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Learning to Leverage Your Pockets of Profitability

Share current LOB: SmallBusiness
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It is second nature for business owners to know their largest customers, products and markets by revenue, but the work involved to track profit by customer, product or market is more cumbersome. According to SunTrust Business Owner Research, only 20 percent of business owners measure profit by market. Knowing which customer and markets are most profitable makes it easier for business owners to properly allocate time and other resources.

Fortunately, easy-to-use accounting software such as QuickBooks® makes it easier than ever to identify the sources of your highest and lowest sources of profit. Bookkeeping is generally viewed as overhead or a non-revenue generating function, but your accounting data is really the knowledge base of your company. Properly structuring your accounting and financial reporting system can provide standardized reports to answer the following key business questions:
  • What market segments or customer groups are most profitable?
  • Who are your company’s most profitable customers? Least profitable?
  • What are your most profitable products and/or services? Do you have loss leaders?
  • Which customers, products and services offer you the greatest future value?

Use the following steps to transform your financial data into a strategic asset:

Step 1: Use accounting history to create meaningful customer groups

Your first step is to make your accounting system specific and meaningful to your business and your drivers of growth. Analyze each customer and sale from the past year, looking for common characteristics. Then organize your findings into groups. You can also look at job proposals to help you think about business for which you competed and your success rates in landing different types of customers and jobs. With this history in mind, you can now create categories for customer groups. The key is to create enough categories that you can mine your accounting data for opportunities, but not so many that the data is difficult to gather and track on an ongoing basis.

  • Form customer categories and sub-categories using variables such as:
    • Ownership (Government vs. Business vs. Consumers)
    • Industry
    • Size (Revenue, Number of Employees & Income)
    • Distribution (Online vs. Retail vs. Wholesale)
    • Purchase frequency and customer history
    • Demographics (Age, Gender, Ethnicity & Lifestyle)
    • Source of business (Marketing Program, Referral, etc.)
  • Create and document consistent definitions for each category for anyone who enters customer information into your system.

Step 2: Decide on product and/or service groupings

By using the same grouping process as described above for customers, you can identify the groups of products and services to track.

 

Step 3: Assign direct costs to customers and jobs to track profitability

Most businesses track basic direct cost information such as labor and materials. Build on this by having your accountant set-up your accounting structure to assign direct costs to jobs and customers. Work with your accounting staff to revise how cost data is gathered to tie it to specific jobs. You may need to revise or implement timesheets or other record keeping to tie hours to specific jobs and customers. You can then easily assess profit margins on specific customers, products and services. Share your goals for tracking profitability with employees, so that they understand the outcome that you seek. Employees sometimes resist the implementation of timekeeping, because they misunderstand the objective of the exercise.

 

Step 4: Use customer, product or service-level financial reports to focus on pockets of profitability

With your newly organized database, you will be able to generate profit and loss statements by product, project/job or customer. By filtering these reports based on the categories you have developed, you can now quickly and easily generate reports showing profit margins with specific insight to what drives the cost structure for each category. For example, you may find that certain projects “cost” more than you thought because of costs that were previously disguised by only looking at costs in aggregate.

To leverage this information, use company forecasts, industry data, and competitive analysis to establish benchmarks (e.g., targeted sales size, targeted profit margin on each service sold, employee efficiency ratios, etc.). Use this information to create strategic customer and product plans, so that you can prioritize and allocate resources. Analyze the pockets of unprofitability to determine the types of projects to avoid or products to cull. Compare your actual profit margins by customer, products and services to forecasts and benchmarks on a periodic basis throughout the year.

About SunTrust Business Owner Research: SunTrust surveys small business owners and advisors as part of its ongoing business seminars and symposiums. The small business owners attending these events include both SunTrust client and non-client business owners and are representative of the broad spectrum of businesses located in the SunTrust markets. The research cited in this report is extracted from these 5,425 small business owner surveys collected between 2007 and 2011.

This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.

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