There are effectively only two ways to improve your profit margin, either you must increase your price or reduce your costs. The former is always subject to the customer’s willingness to pay, especially in times of increased competition and price pressure, hence it makes sense to rather pay attention to how we can run the business better.
Many would argue that efficiency and productivity are synonymous. There is, however, a subtle difference. Efficiency is concerned with achieving the same production volume with fewer resources e.g. fewer employees or lower running costs, whilst productivity is about achieving better results with the same resources.
Productivity has to be compared to something. It cannot be seen in isolation. For instance, in Company ABC 10 employees produce 50 widgets at R100 per widget. This information alone is meaningless. To be able to measure if this is ‘good’ or ‘bad’, we need to compare this to industry norms as well as the volumes produced historically in the same company. If Company XYZ is producing 70 widgets with 10 employees at the same cost, then this immediately indicates a problem in Company ABC. Similarly, if we see that the volume of widgets produced month on month, with the same resources, is either increasing or decreasing, this tells a story.
When examining the efficiency of the business, there are several measures or calculations that can be used, including stock turnover, debtor turnover, and creditor turnover.
- Stock turnover ratio measures how often stock is ‘turned’ or sold. Stock on the shelf is literally the same as cash sitting on the shelf – the quicker it is sold and converted into earnings, the healthier the bank account.
- Debtor turnover ratio analyses the efficiency of debtor collections or in layman's terms – how quickly do you get the money in? Large gaps between the time of sale and the money received hurt available working capital.
- Creditor turnover conversely measures how quickly a business settles debts with its suppliers. A business that is consistently slow to pay is deemed to be experiencing cash flow problems. It is helpful to compare the creditor and debtor ratios to determine possible savings or losses.
A focus on both efficiency and productivity is essential to ensure the long-term health of the business and to be attractive to investors. Business owners should work with their employees to constantly identify inefficient processes, waste, and downtime (efficiency), as well as seek to improve the quality or quantity of outputs with the same inputs (productivity). Improved performance from labour and/or equipment results in improved productivity... which results in increased profit.
An important question to ask: “Have I got my best employees working on business-critical functions, with the best tools and equipment?”
For more information please refer to The Essential Guide for Small-Business Owners, Nedbank