Categories:Funding & Financials
August 11, 2011
Disclaimer – For this piece I consulted with a business advisor who has requested anonymity. His background, however, includes more than 30 years in the international finance world and nearly 10 years as the president of a local bank where he worked daily with small business entrepreneurs. He has also been a financial advisor and consultant to numerous small businesses around the country as well as being on the board of several nonprofits. He has personally been critical in helping me get my own small business up and running and I trust his input implicitly.
Revenue is obviously an important part of your business. Specifically, the markup over your products’ costs and how much profit you will make on every product sold is the lifeblood of your small business. By really understanding your customers’ buying behavior you are better equipped to manage you mark ups and quite possibly increase your gross profit margins. To do this you need to intuitively understand, and access, the price elasticity of demand for your products.
Basically, the price elasticity of demand helps you to determine how sensitive demand for your products are to price changes. For example, if your products have a very high price elasticity, if you raise prices, your sales will fall off significantly. Alternatively, if your products have a very low price elasticity, a price increase will have very little, if any, impact on sales. A very comprehensive description of price elasticity is available here along with the mathmatical formula to determine your specific price elasticity if you’re so inclined.
Since readers of this blog most likely have food companies of all types and sizes (and if you have another type of small business then welcome!) it’s impossible to generalize, but just ask yourself a question “If I raise prices (you fill in the blank, e.g. 5%, 25%, etc) what will be the likely impact on sales. If your answer is “probably none”, this might be an opportunity to selectively increase you mark-up on certain products that you feel have a low price elasticity of demand. I know this probably sounds geeky, but just put yourself in the shoes of your customer and say “would I pay (you fill in the amount) more, and still feel that I’m receiving good value.” If a bakery were able to get $0.05 cents more on an item, or an apparel shop could get $0.50 cents or $1.00 more, over the course of a year, that really adds up. Again, knowing the price elasticity of demand for your products is key.
Now, lets say you’ve identified ways to reduce your operating expenses by 10% and increase your gross margin by 5%. Feels pretty good, doesn’t it? You’ve fine-tuned your business and you’re more in control of the things you can actually control. When things in the world are this uncertain it’s nice to feel like you’re in control of something, isn’t it!
Be sure to check back tomorrow when we’ll look at what you can do to control both the assets and the liabilities on your Balance Sheet.