How to Maximize Profit
- Leverage discounts
- Maximize efficiency
- Burden your expenses
- Manage your cash flow
- Grow responsibly
Profit maximization might be the most misunderstood concept in business. After all, doesn’t it make sense to increase sales as much as you possibly can? Won’t profitability automatically come with those increased sales? It seems counterintuitive, but the answer to that is actually no.
So what is the answer to “how to maximize profit?” Although it’s not as easy as simply increasing sales, it’s not as hard as you might think. But, the answer to that question is important and one you should learn today.
Let’s find out what profit maximization is and how to get there.
What Is Profit Maximization?
To understand how to maximize profit, we first have to understand what profit maximization actually means. So, before we go any further, let’s take a quick trip back to Microeconomics 101.
The profit maximization definition is essentially the ideal level of sales, where your business achieves the highest profit. But what does that really mean?
- Higher sales totals do not always mean higher profits. Often, business owners decrease their prices in order to increase their sales. Decreasing price in order to increase sales is a tricky business and can often lead to more problems than the temporary inflow of cash solves. Is doing something like this sustainable or scalable?
- As your revenue is increasing, your costs should decrease, up to a certain point. In retail, this could be due to volume discounts or special arrangements with your suppliers. In service businesses, you can decrease costs by increasing efficiency through the implementation of systems and processes. As your grow, for every dollar you invest in your business, you should get more and more out of it over time.
- There will come a point where your costs will begin to increase again. This happens once you reach capacity—either in the amount of product you can sell or the amount of service you can provide with your available manpower. These increased costs come in the form of hiring new employees, opening a new location, improving your software to continue to produce your service, etc.
- Profit maximization occurs at the point where your costs are at their lowest point in relation to your revenue. This is the sweet spot, and it doesn’t always occur when sales are at their highest point. Because again, we know profit and sales are not the same thing!
When you are in the trenches and running your business, it’s easy to focus on the immediate need, which is often getting more cash into your bank account. But now that we have been reminded about the concept of profit maximization, we can see where we might have made some missteps. That’s okay! We just need to fix them.
Here’s how to do just that.
5 Paths to Profit Maximization
We now know higher sales do not always lead to higher profits. The biggest trap for small business owners to fall into is thinking they need to discount their prices, so they can increase their sales, so they can pay their bills. This happens because cash flow is tight, and discounting prices to increase sales volume seems like an easy solution.
Unfortunately, this leads to more problems down the road.
Frequently discounting your product or service can lead your customer base to engage in purchasing behavior that results in a sustained lower profit margin. This means less money in your pocket and less money available to run your business. It also takes you further away from profit maximization.
How do we find that sweet spot where costs are lowest in relation to our revenue? What are the key things you can do when figuring out how to maximize profit? Here are our favorite 5.
1. Leverage discounts
We’re not walking back from what we just said. We don’t mean discounting your products or services. Instead, look for available discounts from your suppliers. T
he most underused discount we with small businesses is the early payment discount. Often, a vendor will give you a discount—usually ranging from 1% to 5%—if you pay their bill within 10 days. You can sometimes also get a discount for prepaying. Ask your suppliers if they offer discounts for early payment. It could be big savings for your business.
2. Maximize efficiency
This is a common area of profit leakage in service businesses. We spend too much time doing things that could be automated or streamlined. In our efforts to save money, we actually end up losing more than we realize. Even if you run a service business that bills for outcomes instead of time spent on a project, time is still money. You have to pay your staff or subcontractors. Don’t have staff or subcontractors? Your time is valuable, too. Any unnecessary time you spend working on a deliverable is time you aren’t spending managing your business and preparing for future growth.
In today’s world, it is easier than ever to outsource administrative tasks or other things that you shouldn’t be spending your time on. From virtual assistants to sites like Fiverr, you have affordable options than can make a real difference in both your business’s and your own efficiency.
3. Burden your expenses
Profit maximization puts a lot of focus on the cost of the sale, but your operating costs are just as important. Aside from certain services businesses (architecture and engineering firms come to mind), most small businesses do not factor in burden rate. But given what you’re trying to accomplish here, it might be a good practice for you to adopt. Burden rate is the allocation rate for indirect costs to direct costs, and it can be a real eye-opener when you are trying to achieve profit maximization.
4. Manage your cash flow
As mentioned above, when faced with a cash flow shortfall, many—we would go so far as to say most—business owners run a sale or discount their services to get more cash in the door. This is a short-term solution that usually leads to long-term problems. It is the opposite of a good answer to the question “how to maximize profit”.
It is important to remind you that cash flow is what’s toughest for most business owners. After all, it is one of the top reasons small businesses fail. Staying on top of your cash flow is going to be the answer for so many of your business questions (or cure for your business problems) in the years to come. It is imperative you adopt a software, system, and resources that give you the confidence that you’re on top of this.
If you don’t have a great accounting software, look into options today. QuickBooks is the market leader and one most bookkeepers and accountants are comfortable with. You can also look into Xero, Freshbooks, and Sage.
5. Grow responsibly
It is so hard to avoid the temptation to close every sale, no matter what concessions you have to make to do it. Especially when your business is in the early stages, you want to grow it as fast as possible. Here’s a hard truth, though: top line revenue growth is a vanity number. If you are only focused on growing your top line, and you are ignoring what steps you need to take to sustain that growth and reach profit maximization, you could be heading for disaster. Sometimes you have to say no to growth for the health of your business. While this might be a new way of thinking for you, it is one you need to adopt. As you grow, make sure you’re understanding what it takes for you to achieve that growth. You don’t want to have the rug pulled out from under you when you think you’re making a ton of money to only find out you’re losing even more.
Embracing a Profit Maximization Mindset
Though often ignored due to the complexity with which the subject is approached in economics, how to maximize profit isn’t a mind-bending mystery. By developing an awareness of your business as a whole, resisting the temptation to grow indiscriminately, and implementing the steps outlined above, you can easily attain profit maximization in your business.