Put Profit First!
by Phil Latz
This blog was written for bicycle retailers but many of the principals are universal, so if you’re not a bicycle retailer, you should still find this useful.
Why did you start your bike business? Because you love riding bikes yourself? Because you’re an ex racer and it’s all you know? Because you love seeing young kids get their first bike? These and many other reasons are all well and good, but the only way you can stay in business for any length of time is by making a profit!
My favourite subject at school and later at university, was economics, probably because it closely relates to the world of business, to which I’ve been magnetically attracted since a young age.
I’ll never forget my high school economics teacher asking the class, ‘What is the aim of a business?’ After patiently hearing a wide range of often idealistic answers from his students he forcefully stated, ‘The aim of a business is to maximise profit! Full stop. No ifs, buts or maybe’s.’
All of the other lovely things, helping kids to start riding, spending more time with your family, whatever you like… they’re all fine, but they’re your personal goals. Please do not confuse the two.
Another great saying that always bears repeating is, ‘Turnover is vanity, profit is sanity.’ Sometimes a third part is added to the end … and cash is king!
Many bike shop owners tell me their sales. They know their sales numbers, if they’re up or down on the same month last year and so on. But very few of them know their profit numbers, which is ironic because that’s the only portion that as a business owner you can truly spend on whatever you like – after paying tax of course.
The vast majority of your sales revenue has to go back to paying for the goods you sell (bicycles, parts and accessories) or your expenses, including wages, rent, insurance, electricity, tax, phone… the list is always too long!
I was pondering this recently when I was almost home from a leisurely 40 kilometre bike ride. If each kilometre represented sales revenue and I was making 5% net profit, then I’d be just a few minutes from home, two kilometres away to be exact, before I start riding for myself. For the previous 38 kilometres I’ve been riding for other people: my suppliers, insurer, landlord, bank manager and others. (Why do they all seem wealthier than me?)
If I’m making 2% profit, which is all that some bike shops manage, then I’m not even riding the last full kilometre for myself, only the final 800 metres.
Those profit percentages may sound quite dismal, but if you dive into the data provided by the Australian Bureau of Statistics (ABS), you will find that the average net profit margin across wholesale business is typically in the 3% to 4% range each year with retail only slightly better at 4% to 5% average net profits. You can see detailed data here.
With many bike shops having closed in recent years, clearly there are some bike businesses not making any profit at all. Yet I’ve heard of others making close to 20% net profit.
Why such a difference?
Start with Defence!
In both sport and war, we talk about offence and defence. It’s no different in business. Offence includes things like marketing and growing sales revenue. That’s all very exciting and what business owners like to talk about most, but I strongly urge you to start by strengthening your defence. In business, as my accountant loves to hammer into my thick skull, that means three things: cost control, cost control and cost control!
Why is this the most important place to start?
Let’s say that by going through all the expense line items on your profit and loss statement (Yes, you do need to look at your financial statements!) you contact key suppliers and negotiate slightly better rates on everything from your insurance to your bank interest. It’s not that hard to do – if you don’t ask, you don’t get!
Let’s say that in total your savings add up to $10,000 for your shop that’s turning over the Australian bike shop average of $863,875 (based upon the last survey done in 2015/16).
You’ve just increased your net profit by 1.16%. That might not sound much, but if you’re running in the middle of the ABS average for retail net profit, 4.5%, that would increase your net profit by just over a quarter, 25.7%, to a new net profit of 5.66%. In dollar terms you’ve just increased your net profit from $38,874 to $48,874.
This is additional to owners wages, which should always be shown within your total wages expense line, before you calculate net profit.
Offence is Usually More Work
On the other hand, if you don’t worry about defence and just focus upon your offence through increasing your sales, how much more do you think you’d have to sell to get the same bottom line result of a $10,000 increase in net profit?
Using our example, if you are running at 4.5% net profit, then to increase net profit by $10,000 you need to increase sales by a staggering $222,222! Think how much work would be involved in increasing your sales by that much. You might need more staff to build bikes, a bigger store, more stock, higher insurance premiums and so on.
Therefore the real world answer is not quite so simple to predict as making a simple projection based upon unchanged profits. It depends upon how much your cost of goods sold and expenses increase relative to your increase in sales. Perhaps you’ll find some economies of scale and net your profit percentage will also improve when your sales grow. Great! But don’t just assume this will happen without you consciously working on it. Often businesses go the other way – ‘Now I can afford that bigger premises!’ Or a new shop van, extra stock, there’s a long list of ‘must have’ expenses you can find yourself paying ahead of actually banking some profit.
Whatever you decide to do, any positive action is better than falling asleep at the wheel, content with the status quo. I’ve just finished reading a business book called Profit First by Mike Michalowicz. It’s full of way too many corny jokes, but contains some interesting ideas that I’ve not seen in any of the many other business books and articles that I’ve read over the years.
To distil 224 pages into a couple of lines, Profit First says you should flip the usual financial system on its head and say, ‘sales, less profits, equals expenses’. Then you should set up separate bank accounts for profit, tax and other key items and make small but regular payments into these accounts – before paying your bills!
Of course there’s a lot more detail, so read the book before you try it. But I was sufficiently impressed that I’m going to try it for my own business, new bank accounts and all. In the coming months and years, feel free to ask me how it’s going!