Common Financial Mistakes - Part 2
Jul 15, 2019 by Roger Scherping
This blog is part 2 of the most common financial mistakes that I’ve seen small business make in my 30 years of small business experience. In part 1 I discussed not understanding your numbers of your business and thinking that profit is the same thing as cash flow. Today I have two more for you. Avoid these big ones and you’ll miss some potentially huge setbacks.
Mistake #3: Markup is not the same as Margin I have seen this mistake many, many times. People use the terms Markup and Margin interchangeably. They are very different, and you need to understand the difference! Markup means the amount that you add to your cost of a product to determine your selling price. For example, if something costs you $10, and you mark it up 50%, that means your selling price is $10 + 50% of $10 = $15. That $5 over and above your cost is your Markup. Gross Margin means the amount of each sale that you get to keep. If you sell something for $15 and that product cost you $10, then you get to keep $5 from that sales. This is often expressed as a percentage called Gross Margin Percentage, which is calculated at Gross Margin / Sales Price. In this case, your Gross Margin Percentage would be $5/$15, or 33%. Does that all make sense? Now, here’s where people go wrong. They say, this product costs me $10, and I want a 50% gross margin, so I’ll mark it up 50%. So they take $10 and add $5 and sell it for $15. Well, what’s their gross margin percentage? We just calculated it as 33% ($5/$15). So a markup of 50% gives you a gross margin of only 33%! I have seen many people underprice their products due to this misunderstanding. Markup is not the same as Margin! Understand this, and you’ll avoid the mistake of making less money than you intended to on every sale. Mistake #4: Forgetting to focus on Sales, Profits and Cash There are so many aspects to running a small business, but as a small business owner everything that you do should always be tied to improving sales, profits, or cash. When you’re focusing on sales, you’ll be trying to get more customers, or looking at new products or services to offer, or working to keep the customers that you have. When you’re focusing on profits, you’ll be finding ways to reduce expenses, or looking for new vendors with better pricing, or figuring out how to produce your products with less waste. When you’re focusing on cash, you’ll be finding ways to collect your receivables faster, extend your payments to vendors, or shortening the time it takes you to turn an order into cash (your cash cycle). As a small business owner, you need to put all of your energies into these three areas. All of these activities will lead directly to an improvement in your finances. If you should ever find yourself doing something that won’t improve your sales, your profits, or your cash, then stop and redirect yourself. I have seen many small business owners forget what is most important. They forget where their energies need to be directed. Understand this, and you’ll avoid the mistake of not maximizing your time, failing to improve your finances, and causing the entire business to lose focus. I hope that learning about these four common financial mistakes will help you avoid them and help you miss some potentially huge setbacks in your career as a small business owner. Roger Scherping