As I was reviewing the monthly financial results with one of my clients, we spent a great deal of time analyzing the gross margin. She asked me to do a training session with her and her key managers so they could better understand how to improve it. What follows is a brief, and hopefully simple, summary of our discussions.
You can improve profit only 4 ways (there are really 5, but I will get to that at the end).
You can raise the prices of the items you sell. Number 1. And this has a 100% improvement to profit. For every extra dollar you charge, you make another dollar. Simple.
I once missed a financial exam question that asked which has the quicker and greater impact on profit: higher prices or more volume? I picked volume. My logic was you cannot raise prices without volume, because a price increase on no volume is still zero. I got the answer wrong, but you know, I was partly right. You can increase volumes to raise profits, even without a price increase. That is Number 2. But, therein lies the tension that owners and managers face: how much volume do I lose if I raise prices? But the math is the math. Raise the volume at the same price levels, and you will make more profits.
Number 3 is to reduce the cost to make or manufacture. That means reduce manufacturing labor costs, material costs, and overhead costs. These are all topics for other discussion. But again, the math says if you can reduce the costs of what you make, you make more profit.
Number 4 is also cost control: reduce general and administrative costs. Administrative salaries, rent, office costs, computers, benefits, and so on.
Those are the only 4: Increase sales prices (number 1). Increase sales volumes (number 2). Reduce costs to make (number 3). Reduce administrative costs (number 4).
About the 5th way? That is balance sheet management. Control the accounts receivable levels, reduce inventory balances, manage accounts payable, tighten capital expenditures, limit debt levels and lower interest costs, etc. All of these are asset and liability management that impact profits. But for strictly managing operations, there are only 4 things to work on. Simple to describe. Hard to do.