Over the past year, businesses have remained focused on maintaining revenues as the pandemic has impacted companies in many different ways. But an important factor not to be overlooked is a business’s ability to maintain its gross margins, which is especially meaningful during difficult financial times.
Gross margins in its simplest form is revenue less cost of goods sold, and for some companies this is not complex. But understanding how to maintain and even improve your margins requires a complete understanding of your customers, vendors, labor, and other costs that make up cost of goods sold.
Focusing on Revenue
Sales has a significant impact on a company’s ability to increase profit margins and is one of the first areas of focus to achieve improvement. Some of the areas of focus include:
- Review pricing – At a minimum, it is a good practice to review the pricing of all customers on an annual basis. Inconsistent pricing can lead to price erosion with certain customers, which becomes more difficult to correct over time.
- Increase prices – This is often easier said than done. There is often a lot of pressure from customers regarding price increases, but it is important for a business to have a plan to consistently (annually) increase their prices in order to keep up with the increase in labor and material costs.
- Focus on the characteristics of your best customers – Every business has a core set of customers, and many of those customers have similar characteristics that define their value as customers to your business. Focusing on retaining those customers and targeting customers with similar values will assist in growing the business and improving gross margins.
Don’t Forget about Cost of Goods Sold
The other significant component of gross margins is the cost of goods sold. Focusing on labor and purchase costs is an excellent way to improve margins and increase earnings. Areas to consider include:
- Pricing - Consider all of your significant vendor relationships and think about negotiating for lower prices. Long-term relationships are important and develop over time, which may give you an advantage in your request. It is important to do your homework and understand the marketplace and what kind of pricing you are currently receiving. This will give you leverage in negotiating prices.
- Vendor discounts – Make sure you are utilizing all available vendor discounts. This ensures you are taking advantage of the best available price from that respective vendor, and can add significant savings to the business. If there are certain vendors that do not offer discounts, consider offering terms to your vendor for an early pay discount.
- Efficiency – It is important to understand all of your labor costs (payroll, benefits, etc.) and their direct impact to the cost of goods sold. Do you have the right number and mix of people in production? Is there a lot of turnover within departments? Is the acquisition cost of talent high? Often, people costs are among the highest of a business, and it is important to thoroughly understand every aspect. Turnover can be especially costly since skilled labor is becoming more difficult to find. This can impact production levels and delivery of services or products. Businesses should be investing in programs to improve efficiencies regarding their people costs and hiring processes, because doing so may lead to improvements in production/services and dollar savings.
- Inventory management – This is a key area for most manufacturing and distribution companies. Monitoring turnover, waste and spoilage, and obsolescence is a way to improve cash flow, cut down on waste, and ensure that the company is not writing down or writing off inventory that is no longer saleable. Managing the quantity on hand and controlling the timing and amounts needed helps a company manage cash flow. Reviewing production and understanding the amount of waste and scrap may lead to improvements that can directly save a company money.
By focusing on key items impacting your gross margins, a company can improve efficiencies, cash flows, and earnings, which can translate to improved working capital and liquidity.
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