I tell business owners that there are two ways of making money; and they usually only know one!
The first is the difference between Sales and Costs; the profit margin. This is where most of the energy and focus is – cutting costs, increasing prices ( if you can) and it is a linear approach that has its limits. This is what business owners know.
The other is called the velocity of money. For businesses this is watching how their assets’ turnover. If in a given period of time ( usually 12 months) , your assets turn over, say 5 times and if you can improve to make it turn over 6 times, you will make more money because you added an extra turn. Businesses have some idea of this but really do not appreciate its’ importance nor do they focus on its value to generate profits. Asset turnover can be further broken down into Fixed Assets and Current assets turnovers’. The easiest is to concentrate on Current assets – this is Receivables and Inventory. If the turnover of this can be improved, then you are achieving an increase in the velocity of money.
The reluctance to improve this is prevalent in my experience, because it takes methodical and dedicated work. Most businesses ignore or neglect the “nitty, gritty” work it takes to analyze and improve the Receivables and Inventory turnovers. However, if you can improve this the positive impact is permanent and the business moves to a new level of prosperity. It is like having built a solid foundation for your house. How do you do this? Systematically break down your Receivables in terms of large and small customers – how long does each take to pay? Do the same for the Inventory – large value and low value items- how long do you hold them? Start by knowing your statistics today and where you want to be. Then work backwards in breaking down where you are and where you want to be and translate this into a series of action steps customized to each customer ( or group) and to easy Inventory item ( or group).The collective improvements achieved will have a cumulative impact in increasing your asset turnover and thereby your profits.