Imagine that you have been in the market for two years, you are not selling everything you expected and the viability of your project is faltering. "Entrepreneurs foresee, for the first year, sales of 100, and later the reality is imposed and they only sell 20. They foresee margins of 7% and only earn 1%", summarizes José Luis Barbero, professor of the Entrepreneurial Initiative area of the EOI.
Imagine now that you have to make a decision: you need liquidity and you have to concentrate your efforts, because you don't have enough resources to take care of all your lines of business. Which ones would you take care of and which ones would you leave behind? How do you make that decision?
You may find that by giving up one line of business and dedicating more resources to another, you get liquidity to survive or to invest - be careful, you don't have to go wrong. But to be able to do this, you need to know the profitability of each of your product lines and you have no choice but to know what margin they leave you.
The line of business with the highest turnover does not have to be the most profitable. And what's more, it may even be weighing on your profits. For example, because it requires a high investment in marketing that subtracts resources from other lines in which you do not spend a penny on promoting. By investing in breakfasts with journalists, you miss out on investing thoroughly in a couple of strong AdWords campaigns in two other lines of business with potential for growth.
Too short term
How often do you review the costs incurred by your product or service lines? Do you know what real weight each of them has in your billing? If you regularly ask yourself these questions and have had a cost analysis system for a long time, congratulations, you do not have to read this report, go directly to the dossier on how to reinvent yourself, that you are going to get more out of it.
We ask you these questions because we find that many SMEs work in the short term. It is a vicious cycle: fires are constantly being put out and decisions are made within that period. We often meet entrepreneurs who say: "This month we have to reach this figure." And the actions they take to achieve it mortgage the following months.
“You often reach the wrong conclusions because you try to simplify the analyzes and you try to reach large conclusions without performing complex analyzes. Appreciations of the type are made: 'As this client has a rebate, it must be not very profitable' or 'the raw material of that product costs little, and, therefore, a lot of money must be earned… ”, sums up Eduardo Navarro, president from the business consultancy Improven and author of the book Do you want to save your company? (Management 2000).
"It may happen that you are dedicating 60% of your time to the business line that is giving you the least profitability on your sales and the rest works in automatic mode without you paying attention, but also without getting more out of it," says Javier Fuentes. Merino, professor of Commercial Research at the Autonomous University of Madrid.
You have to see, of your entire product portfolio, which ones are being sold. It happens to many SMEs that usually have a portfolio of products or broad offers, but in the end they make a global volume of sales with a small group of products and have others with little demand.
This type of reflection has to lead you to make decisions about which product or service lines you have to leave or promote or invest more. You may find that a group of products gives you volume, but with a marginal profitability.
“The belief that to sell more, the more customers the better, is a misconception. The truth is that to sell more, the more good customers, the better. Billing more can be achieved by abandoning some. Between 20% and 30% of clients are not usually profitable, so they must be transformed into good ones ”, adds Navarro. “The problem arises when you don't want to accept reality. Phrases such as "that business has always been good" or "we lose money this year, but surely the next one will give good results" are frequent. These beliefs generate emotional traps that can end up having dire consequences, wasting time and money, ”he says.
What you have to do?
Ok, this is all very well, but how do you carry out your portfolio analysis? "If your company has resources, the ideal would be to develop a scorecard that allows not only obtaining information on the profitability of the products but also useful information to make strategic decisions in the company ”, argues Raquel Piñeiro, Promove consultant.
"Another possibility is to design a specific scoreboard that allows you to make sales predictions for each product-service line; carry out a cost analysis (fixed and variable) linked to the production process of each product-service line; study benefits and margins obtained in each product-service line; analyze the market segments that offer the highest profitability; see your competitive advantages with respect to competing companies and substitute products ”, he continues.
If you don't have resources
But the normal thing is that you have neither the time, nor the resources, nor the indicators - let's see, how many SMEs and freelancers really have a scorecard? -. So, being realistic, Piñeiro proposes, "what you have to do is analyze your operating account and calculate what the contribution margin is for each product and service line."
Do you cover fixed expenses?
"The operating account of your business reflects, in an orderly manner, the income and expenses of your company, directly establishing the profits and losses for the financial year", he summarizes. Most importantly, “cost splitting allows you to calculate the variable contribution margin, which is the difference between the sales price (total or per unit) and the variable costs (total or per unit). The contribution margin must cover the fixed costs [rent, financial expenses, payroll, etc.] and the profit (profit) expected for the product ”, explains Piñeiro. What do you have to see?
1- “If the contribution margin is positive, it allows you to absorb the fixed cost and generate a margin for the expected profit. The higher the contribution margin, the greater the profit or profit of that product ”, he points out.
2- “When the contribution margin of the product is equal to the fixed cost associated with it, it does not leave margin for profit, so it is considered that the company is at the equilibrium point: it neither gains nor loses from the point of economic view. But, of course, it will be necessary to analyze the social and strategic profitability of the company, the opportunity cost, etc. ”, explains this consultant.
3 -If the contribution margin is not enough to cover fixed costs, “the company must take measures in the medium term to improve profitability. For example: increase sales, raise the price, etc ”, he assures.
4- "And when the contribution margin is negative, that is, the variable costs are higher than the sales income, the company must necessarily make the decision to dispense with that product," he points out.
“Now, the business lines are not independent. Do we really know what happens if we cut? Maybe if I cut a line aimed at large companies, then I can't sell to SMEs online. Or it has no influence. An appliance company loses money on refrigerators. If you sell washing machines, how can you not sell refrigerators. By brand image; by possibility of cross selling. In a cold analysis, you realize that nothing happens for not selling refrigerators. You have to see businesses as independent, ”warns Javier Fuentes Merino.
Are fixed costs weighing you down?
"Maybe I'll get out of here ... but what about fixed costs?" Perhaps, by eliminating a product or a line, you do not get later to amortize your salary. Maybe you are paying off fixed expenses, even though you are not covering variable expenses. He is paying you for part of the infrastructure and if you only have one line, it turns out that it will not be enough to pay for the infrastructure ”, he adds.
Thus, it is advisable to see what type of costs are behind each product or each product line: are they fixed or variable costs? How many do you have more clients, fixed costs or variable costs? Do fixed cost products or customers compensate you ...? Also ask yourself if you amortize the variable costs (otherwise you will enter into losses) and do not forget to analyze the causes why you do not reach profitability.
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