Three P’s for Better Performance

Here are three aspects of your business to focus on that will propel you in the right direction: profitability, pricing, and projections.

Profitability

Profits are the lifeblood of an organization and broadly refer to financial gain. In the context of a business, it’s the difference between total income and the amount spent to generate that income. Focusing on profitability is critical because it’s what allows you to pay yourself, reinvest, and grow your business. I recommend you track both your net profit and your profit margin on a monthly or quarterly basis. For profit margin, divide net profit by revenue.

Revenue and profits are related, but they are not the same. Revenue is top line or “gross” income: total funds that come into your organization from sale of goods and/or services. For nonprofits total income includes grant and donation contributions. Profit is bottom line or “net” income: revenue less business expenses for the same period. It is important to recognize that while increasing revenue can bolster profits, that’s not necessarily the case. For example:

Company A has $200K in revenue and $180K of expenses. A has $20K in net profit at 10% margin.

Company B has $150K in revenue and $100K of expenses. B has $30K in net profit at 20% margin.

Which business would you rather be? Company A might claim they “made” more money, but Company B is more profitable. When someone says they “made” a certain amount, they should be talking about profit and not revenue. Sales figures alone are misleading; profitability is key.

In many cases selling more product will lead to increased profits, but be aware that as you grow that your cost structure will likely change. In some instances, product is cheaper to provide as you scale, but there can be additional expenses to expanding operations. You might need to hire employees, purchase machinery or software, rent a larger space, or increase your marketing budget. The costs to generate an increase in revenue could actually erode your profitability if you’re not thoughtful about growth. Selling more only helps you earn more money if you scale with intention and hyperfocus on your cost structure and pricing. Intentional pricing for your product or service is essential to enhancing profitability.

Pricing

Strategic pricing starts with considering your costs and your competition. Price too low and you won’t make enough on each sale to profit adequately. Price too high and you might not make many sales at all. A basic tenet of economics is that the price of a product is inversely related to the number of sales (visualized as a demand curve). Some businesses price at one end of the curve or the other. “Value pricing” means they choose to price below competition knowing that they will sell a high volume but at a low profit margin. “Premium pricing” means they charge more than competitors, sacrificing sales volume in favor of a higher margin. A third strategy is what I call the “Sweet Spot” where firms evaluate the demand curve and competitive dynamics to determine pricing that balances volume and margin to optimize profitability.

Value pricing tends to work for companies that have the scale to produce or provide their offerings more cheaply and widely than their competition; they need to distribute a lot of product to earn profits given slim margins. Premium pricing tends to work for companies that have enough capital to withstand slower periods when they aren’t selling as much; each sale brings more significant earnings but lower volume means there will likely be times when less cash is coming in. Pricing at the low or high end of the market can help differentiate an offering, but each comes with downsides.

Sweet spot pricing, in my experience, is where most small businesses aim. The goal is to have enough profit in each transaction to sustain your costs and earning demands while remaining competitive and making consistent sales. Picking that price is a science and an art. Here is a look at a classic demand curve: 

For example: if you have a product that costs $10 to make (including all direct and indirect costs), everything over $10 is profit. Let’s assume that priced at $20 you’ll sell 100 units, if priced at $18 180 units, at $16 270 units, at $14 370 units, and at $12 500 units. What price point would you pick?

At $20 you profit $10 per item for $1,000 total. $18 price = $1,440 profit. $16 = $1,620. $14 = $1,480. $12 = $1,000. Sixteen dollars is the optimal price for the product.

Of course, you don’t know in advance exactly how much of what you’re selling will be bought at a given price until you have your product in the market. But you can make an educated guess by weighing your industry, market, competition, costs, seasonality, and other considerations. Realistic projections are essential for pricing, planning, and profiting.

Projections

Financial projections provide an important framework for prudent business decisions. Projections are rarely precisely accurate. But just the process of making some educated estimates of where your business will be in six months or a year gives you significant insight to help inform better strategy. The basis for good projections are justifiable assumptions. Because financial forecasts are based on future events tyou will need to have a sound basis for your assumptions. Assumptions can be based on past events, market dynamics, upcoming changes, or a combination of these (and other) factors.

Projections are helpful for pricing and many other financial, operational, and strategic decisions. You should have projections for at least the next 6 to 12 months, including estimates for sale volume, top line revenue, primary operating expenses, and profits which will allow you to estimate cash on hand for the foreseeable future. Using your predictions you can determine when is a good time to make an investment, attempt to expand, curtail spending, raise or lower prices, hire staff, etc. There are a lot of elements that go into making projections and the process can be intimidating. Remember: there are no crystal balls or wrong answers, but making projections forces you to think and plan carefully. Over time you will gain a better understanding of how to predict your organization's finances and have more accurate information on which to base your decisions on.

Wrap Up

Optimizing profitability is most entrepreneurs' goal. Strategic pricing is essential for maximizing profits. Financial projections will help you make sound decisions on pricing, spending, and strategy. Prioritizing these three P’s will significantly strengthen your small business.