring a lot of research, numerous revisions and a great deal of time spent in client meetings. The second service attracts far fewer clients but is by far the quickest to deliver.
The second service might well provide a better return on the time and resources you've put in.
Review your products and services individually. Consider:
What products and services are the most profitable?
Which customers take the most time and support?
Are certain jobs consistently taking longer than anticipated?
Do low margin services require a price change or a different delivery process?
Once you've got a handle on those differences you can then concentrate your marketing and your resources on the more profitable opportunities.
You don't necessarily have to get rid of the lower margin products. On occasion it's simply a matter of changing the price, the scope or the way the service is delivered and that's all it takes to make it viable from a commercial point of view.
5. Improve Operational Efficiency and Employee Productivity
Profit margins can also be affected when the day to day business processes take longer than they should.
Repeated manual work, bad staff scheduling, excessive admin and avoidable mistakes all take up time and resources. They may not be a separate line item on your P&L but they do impact the amount of work you can actually get done.
Start by working out where the time is actually being lost.
For instance if staff are spending several hours a week manually entering data into various systems then appropriate accounting or workflow software could eliminate that duplication. Better scheduling could also see businesses not being paid for hours of staffing during the quieter periods. Her improvements may include:
Standardising frequently repeated tasks.
Reducing the number of errors that result in rework or wasted materials. Signing responsibilities more clearly.
Reviewing the workloads to avoid any unevenness in staff utilisation technology where it offers a genuine time or cost benefit.
Small businesses don't need expensive systems to be more efficient. A better invoicing process, clearer staff responsibilities or a more systematic approach to inventory management are all things that can make running the business a lot easier. The important thing is to measure whether a change actually saves time or money rather than introducing technology simply because it is available.
6. Improve Cash Flow and Manage Outstanding Payments
Profit and cash flow are linked but they are not the same thing business can report a profit while still struggling to pay its suppliers, employees or other bills. This often happens when customers take too long to settle invoices.
Imagine a tiny consultancy doing $20k of work in a month. The money's been earned, but a number of the customers haven't paid yet. Wages, rent and software costs are still going to have to be paid. Business may be profitable on paper but short of available cash.
To avoid this scenario entirely, make payment management part of your normal routine and invoices as soon as work is completed.
Set out your payment terms clearly before you start the project.
Follow up on overdue invoices immediately.
Review your outstanding customer balances on a regular basis.
Plan for ongoing expenses and the seasonal variations.
Prepare cash flow forecasts to anticipate the next shortfall.
It's also worth looking at the payment terms with your suppliers. Where you can, try to negotiate terms that give you sufficient time to collect your customer's money before your own bills come due.
A cash flow forecast will help you to work out when money is expected to come in and when the big expenditure items are due to be paid. It makes it much easier to plan your purchases, manage your commitments and avoid having to borrow unnecessarily.
7. Monitor Financial Performance and Review Your Business Regularly
Improving profit margins is not a one-off thing. Costs, customer demand, supplier arrangements and the priorities of the business will all change over time. A strategy that's working today may well need tweaking a few months down the track.
Set time aside each month to review your financial performance.
Your regular review should include:
Monthly P&L's.
Gross and net profit margins.
Actual expenses versus your budget.
Revenue and sales trends.
Outstanding customer invoices.
Cash flow forecasts and the forthcoming payments.
Look at the changes rather than at the individual figures in isolation. If revenue has gone up but net profit has come down then look at whether it's the higher operating costs, the discounting or the increased delivery costs that are to blame.
You should also be looking at the results month on month and where appropriate against the previous financial year. Seasonal businesses in particular may well need to take seasonal trends into account before reaching any conclusions.
Accurate financial records make the reviews more useful and enable you to pick up any problems early rather than at the end of the financial year.
Why Small Businesses in NZ May Need Professional Business Advisory Support
Managing money gets harder as the business grows. The owner may well understand their sales and their day to day expenses but it becomes increasingly difficult to work out why profit margins are changing or what areas are in need of attention.
Professional accounting and business advisory services in NZ can help you make sense of the figures.
An accountant or business adviser can help when:
Revenue is up, profits aren't.
Operating expenses are proving very difficult to control.
You're not sure which of the products, services or customers are actually delivering the best returns.
Cash flow is inconsistent.
The financial reports are available but are not being used to inform decisions.
You need more reliable budgets and financial forecasts.
At Bizdom business owners can access accounting support as well as practical business advisory services. This includes financial reporting, internal management accounting, monthly reporting, cash flow forecasting and one to one advisory.
Rather than just looking at the financials, the objective is to understand what the numbers mean and how they can help you in your next set of business decisions.
Conclusion
Improving profitability isn't necessarily about finding more customers or growing sales. Often the biggest opportunities are to be found in understanding where the money is going, reviewing the pricing and making better use of the resources you already have.
For NZ small business owners, it's absolutely essential to be monitoring your financial performance on a regular basis if you're to make informed decisions.
Whether that's about managing your outgoings, improving your cash flow or working out which bits of your business are actually the most profitable, having a clear view of your numbers is the first step.
If you want a better understanding of your business finances and practical guidance on improving performance, explore Bizdom's accounting and business advisory services.
Frequently Asked Questions (FAQs)
-
A small business is often valued by examining its maintainable earnings and applying an appropriate method or earnings multiple. Its assets, debts, customer relationships, reliance on the owner, and future prospects may also affect the result.
-
There is no one profit margin that will apply to every NZ business. Retailers, hospitality, manufacturers and professional services all have very different cost structures and operating models. You should compare your results against other businesses in your industry and take into account your own costs, your own growth plans and your own financial objectives.
-
Gross profit margin is simply gross profit divided by revenue x 100. Net profit margin is net profit divided by revenue x 100. So if a business has $100k in revenue and $10k in net profit its net profit margin is 10%.
-
Yes, an accountant can help you to understand financial statements, monitor expenditure, look at profit margins and put together budgets. Business advisory can also assist with cash flow forecasting, financial planning and identifying areas where changes could have a positive effect on the overall performance of your business.
-
You can prepare a rough estimate by reviewing earnings, assets, liabilities, and comparable sales. This can help you understand your starting position, but it should not be treated as a formal valuation when important legal, financial, or ownership decisions depend on the figure.