Some CEOs believe they can sell their way out of cash flow problems. When they try to, they often make poor operational decisions like pricing jobs lower, or offering discounts/promotions to get any job. These decisions can cause margins to be lower than your target margins causing cash flow issues.
There are several ways to improve your cash flow, but it begins with making sure you have effective pricing.
Cash Flow problems can distract you from looking at your pricing model or experimenting with value pricing because you are too scared to lose business.
Optimizing your pricing model will have the biggest impact on cash flow. To really evaluate pricing for your business, start by calculating your gross profit margin, implement job costing, and understand your fully-loaded labor costs, then you will have a better grasp on experimenting with your pricing model. Let's review these four ways to optimize pricing:
Calculate Gross Profit Margin
Gross profit is one of the most often overlooked and underused areas of the income statement. Yet, gross profit and its partner gross profit margin are essential components of the most important decision that a small business owner will ever make: how to price a job.
Setting and using a gross profit target to be able to cover all of your business’s expenses, is the secret to profitability.
Gross profit margin is your gross profits shown as a percent of revenue.
You need to really understand gross profit margins so you’ll know when to increase prices on which products and services.
Increasing your prices, at the right time on the right things, is the best ways to impact cash flow, and as a result, your gross profit margin.
Looking at gross margin percentage is the best way to track the profitability of a customer or job.
Gross margin percent is calculated as follows:
EXAMPLE: ($2,000,000 / $4 million) x 100 = 50%
Tracking gross margin every month and comparing it to your target gross margin, gives a business owner leading indicators of cash flow problems. A change in gross margins can provide insight into issues with a job, client or the company. This kind of actionable intelligence will help with pricing decisions.
Implement Job Costing
The best way to monitor gross profit $ and % is to implement some form of job costing.
A well-designed job costing system tracks the true costs to deliver a service or product so you can charge prices that help achieve target gross profit margins and improve cash flow.
If you make money on your people’s time, you need to implement a simple time tracking system to see if you’re allocating the right fees for the time spent on the job.
The biggest benefit of true job costing is knowing that nothing slipped through the cracks and you're getting paid for all the value that you delivered.
Understand Fully Loaded Labor Costs
Understanding your true fully loaded labor cost will help make sure your proposals and price quotes achieve your target gross profit percentage. This will help you get your pricing right and solve most of your cash flow problems.
You can cover all your costs and bill for all your value, if you know, and can explain, what it really takes to deliver on each job. Having visibility into real costs allows you to include details of all your value and time spent in your proposals, which will help you sell a higher dollar amount on every job. (Visibility into time leakage helps eliminate waste.)
Compare your gross profit percentage on every job against what you expected it would be and your industry averages. That will help you increase the accuracy and include value pricing in future proposals.Two Ways to do Labor Cost Allocation
Cost of Goods Sold (COGS)
Cost of Goods Sold (COGS) is an important number to help with your pricing because it’s used to calculate gross profit on a job. Make sure you know what your fully loaded hourly labor cost (with full true fringe benefits) is costing you. Do you understand how COGS relates to your organization's gross profits?
Use TSheets® with Intuit™ Payroll and you can automatically allocate labor cost to every customer or job in QuickBooks™.
Experiment with Your Pricing Model
If you put more thought into optimizing your pricing model, it will have the biggest impact on your cash flow. As we said in tip #1, gross profit and its partner gross profit margin, are essential components of the most important decision that a small business owner will ever make: how to price a job. How well you price your products or services, and the margin that pricing produces, is key to maximizing cash flow.
You have to have your prices cover your direct costs. They have to recapture your overhead, and give you a profit.
Consider the pricing model that fits best your business:
- Value Based Pricing
- Fixed Fee
- Time & Material
- Milestone Driven
So how do you optimize your pricing model to improve your company's cash flow and profits? You turn to your management reports and look at the data.
Management reports help you figure out if you are pricing your jobs right, and also to help you to really understand who your most profitable clients are, and what makes them profitable.
If you are ready to dive into more ways for improving your cash flow, we encourage you to read our ebook, The CEO’s Guide to Improving Cash Flow - 28 Ways to Gain Efficiency and Peace of Mind Using Cash Flow Best Practices...