Okay, maybe that’s a little dramatic, but I see troubling signs everywhere that inflation is robbing small businesses of their margins. I was having a sandwich with my son the other day and I had sticker shock. Understand, I’m one of those people that NEVER looks at prices (much to the chagrin of my wife). The sandwich was $12. This wasn’t downtown Manhattan. Heck, this wasn’t even downtown Oklahoma City. So what gives?
I’ve written about this topic before (three years ago), and I believe things are worse. For further evidence, visit our friends at ShadowStats. Large companies have legions of analysts and accountants to monitor and change prices, but who does the small business look to for help? Usually no one. Too many accountants are historically focused. If you’re lucky, they will tell you NEXT year that your margins are down, but don’t hold your breath. For most small business owners, that’s too little too late.
So what does a small business owner do? Here is where I would recommend starting:
I know, boring, right? It is imperative that you have good financial systems in place to capture accurate and timely financial information. The more complex the business, the more complex the accounting systems. But even simple businesses can gain tremendous insight into their finances with good accounting processes. Establish or fine tune your accounting systems FIRST. Call in an expert (e.g. CPA) if necessary.
What’s more boring that regular accounting? Cost accounting! You have the systems in place to record the finances, make sure you’re measuring all of the right things. Have you identified all of your variable costs associated with each type of product or service that you deliver? Have you properly allocated semi-fixed costs to each product or service? Boring as it is, you must make sure that you have complete information before proceeding to the next step – analyzing. Making decisions with incomplete information is often worse than standing pat.
Some businesses may simply have to determine their most profitable product or service and focus on selling more of it. Others may have to do more complicated calculations to consider fixed costs (e.g. machines in a shop), or how different products and services are related (i.e. the more vehicles we sell, the more service revenue we have). You must know what levers to pull to bring more margin to the bottom line. Again, it usually is recommended to bring in a professional like a CPA during this analysis.
One of the often overlooked items in margin analysis is the customer themselves. It’s easy to get zeroed in on the numbers and just say, “We have to sell more of X!” Your calculation must include the profitability of your customer. You need to know the lifetime value of your customer, the profitability of each customer, and how often that customer refers additional business to you. It’s okay to deviate from the “increase the margin plan” if it takes care of a good, long-term customer.
After all that, I would recommend you not overthink it. Most businesses can raise prices 3-5% without meaningful pushback. Here are two tools I recommend. First are simple pricing tables that show you change in gross margin for each percentage price increase. This helps you quantify how much business you can lose and still be ahead with a price increase. The second is a great book, Pricing with Confidence. This is a great primer, written by an expert, on how to increase prices and make your clients happy you did!
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We also have some great tools to analyze your company’s margins, comparing trends to industry, and to your own history. Call us today for a free evaluation session with one of our Certified Master Business Advisors. Contact our offices in Oklahoma City: 405-720-1244 or Tulsa: 918-477-7650 to get the help you need.