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Rationalize Your Revenue: Know Your Costs of Sales

Rationalize Your Revenue: Know Your Costs of Sales

Now that you’ve gained a clear view of cash coming in versus cash going out, and the timing associated with that inflow and outflow, it’s time to dig deeper into the nature of your revenue.

As we like to say at the beginning of our Managing Your Money podcasts, money makes the world go ‘round, and it makes your business move forward. Hopefully, every month after opening your doors for business, you’ll have sales. But those transactions come with a price, or better said, “a cost.” Just as your business takes in money from what you offer, it incurs costs to make that offering possible.

What we’re focusing in on here is the difference between “revenue” and “net income.”

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You may have a sales forecast for the sale of a certain product, but that information does you little good without knowing how much it’s going to cost you to achieve those revenues. For example, how much are you really taking in on a transaction after marketing, development,  commissions, or hard product costs?

Managing and maneuvering these costs is as important to your success as the revenue you take in. After all, who cares how much you make – it’s all about how much you keep.

Fixed vs. Variable Costs

Fixed Costs = expenditures that are always and unavoidably there every month

Variable Costs = things you spend on only by choice or as a result of sales

Fixed costs include things like rent, telecommunications, salaries, interest payments, anything that is a constant. Frankly, it’s the stuff that’s easy to plan around because it’s steady – always there for you to have to pay. In any venture, from tiny little you to the biggest behemoths in industry, it’s always desirable to keep fixed costs as low as possible. The fact that you have to pay them is the problem. Even if you have a bad month of revenue, money to pay fixed costs must still be doled out.

As the name implies, there’s not a lot of flexibility when it comes to fixed costs. That’s why, whenever possible, you want to shift your costs to the “variable” category. Variable costs are those that do have some flexibility. If your sales go down, you can quickly react by reducing variable spending.

To demonstrate how to think about fixed versus variable costs, take this example: Instead of hiring a secretary as an employee, consider outsourcing to a contract worker such as a virtual assistant. That way, a) you use only the hours you can afford to at any given time, and b) you don’t have to commit to office space necessary to accommodate that employee. If revenue plummets, scale back hours of out-sourced support. If revenue spikes, ramp back up to the ideal level of support.

Here’s another one: Instead of renting a dedicated warehouse facility to house your inventory, find a warehouse company that will allow you to use “flex space,” where you pay only for the space you use. This way, if your business is seasonal, you only carry the cost of the necessary level of warehousing.

Basically, if possible, reduce your fixed costs to the lowest possible level, and put as many line items in the variable category as you can. The more nimble your business is on the spending side, the more likely you are to preserve cash.

Payment Terms

Payment Terms = you allow for customers to pay within a preset number of days after the time of the actual transaction, typically “Net 30 Days” (within 30 days).

The saying, “communication is king” definitely rules when it comes to getting paid promptly. It’s your responsibility to ensure that you get paid in a timely manner. Buyers somehow become conveniently distracted when it comes time to pay up, so it’s very important that you openly and deliberately stress the importance of payment according to schedule. It’s all about setting customer expectations with appropriate emphasis.

Need more than “emphatic” communication to get customers to pay on time?

Here are some ways to get the dough you’re owed:

  • Offer a 2% discount if a customer is willing to pay you within 10 days instead of the usual 30 days.
  • Accept credit card payments so customers can enjoy the benefits of paying later through their credit card statement, while you enjoy immediate payment through the credit card company (or Paypal, as the case may be).
  • Just ask for immediate payment! Even if you offer extended payment terms, it doesn’t hurt to ask for payment right then and there. Some customers will actually pay right then and there, unless they’ve read our advice here in 8 Steps to Managing Your Money, that is.
  • Consider factoring, where your customers don’t change their “slow fuse” payment habits, but instead you get a financing company to provide the money today that your customer owes you 30 days out. In exchange, the factorer gets a cut of the total receivable. This is explained more in Step 6.
  • Make deposits regularly and frequently – a negotiation that only requires agreement between you and … you. Instead of depositing funds into your account at the end of the week or even less frequently, move money into your account same day as it’s received.

Be Realistic

Finally, be realistic when making assumptions about how much money is coming in. As we stressed in Step 1, it’s common for first-time small business owners to overestimate revenue because of over exuberance.

If success if your goal, it’s best to plan your business on conservative assumptions, not on shoot for the moon numbers.

Tip

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Price yourself with confidence.

When you’re just starting up a business, it might seem logical to think that you should charge less than other outfits because you have less experience.

Abandon that attitude, says Veronica Rebella, the owner of Thomas & Fees, an accounting firm in Irvine, Calf. “Don’t be insecure about your abilities,” she says. “You’ve got to get over it.”

We agree! We’ve seen countless entrepreneurs who try to compete strictly on price and struggle constantly to eek out a profit margin while battling with other price pressured hucksters. These days, there’s too much competition to build a future on “best prices” alone. Instead, you have to rely on other things like unique offerings, better quality, special customer experience, and other distinguishing factors. That way you move away from the look-alike contest and toward a category of your own at prices that allow you to build a viable business.

If you must play the discounting game, or even more extreme, must offer free products or services to get customers warmed up to you, just make sure your customers know it’s a “limited time” or “introductory offer.” This way, you won’t pollute customer expectations permanently.

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