Profitability is directly related to a company’s gross revenue, particularly as it relates to its varied customer types. What does gross revenue mean to your company’s profitability? Everything. Let’s back up to review the concepts we’ve covered in previous posts so we may explore gross revenue further.
When we looked closely at your company’s gross revenues in our last post, Pareto’s Principle (80/20 Rule) Applied to Business, a few weeks ago, it became clear that sales made to all customers/clients fall into either the 80% or 20% category (below or above the Pareto’s Principle line). Specifically, those customers/clients who appear above the line usually number about 20% of your total, yet they produce 80% of your business’s profit.
Pareto’s Principle Tells the Story
This reality can be quite scary, especially when you consider the flip side of Pareto’s Principle.
Think about it for a minute. It’s very likely that the majority of your activities, and consequently your company’s resources, are dedicated to producing a product or service for that part of your customer base that offers little or no profit (the bottom 80% of customers that produce only 20% of your profit). To more fully understand this, it is good to look at the average gross revenue for each of your customers/clients on a yearly basis.
Let’s go back to the list of customer/client’s revenues for the prior year. We looked at this in a previous post when we calculated the average revenue.
Calculate the average gross revenue amount for customers/clients who appear above the Pareto’s Principle line by totaling the gross revenues for this group and then dividing that sum by the number of customers/clients in the group.
Do the same for the customers/clients who appear below the Pareto’s Principle line.
You will likely find the average gross revenues from these two groups of customers/clients differ greatly. It wouldn’t surprise me if you told me that the Average Gross Revenue for the second group (those that fall below the Pareto’s Principle line) is not enough to cover the direct costs to produce an order or deliver a service.
So, here is where you should pause and ask yourself if you are making any profit on the customers/clients in the group that falls below the Pareto’s Principle line.
Is your company set up to handle these customers/clients or is there a better fit for them elsewhere?
And here are the most powerful questions:
- What if you had only clients/customers who produced the average gross revenues similar to those who fall above the Pareto’s Principle line?
- What would your company look like?
- Would you be more profitable and maybe not work as much?
- Would your employees be happier?
If you have taken the time to crunch these numbers, please share with us what your insights are and if you plan to change anything about your business model.
Holly also founded ExitPromise.com and to date has answered more than 2,000 questions asked by business owners about starting, growing and selling a business.
Latest posts by Holly Magister, CPA, CFP
- Understanding the Business Buyer Types When Selling Your Business - April 12, 2019
- How to Prepare and Include the Business Owner’s Family in the Exit Planning Process - March 14, 2019
- How to Prepare for Due Diligence When Selling a Business - February 12, 2019