Posted on March 30th, 2009 at 3:48 pm by Cristian Graziano
Everyday businesses make purchases that don't require special approval. Notepads, printer paper, and paperclips. While the cost of these items are minimal, the problem is how it affects the returns of your business. Read on to learn how a box of paperclips is making your business have to work harder to keep its returns up.
Understanding Business Returns
Every for-profit business has one primary purpose: to increase the wealth of its shareholders. You may love manufacturing blue widgets, but your hope is that you'll manufacture blue widgets at a cost of x and sell those widgets for a cost of x + y (leaving you with a profit). In its most basic form, returns work like this: for every one dollar you put into your business, you are working to produce something more than one dollar. If you can take one dollar, manufacture a blue widget, and sell that widget for $1.20, you just made a 20% return. The idea is that if you can continue investing dollars into your business – lets say $100,000 – you can make a larger return in dollars (at 20%, you'll have a return of $20,000 on a $100,000 investment).
Hold on a second…it's not so rosy
Before you start plowing money into your business, consider this. Every dollar you invest into your business doesn't go towards earning you a profit. You need a phone, lights, bathrooms, paperclips. These items don't necessarily help create profit – they are just necessary items that you need to keep your business running. So if you invest $100 and produce $120, but need $5 to go towards non-profit-producing costs, you now brought your profit down from 20% to 15%. In order to end up with a 20% return, you actually need to produce a return higher than 20% in order to compensate for non-profit-producing costs (like paperclips).
Why you should be concerned
This all seems rather pointless. A box of paperclips can't be more than a few dollars, right? That's exactly right. But this post isn't about a box of paperclips – it's about what a box of paperclips represents. The box of paperclips could be anything that doesn't directly add value and go towards producing profit for your business.
As a business owner, you should be aware of what costs are profit-producing and what costs are non-profit-producing. This is critical. The more your business spends on non-profit-producing costs, the more you are going to have to compensate by squeezing higher returns out of profit-producing costs. Costs can be an actual outflow of cash, or they could wasted time or opportunity cost. Be sure you are aware of all types of costs.
So how do you squeeze out higher returns?
First determine what your target profit margin is. Then determine what your actual profit margin is. Then look at your profit and non-profit producing costs. Can you reduce the "paperclip expenses" further? That's the first place to start.
Once you've done that, how can you create greater returns? You can make your manufacturing or service process leaner. Cut out wasted time. For example, if you have parts waiting in line to get painted, that is non-value-added time. Can you cut back on that time so you can paint more parts in the same amount of time?
If you are running a service business, can you increase the percentage of your time that is billable? Try monitoring your time for a month to determine what percentage of your time is billable vs. non-billable. Where is your non-billable time going? Business development? That's okay – as long as you are being effective at it. Record-keeping or administrative duties? Find ways to automate the process or consider a virtual assistant to help you with those tasks (if your time is worth more than what the assistant is costing you).
Because I work in a service-based business, time is the precious resource. I invested in time-tracking software that allowed me to initiate a task, make some notes, and time myself. I realized I was spending lots of non-billable hours on quoting projects that never went anywhere, on administrative tasks, and that I was underquoting fixed-fee projects.
Here's how I fixed it: I spend a very long time quoting projects. Not just thinking the project through, but in putting together a high-quality proposal for the prospective client. To reduce my time spent quoting projects that didn't go anywhere, I began asking more questions when prospects first called to see if we would be a good fit for each other. I ask for budget upfront, or quote a ballpark figure and run it by the prospect. I tell them that if the ballpark figure is within their budget, I can put together a detailed proposal. This saves me lots of time with people who were looking to spend less – and I can spend more time dedicated to putting together high-quality proposals for those who might be a better fit.
I found ways to speed up my administrative tasks through trial-and-error, and I developed a method for more accurately quoting fixed-fee projects.
The idea is to evaluate your business and understand where you are producing profit, and where you are taking away or losing profit. If you can maximize the first and minimize the latter – you'll be better off. Sounds easy, but it takes diligent monitoring and sometimes creativity to do. But you'll be better off because of it.