Improving the Profit Formula Part 5 Increasing Gross Margins

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Improving Efficiencies

In my 30+ years as a CPA, I have reviewed thousands of income statements for companies in hundreds of different industries.  Without fail, 70 percent or more of the total costs is in product purchase and/or manufacturing and employee costs.

Yet when the owner decides that they need to cut costs, they spend very little time actually looking at trimming costs in these areas.  I often joke that a business owner will spend more time and effort complaining about bank service charges and telephone bills which, when combined, usually represent less than 1 percent of their costs.

Business owners will also spend more time complaining about property tax increases than they will looking for ways to lower the cost of producing and delivering their product.


Because for most expenses, all you need to do is shop for a less expensive provider.  The costs of producing and delivering your product are closely related to the operating systems you have in place.  Changing them takes hard work.

But the payoff of this hard work can be huge.

Let me illustrate with three examples.

In the late 1980s I was the CFO for a regional Coca-Cola bottling plant.  My special project team outlined all the steps in a sale—from the customer ordering our products, to creating and delivering the product, to finally billing the customer and collecting the payment.

We then questioned every step in the process.  We asked three questions.  Why are we doing it this way?  Can we do this more efficiently?  Can we do this at a lower cost?

We were constantly told that the reasons for doing any process and having any system were:

  1. “That’s how we've always done it here.”
  2. “That’s how all bottling companies do it.”
  3. “That’s how I was taught.”

Even more disturbing was how often we found employees doing the same job differently.  This was caused by not having well-defined processes.  This lack of consistency was very scary and usually very inefficient.  But we often discovered better ways of doing things simply by observing the employees' original methods for completing their work.

Over the next two years we worked hard to improve and document every step of every process.  The most important results were:

  • A dramatic decrease in employee theft.
  • An increase in sales and cash flow because of better communication and coordination between sales and production.
  • A reduction of inventory due to improved planning.
  • A $10 million dollar annual savings in production costs by consolidating all production into one plant.

These types of systems improvements often result in big savings and huge increases in sales for every business, no matter the size. 

A local Mexican food restaurant improved their processes so much that they could seat the customer, take the order, and serve a great quality lunch in about 15 minutes.  This allowed customers to be on their way in about a half hour. 

The result?  They are able to serve more customers during the peak lunch hours.  This means they have more lunch sales than the average restaurant.  Word of their "lunch speed" has turned into a fantastic marketing tool that has brought in even more customers, especially those who are pressed for time but don’t want to settle for fast food.

I have also used system improvements to expand my local CPA firm.  Like most service firms that basically sell knowledge and time, I had reached the maximum number of tax returns I could handle.  The normal industry solution is to hire expensive tax preparers to get more returns done.

I documented all of my systems, asked myself the tough questions, and put together a procedure I called the “Life Cycle of a Tax Return.”  The changes we made allowed me to more than double my sales without adding staff.

The results were only possible because I questioned everything about what I was doing and why I was doing it that way.  But the biggest breakthrough came from seeing what my industry normally did and looking for something different.

Many CPA tax preparers meet with a client when they drop off their tax documents.  They then prepare the return and meet with the client again to go over the finished return.  This is very time-intensive and limits how many returns can be done.

One day while in a doctor's waiting room, I had a breakthrough.  Our services were not that different.  We both sold our knowledge and our time.  But you only get to see the doctor for 10 to 15 minutes for the important work only a doctor can do.  Everything else gets handled by the staff.

I changed everything to model this behavior.  I still meet with every new client to create a plan of action for their particular situation.  But everything else changed.  I work hard to only work on the really difficult returns.  I rarely meet with returning clients when they drop off their work.  And I only do a basic review with most clients when they pick up their returns.  Most of the time reviewing is done with my staff.

We are now able to prepare more returns and our clients are happier.  My staff can spend more time with the clients going over the returns and answering questions.  I still answer the unusual and hard questions, but now they don’t feel like I am rushing them so I can get back to work.

Here is an outline of the steps to take to improve your operational systems.

  • Document all of your current systems.
  • Create a Special Project action team whose only job is to improve your operational systems and reduce costs.
  • Question everything with the three questions we mentioned above.
  • See what the industry norm is and look for a better model in a different but similar industry.
  • Calculate your total Activity-Based Cost (ABC) for all of your products to make sure they are “cash cows”.
  • Eliminate most of your hiring mistakes. Better yet, only hire superstars.
  • Manage using your systems.
  • Train your employees to run the systems.
  • Create a process for constant review and improvement of your systems.
  • Use “Hot Tickets” to identify and eliminate breakdowns or holes in the systems.
  • Include internal controls to reduce fraud and theft.
  • Take time management seriously. The owner’s time is the most important asset in the business, and it is the hardest to replace.
  • Learn how to delegate effectively to your employees.