Do you know your real net profit?

By Jake Voelcker, owner, Bicycleworks

Many small business owners don’t realise they are making a loss with every sale of some types of goods. Are you one of them?

It’s easy to think that any sale which puts money in the till must be good. As long as you sell the item for more than its trade price, then you made a profit, right?

Wrong. There is an important distinction between gross and net profit. Gross profit (GP) is the difference between how much you paid for stock, and how much you sell it for. Net profit (NP) is how much remains once you have also paid the rent, rates, wages, utility bills…

Most business owners understand this difference when it comes to the annual accounts, but how many think about the net profit on each and every sale?

It’s a difficult thing to calculate. If you sell a bike for £1,000 and you purchased it at £600, the GP is easy: £400. But what is the NP on that sale? In other words…

• How much of your rent should you apportion to that bike? (How much floor space did it take up? How long was it in stock for?)
• How much of your payroll? (How long did it take to build? How much time did staff spend discussing it with customers?)
• How much of your electricity bill? Insurance? Accountancy fees? Advertising costs?

It would be impossible to calculate the exact proportion of these costs for every product. Understandably, many small business owners give up, and look only at the GP instead. This is a big mistake, because too often it ends up in over-estimation of your profit margins, and ultimately selling products at a loss. How can we solve this problem?

The answer is: begin at the end, then work backwards.
1. Start with last year’s net profit. Deduct your own salary and dividends, and also any. corporation tax and income tax. What you are left with is the real net profit.
2. What is this net profit as a proportion of your turnover? (To find out, divide the net profit by your turnover, then multiply by 100 to turn it into a percentage). For example, a profit of £10k on a turnover of £200k is: 10/200 x 100 = 5%
3. Apply this percentage to everything you sell. 5% of that £1,000 bike sale is £50. So the £400 profit you thought you were making is actually only £50 net profit.

This is only an average. Some sales are more profitable than others.

For example, it may be that selling P&A is normally quick and easy, involves very little after-sales support, and on average has a 50% gross margin. So we can assume that your net profit on most P&A is above your 5% average.

On the other hand, selling bikes is more time-consuming, involves more after-sales care, and the gross margin is only 40%. Realistically we can assume that your net profit on most bike sales is therefore less than 5%, and in some cases may be close to zero.

What can I do about it?

Armed with the knowledge of how much (or how little!) your net profit really is, you can start making some very powerful decisions.

Beware the trap of commissions and fees. A 10% fee on a bike sale doesn’t sound too bad, does it? If your margin on bikes is 40% then you can afford… oh, wait. Yes. Your actual net margin on bikes is less than 5%. Yet you are giving away 10% as a fee. This means a net loss of over 5% on every sale. You would actually have made more profit by not selling the bike at all…

(For some businesses, the fees are part and parcel of their business model. A business which sells on eBay will always pay a percentage on every sale, and that’s fine as long as they have factored this into their pricing and there is still enough NP left after the fee.)

Don’t discount. The same applies to discounting. A 20% discount may not sound like much, but if you are only making a 5% net profit, then a 20% discount is a 15% loss on that sale.

Do more…
• Do more of the things that make any net profit above your average. Servicing and repairs pay well and don’t involve discounting? Then look to expand the workshop side of the business. Own-branded parts and accessories allow higher margins and avoid online discounters? Expand your range of own-brand items.

Do less…
• Do less of the things that make a lower profit. Cheap bikes attract time-consuming customers and always come back with warranty issues? Consider dropping the budget brands, and only selling bikes above a certain price point.

Stop!
• If anything makes a net loss, you should almost certainly stop selling it! Clothing? Kids’ bikes? High-end groupsets which you can only sell by discounting? Anything which takes time to sell, or requires discounting, or has a high return rate, or a low gross margin, probably has a NP close to zero. Don’t be afraid to drop these products completely. Remember, they are probably making you a loss on every sale already, so you will literally be better off without them.

Once you start thinking in this way, you can begin to really shape your business around doing what you do best. By doing more of the profitable stuff, and spending less time on the loss-making stuff, your overall turnover may fall, but your profit will go right up.

Work less, sell less, but make more profit. Who wouldn’t want that?

Jake Voelcker, owner, Bicycleworks – www.bicycleworks.co.uk
Bicycleworks offers everything you need to launch your own bike brand and build bikes in-house.