Better decisions, better business

Over the past several months we have been noticing a surprising number of companies growing their top line and shrinking their bottom line. Increasing revenues and decreasing profits should set off major alarm bells. Though there are times when that can be a good thing, like right after you hire a new engineer, it is definitely not a situation that can continue for long without causing serious damage.

We have seen a few very sad cases where the owner didn’t realize they were driving their business into the ground. They knew cash was tight, but they just assumed that they were experiencing a temporary problem. And they thought that just by increasing their sales they were going to bail themselves out. In one case they collected up-front fees that generated just enough cash to mask the problem until they had gone way over the cliff.

Here is what to look for.  When you see revenues going up and gross margin going down, this is a strong clue that there is a problem with business fundamentals:

These graphs show a strong indication that a problem exists with pricing, staff utilization, excessive selling costs, or other direct costs. As the famous punch-line goes, “you can’t make it up in volume.” When you have decreasing gross margin you want to take action as early as possible. At that point you only want to make new sales if you can avoid adding any new direct costs. And don’t wait until the problem shows up in overall profits, because you may be too late. Overheads can easily mask problems with gross margin.

The concept of using trend lines is all about getting the picture of where your numbers are headed before you actually run into a problem that is irreversible. It is all about early warning. Looking at numbers one month or one quarter at a time will not show you the story of where you are headed.

There is much more to be discussed about how to correctly calculate gross margin so that you are getting the complete picture, but we will save that for an upcoming blog. For now, just make a mental note to keep a close watch on your revenue and margin trend lines so that you can make needed adjustments before you hit the edge of the road.