Probably the most important formula in business you will ever learn

The 5 Ways to Grow Your Profit

One of the reasons this formula is so powerful is that it takes you away from thinking that only revenue and expenses can be manipulated to increase profits. 

This so called “secret” formula” targets the five key factors that drive profit and they are in every business.

These five key profits generating areas are:

1. Lead Generation
2. Conversion Rate
3. Average Sale
4. Average Number of Transactions
5. Profit Margin

This diagram demonstrates how they work together.

1. Leads. These are the total number of leads / prospects i.e. those who have contacted the business or been contacted by the business in a defined period i.e. hour, day, week, month, year. 
2. Conversion Rate.  These are the percentage of people who buy.  Assuming 10 people enter a shop (leads) and 3 people buy, the conversion rate is 30% (3/10) for that period. 
3. Number of Transactions.  This is the number of repeat purchases one customer will make in a defined period so the number of transactions per customer.
4. Average Dollar Sale.  This is the average dollar amount per sale during the defined period.  As a simplified example from the above number of people, the 3 sale amounts are $20.00, $10.00 and $45.00. A total of $75.00 for that period or an average sale of $25.00 ($75.00/3). 
5. Profit Margin.  This is the profit percentage for each sale. If a business sells something for $50.00, and profit was $10.00, the profit margin is 20%. 

Let us see how these 5 areas relate to revenue and profit?  

The above shows that in a defined period the business converts one in four leads into paying customers, each of whom average two purchases each at $50.00 per purchase and the business makes a 20% profit margin on revenues of $50,000.  This equates to a profit of $10,000.

What if the business focussed on increasing results in each of the 5 areas by just 10%, what would the profit be?

Leads: 2000 + 10% = 2,200

Conversion Rate: $25% + 10% = 27.5%

Number of Transactions: 2 + 10% = 2.2

Average Dollar Sale: $50.00 + 10% = $55.00

Profit Margin: 20% + 2% = $22%

Notice how a small amount of 10% in each of the 5 areas produced a compounding result and boosted profit by 61%.

We have highlighted the five key areas of a business that determine profit and shown how powerful just a small change in each of the numbers are in terms of boosting profit.

Now we will relate those numbers to what action to take in a business.

Number of Leads Generated x Conversion Rate = Number of New Customers. 

If the intention is to increase the number of buying customers, then a business needs to do at least one of two things. It must increase the number of new leads (that being those who are aware that the business exists) and/or increase the effectiveness of converting those leads into customers. 

The ideal is to work on both, and each will require specific strategies.

Number of Customers x Number of Transactions/Customer x Average Dollar Sale/Customer = Total Revenue. 

To increase the revenue the options are to increase the number of times each customer buys and/or to have each customer spend more each time they buy.

Both are achievable and each will require different strategies to get the desired results. 

Now with the total revenue/turnover the amount of profit will be decided by the Profit Margin. 

To increase the amount of profit, increase the profit margin. 

The profit margin is based on the average profit margin, so to increase this, look at working on individual profit margins e.g. across the product range, across the types of services provided. 

Also, rather than resorting to discounting, look at alternative strategies like value adding. 

There are strategies to boost profit margins, several which will be presented in more detail in future articles. 

Whilst there is always a reluctance to increase prices because of the fear of losing customers, this is often a false fear. And even if there is a loss of some customers, an increase in profit margin means a business can afford to lose customers without an effect on profits.

Disclaimer

This article is provided with the compliments of Alan Dinnie. It is genuinely intended to offer readers information to make better decisions and give insight into various aspects of business in general, and more particularly related to the sale and purchase and management of businesses. 

All material presented herein is intended for informational purposes only. Information is compiled from sources deemed reliable but may be subject to errors and omissions. No statement is made as to the accuracy of any description. Alan Dinnie makes no warranties or representations regarding the information and excludes any liability which may arise because of the use of this information. This information is the copyright of Alan Dinnie.

Nothing herein shall be construed as legal, accounting, or other professional advice outside the realm of real estate and business brokerage. 

I trust you enjoy the article and that it provides you with useful information.

To your business success

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