How to Build a More Profitable Business
If you’re looking to generate more profit to fund operating expenses, pay your team more, offer better benefits, and fuel growth—while still keeping more profit for yourself—it’s time to focus on key financial and pricing drivers. Here are actionable strategies to help you improve your gross profit margins and achieve your goals.
When people talk about profit, it can mean different things depending on the context. The two primary types of profit are gross profit and net profit. Understanding the difference between these two is crucial for making informed business decisions.
Gross profit is the revenue remaining after subtracting the cost of goods sold (COGS, for product-based businesses) or cost of sales (COS, for service-based businesses). It [indicates] how efficiently you are producing or delivering your services.
Net profit, on the other hand, is what remains after all operating expenses, taxes, interest, and other costs are deducted from your total revenue.
Essentially, gross profit [shows] how well you're covering direct costs, while net profit [reveals] the overall profitability of your business. Here’s an example of an income statement:
Revenue: $500,000
Cost of Goods Sold (COGS): $300,000
Gross Profit: $200,000
Operating Expenses (Rent, Salaries, Utilities, etc.): $120,000
Net Profit: $80,000
Improving Gross Profit
Think of gross profit as your “new revenue.” Gross profit is the number you should always be focusing on and making sure that your gross profit percentage is high enough to drive your business. Track your gross profit percentage over time to ensure you detect negative changes quickly - or celebrate positive ones. Calculate your gross profit at the product or line-of-business level, not just at the company level.
The formula for gross profit percentage is:
Gross Profit Percentage = (Gross Profit / Revenue) x 100
Poor gross margins will slowly (or quickly) kill most businesses. What constitutes a 'good' gross profit varies depending on the nature of your business. Some products have low gross margins, requiring high volume to sustain that business model. On the other hand, service-based businesses or niche product providers may afford to have higher gross margins. Developing a successful brand also helps command higher margins by allowing you to differentiate your offerings and charge premium prices.
If your gross profit percentage isn't where it needs to be, it will be challenging to cover operating expenses, pay your people, and drive growth. Making gross profit your focus will help ensure that your business has a strong foundation for profitability.
Ways to Improve Your Gross Profit:
1. Reassess Your Pricing Strategy
Pricing is the driver that adds profitability faster than any other driver. If you can increase your price, you will increase profit. That said, you need to find the break point before your increased price decreases new sales and has the inverse effect.
Test Price Increases: Gradually raise prices to determine what your market can bear. Even a small increase can significantly boost profitability significantly without a noticeable impact on customer retention.
Increase Value Perception: Enhance the perceived value of your offerings through better niching, branding, packaging, or additional features. Customers are often willing to pay more if they feel they’re receiving more value.
Introduce Premium Options: Create a premium version of your product or service with added features or benefits to attract higher-paying customers.
Review Market Positioning: Reevaluate your positioning in the market. Positioning your brand as high-end or specialized can justify higher pricing, especially if you target customers who value quality over cost.
Pricing Consultants: Pricing strategy is usually an afterthought and rarely analyzed. Consider hiring a pricing consultant to be more scientific about how you price.
2. Optimize Revenue Generation
Adjust Pricing Strategically: Consider adjusting your pricing based on market dynamics. In some cases, lowering prices can attract more customers and increase volume, while in other cases, a price increase can boost revenue if the perceived value is strong enough. A decrease in profit may increase volume and if your fixed costs are able to stay consistent, may result in more profit.
Value-Added Services: Introduce additional features, services, or product bundles to increase revenue. Warranties, add-ons, and extended support are examples of ways to generate more income without significantly raising costs. Identify what ancillary product or services your target customers need and build that.
Subscription or Retainer Models: Implement subscription-based pricing or retainers to create predictable, recurring revenue. This model ensures consistent income and builds customer loyalty over time. This also creates stickiness over business models that may only interact with customers one time or once a year.
Upsell and Cross-Sell: Look for opportunities to upsell customers to higher-value products or services, or cross-sell complementary offerings that meet their needs, thereby increasing the total value of each sale.
Communicate Frequently: Provide value-added resources for free that ultimately position products or services they need. Newsletters, webinars or promotions are a great way to stay top of mind.
3. Reduce Cost of Goods Sold
Improve Labor Efficiency: Streamline your workflows and ensure employees are working at optimal capacity. Time tracking and capacity planning tools can help here. Many “managers” do not know how to manage so consider training on what proper managing really looks like.
Onshore and Offshore Labor Mix: Evaluate whether some components of production or service delivery can be offshored to reduce labor costs while still maintaining quality through domestic oversight. Using a strategic mix of onshore and offshore resources can provide cost savings while ensuring that quality standards are met.
Negotiate with Vendors: Review your supply chain for cost-saving opportunities. Consolidate purchases to secure volume discounts or switch to more affordable suppliers. Pay bills early if there is a discount.
Automate Repetitive Tasks: Use tools like Xero or Cin7 Core to reduce manual labor costs associated with bookkeeping, inventory, and ecommerce management. Zapier is a great tool to bridge cloud-based systems.
Improving Net Profit
We’ve already explained why gross profit is one of the most critical areas leadership should focus on, as it directly impacts your ability to generate enough profit to properly operate your business. While gross profit is essential for covering the cost of goods sold or services rendered, it is also what enables you to manage other financial obligations. Beyond covering operating expenses—such as rent, utilities, and salaries—your profit must also cover taxes, interest on loans, and capital expenditures like purchasing inventory or fixed assets. Managing net profit effectively involves not only generating enough revenue but also controlling all these costs to maximize what remains.
As with gross profit %, you should calculate and trend your net profit percentage as well. Although this differs by industry or phase of your business, target 10% as a minimum if you have no other number in mind.
The formula for net profit percentage is:
Net Profit Percentage = (Net Profit or Net Income) / Revenue) x 100
Ways to Improve Your Net Profit:
4. Control Operating Expenses
Outsource Non-Core Activities: Consider outsourcing non-core activities, such as accounting, IT support or administrative tasks, to specialized providers who can perform these functions at a lower cost, allowing you to focus resources on your core business operations.
Monitor and Cap Discretionary Spending: Set limits on discretionary spending categories such as travel, entertainment, or office supplies, and monitor them to prevent overspending.
Negotiate Service Contracts: Regularly review contracts with service providers to negotiate better terms or cancel services that are no longer needed. Employee benefits are contracts that are often neglected and are a good place to look to reduce administrative fees and renegotiate. Shop your insurance carriers as well as they will likely increase your premium until you notice and leave.
Adopt Automation: Use technology to automate routine tasks such as payroll, invoicing, and administrative work to save time and reduce labor costs.
Lease Instead of Buy: For capital-intensive items, consider leasing instead of purchasing outright. Leasing can turn a large capital expense into a manageable operating expense, preserving cash flow while potentially offering tax benefits.
Improve Operational Efficiency: Streamline processes to reduce the time and effort needed to deliver products or services. This could involve re-engineering workflows, training staff for higher productivity, or investing in technology that allows for greater efficiency.
Invest in Training: Develop a comprehensive training program and foster a culture of continuous learning. Often, employees lack knowledge that you may assume they already have, leading to inefficiencies. By investing in thorough training, you can improve productivity, reduce costly mistakes, and empower your team to contribute more effectively to profitability.
5. Transition Fixed Costs to Variable Costs
Convert Fixed Costs to Variable Costs: Identify areas where fixed costs, like salaried employees or long-term contracts, could be transitioned to variable costs. For example, hiring contractors or outsourcing certain functions can make expenses more flexible and align them with revenue fluctuations.
Leverage Flexible Staffing Models: Use part-time or contract staff during peak times rather than maintaining a larger full-time workforce year-round. This can help control costs and adjust spending to match business needs.
Utilize Shared Resources: Where possible, share resources such as office space, equipment, or staff with other businesses. This can help transform fixed costs into shared, variable expenses, allowing you to reduce overhead while still meeting operational needs.
6. Manage Other Expenses
Manage Interest Expense: Refinance high-interest debt or negotiate lower interest rates with lenders to reduce overall interest expenses. Consider consolidating loans to secure more favorable terms.
Tax Planning Strategies: Work with a tax professional to identify deductions, credits, and other tax-saving opportunities to minimize your tax liability. Proper tax planning can significantly impact your net profit.
Changing How Your Accounting Is Structured
Accountants are typically comfortable processing transactions to generate GAAP financials, but they are not always accustomed to viewing transactions and accounts in terms of fixed or variable costs. Understanding how these costs can be adjusted is key to building a more profitable business. To leverage your accounting information for better decision-making, you may need to retrain your accounting team or outsource to a firm that can adapt GAAP financials into more meaningful management reports.
One useful tool for experimenting with your business drivers is called Goal Seek, available in an app called Fathom. This tool helps you develop what adjustments you can make and what impact those adjustments will have on the metric you are focusing on. Systems like this will need to know what costs are fixed or variable to perform correctly. This will take time and may require changes to how things are accounted for, including modifying how historical transactions may have been recorded. The more granular you are able to get the better the results may be but don’t go crazy and redo your entire accounting. You may need to phase in these changes over time.
Goal Seek by Fathom
Don’t Get Overwhelmed—Take it One Step at a Time
There are a lot of tips in this post, and it’s easy to feel overwhelmed. But remember, you don’t need to tackle everything at once. Focus on moving one metric at a time that seems most impactful or easiest to implement. Making small movements is fine. Once you’ve improved those areas, move on to another. The key is progress, not perfection—each improvement builds momentum toward a healthier gross profit margin.
Quick Wins to Boost Margins
Raise Prices Selectively: Experiment with small price increases on new clients or specific services.
Cut Low-Profit Clients: Focus your resources on high-margin clients.
Automate and Outsource: Use technology to reduce labor-intensive processes.
Building a More Profitable Future
Improving your gross profit margin isn’t just about cutting costs or increasing prices—it’s about strategically aligning your pricing, offerings, and processes with your business goals. By taking these steps, you can create a more sustainable, profitable business that benefits not only you but also your team and clients. Are you ready to dive deeper into your financials and find opportunities to boost your margins? Let’s talk!
