Healthy revenue for manufacturers
All revenue is not necessarily good revenue. Here is a how to tell the difference.
On the surface, revenue seems to be a simple concept. You make product, you sell product and you drive revenue. As long as product is heading out the door, you’re making money.
However, if that’s the case, why do some manufacturers produce millions upon millions of units per year, ship to a full roster of customers, charge competitive prices and still struggle with their margins? Simply put, there’s more to revenue than product out, money in. Revenue can be healthy for your business, or it can be unhealthy.
“Healthy revenue allows a company to not just grow, but grow profitably,” says Mark Lemke, a consultant in business advisory services with The Shealy Group.
Understanding profit margins and growth
A central factor in healthy revenue is gross profit margin, which is governed by a number of variables related not just to the money your business is making but where and how it spends money.
“As an example, say a company needs to have a 25 percent profit margin to grow its operations, support its operating expenses, maintain positive cash flow, service its debt and so on,” Lemke says. “But say that in order to grow from $10 million to $15 million in sales, it can only do that at a 10 percent gross profit margin. That’s not healthy revenue.”
To maintain healthy revenue while growing your business, you must first understand, in detail, the financial situation of your business. How much does it costs to run your business in terms of operating expenses, payroll and material costs? How much money are your sales generating?
Once you have a clear grasp of your total cost structure, measured against the revenue coming in, you can then project a realistic growth goal for your revenue.
“You can’t just grow your sales to grow your sales, because any type of revenue growth is going to require the commitment of money and resources to make it happen,” Lemke says. “You have to figure out why you want to grow, is it a good reason and then establish your growth goal.”
From there, you need to work with your sales, marketing, operations and accounting teams to determine whether your current mix of products will provide the revenue to carry your company to its growth goal, while still maintaining enough of a gross profit margin to cover your expenses and meet the definition of healthy revenue.
“You need to know your markets, which is going to allow you to determine whether your existing sales channels will allow you to grow your revenue to the goal you set,” Lemke says. “If not, then it becomes about determining what adjustments you can make to your existing product mix to make up the difference.”
If the numbers still don’t project as healthy revenue growth, you then need to look at adding new product lines or branching into new markets.
“You can only grow a business in three ways: By selling more existing products to existing customers, selling new products to existing customers or entering new markets,” Lemke says. “The whole time you’re trying to tap those three areas for revenue, you’re still trying to meet that gross profit-margin goal. If you can’t, you’re not quite ready to grow in that way.”
Build customer relationships
The relationships you build with customers, and the contracts you negotiate with them, can also have a major impact on your ability to generate healthy revenue. Even if the numbers add up to healthy growth, if your cash flow cycle (invoices, collecting receivables, paying payables) is not efficient and timely, healthy growth will stall.
“That’s something you have to look at when negotiating any new contract with a new or existing customer,” Lemke says. “If you keep your customers on at least 30-day pay cycles, and a new customer wants to pay you on 90-day pay cycles, are they a good fit? Maybe it’s a big customer, but if their payments don’t meet your cash flow demands, why would you sign on with them?”
That’s why you need to clearly communicate with a potential customer before a contract is drafted or signed. If you need a certain pay cycle to meet expenses and maintain healthy revenue and positive cash flow, that should be made known up front. On the other side, give your customers the same courtesy. If your customers feel like you’re taking care of them, you will likely find them much more willing to do business on your terms.
“Customer relationships are a key to maintaining healthy revenue,” Lemke says. “You need to treat them how you’d treat your own employees — lots of open communication. Ask them if your product is meeting their needs, if you’re providing it in a timely manner, if there’s anything you can change for them — things like that. If you give them that level of attention, they’ll work with you to help you reach your goals.”
For more information on healthy revenue and how it affects your manufacturing business, contact Mark at email@example.com.