A Formula for Rebuilding Your Profit
2020 has been, for many businesses, one of the most challenging years in a very long time. While each industry and each business has been uniquely impacted by the throes of this year (from a pandemic to a derecho), it’s not too late to focus on profit this fourth quarter. I wanted to share again ActionCOACH’s Five Ways formula, a unique approach that breaks “sales” into five separate components. These activities can be worked on individually and across the board to leverage profits on your bottom line.
Conventional business looks at sales from the standpoint of three activities, namely sales, expenses and profits defined by the formula: Sales – Expenses = Profits.
In this approach, each action depends on the other, forcing businesses to look at either increasing sales or decreasing expenses in order to influence profitability.
In the ActionCOACH business coaching model, this is termed “The Five Ways.”
According to the “Five Ways,” all business is driven by five key profit generating areas: Lead Generation, Conversion Rate, Average Dollar Sale, Average Number of Transactions and Profit Margins. These areas are highlighted in the following equation:
Lead Generation x Conversion Rate = Number of Customers
Number of Customers x Average Dollar Sale x Average Number of Transactions = Revenues
Revenues x Profit Margins = $ Profits
A closer look at each of these five activities reveals how an increase in any or all of them can increase sales and profits, while keeping expenses constant.
Understanding Lead Generation, Conversion Rates and Average Dollar Amounts
In today’s highly competitive business world, it is not possible for business owners to sit back and see the profits roll in. It becomes vital for businesses to test and measure everything. A good place to start is lead generation. This is defined as the total number of potential buyers that a particular business contacted or that contacted the business last year. Leads are also known as ‘potentials’ or ‘prospects.’
Most people confuse responses, or the number of potential buyers, with results. The sound of ringing phones does not mean that the cash registers are ringing as well. This is highlighted by conversion rate, or the percentage of people that did buy versus those who could have bought. An example of this is 10 people walking through a store with three people buying something. For the day, the store had a conversion rate of 3 out of 10, or 30%.
The next part of the ‘Five Ways’ is the number of customers. This is the number of different customers a business deals with, and it can be determined by multiplying the total number of leads by its conversion rate.
Average number of transactions is the number of purchases the average customer will make over the course of a year. It helps to keep a database of past customers, and many business owners make the mistake of subscribing to the myth of once a customer, always a customer. The average number of transactions is closely related to the average sale of each purchase, which is also forecast over the course of a year.
Discovering Revenues and Working on Margins
The next important concept in the model is revenue, which is computed by multiplying the total number of customers by the number of times that they bought, multiplied by the average amount they spent.
The resulting number is “revenue,” or the total amount value of overall sales for a business.
This figure leads to the concept of margin, which is the profit percentage of each and every sale. Simply put, if a business sells something for $100, and $25 was profit, the profit margin is 25%.
The final step takes the resulting revenue number and multiplies it by a company’s profit margin percentage to reach bottom-line profit.
The innovative idea around the “Five Ways” is that businesses can leverage the concept even if they have a product or service with a long-term buying cycle or a limited number of transactions.
In those cases, a business could work with the other action steps to improve bottom-line profit, including boosting its marketing efforts to capture more qualified leads, finding ways to increase conversion to customers, raising prices to leverage average amount sale or upgrading profit margins.
By stepping outside the conventional accounting perspective of profit, and recognizing that a number of additional activities drive the bottom-line – ActionCOACH gives owners a new perspective on business, and equips them with the tools that positively impact each variable of the equation.