Managing the levers of business

How to navigate the 'levers' of business: sales, direct costs and overheads.

16 July 2018

Most business owners love to talk about their businesses and tell stories of their humble beginnings, looking upon their creations with great pride.
Often, they measure success in terms of tangible factors like the quality of their premises, or the numbers of and quality of operational assets. Others are proud of the great people working for them, their capability, operational excellence, or great environmental and safety records.

Despite all the blood sweat and tears, often their financial results are underwhelming and let’s face it, the reason they went into business in the first place was to thrive, not just survive.
The facts are brutal. one in three new businesses fail in the first year and 70 percent of business owners fail within five years.
Many owners struggle and have great difficulty with the financial aspects of their businesses, the lack of basic business literacy and experience being a massive factor in failures. Being good at what you do doesn’t mean you’ll be successful in business.
The numbers should be telling you a story, but like any ‘language’, you need a basic understanding to make any sense of it. If that’s you, here’s a quick and easy as 1-2-3 method, that will help non-financial people getting their heads around the numbers, hopefully steering them on the path to success.
I use a simple analogy to explain the three variables affecting profit. Think of yourself sitting in the driver’s seat of a 3-levered machine.
One lever is sales, the middle lever is direct costs and the other lever is overheads. You can push forward or pull back on each lever, in all there are 27 combinations.
You don’t need to learn all combinations but try to appreciate the dynamic nature and understand that pulling one lever is likely to impact on the others.
Sales less any direct costs gives you gross margin.
I can’t stress enough, the importance of gross margin in business – make sure you learn this.
Gross margin as a percentage is a very important measurement that you can use to detect changes month on month, or year on year.
If your goal is to improve the gross margin of your business, you will need to sell more, sell at a higher price or increase efficiency and reduce costs. That’s the easy part. Knowing how to do it is the hard part.
For more sales you can increase price, but you might lose some sales volume.
You can sell more goods, to either more customers, or from more touches per existing customer, but if you need to make more goods you will incur extra costs in making them. You might also consider some extra marketing to increase demand, because most consumer behaviour is based around wants not needs. Marketing will help persuade or remind people to buy.
With direct costs, you might break these up into categories, like fixed and variable. These are things like materials, premises costs, equipment and direct labour. You’ll need to review the operation looking through a lens, to reduce any inefficiency or waste. Can you buy similar quality, but inputs cheaper from alternate suppliers? Can you get volume discounts? Can you manage your stock better? How much re-work is currently being done?
Gross margin, less overhead costs leaves you with net profit.
With overhead costs, you can categorise these into two piles, either necessary and discretionary. Under discretionary and look for any excess, focus on travel, accommodation and entertaining. Staff costs are usually the largest expense in overheads, so attracting, retaining and working out the right number of staff requires a general understanding of people management, productivity and motivation. Good managers get the most from whatever resources they have and adopt efficient work practices.
So next time you look at the numbers, don’t be overwhelmed.
The numbers might tell you the real story of what’s going on, letting you see the forest for the trees.
Be systematic, break the business up into the three levers, then dive deeper into each section, looking for inefficiency, waste and excess.