Lets start off by exploring what exactly is a business model. In CFO terms, your business model is how your company generates revenue and the costs incurred to produce that income. We hear many business owners say, "we generate profit, so our model must work." That's not always the case. Lets take a deeper look to see if your business model is working for you!
What Drives Your Revenue
What drives your business' revenue? It's a simple question, yet businesses lose sight of it often. We get entangled in personnel issues, tax compliance and employee surveys. While those are all great things to address, they do not produce income for your business.
Take Still Water Financial Operations for example. We provide outsourced accounting, profit coaching and business strategy services. These services are what our clients pay us for. Anything else, is a distraction. Take the mile high view, and examine what your customers truly pay you for.
Calculating the Cost of Producing Revenue
Discovering how your business makes money is easy. The harder part is finding the true cost of producing that revenue. This is where a good CFO earns their keep.
To calculate the cost, you will need to add up all of the expenses incurred to make that sale. Lets take Still Water Financial Operations for example again. Our clients pay us for outsourced accounting services. For us to provide those services, we incur costs, costs such as salaries and software expenses. If we did not perform those services, we would not have to pay those expenses. Therefore, they are directly associated with revenue generator. These expenses are called cost of goods sold.
Take your costs of goods sold and subtract it from your income. This will give you your gross margin. Your gross margin is a great indicator of whether your business model works or not. Take this gross margin as a percentage and compare yourself to others in your industry. If your competitors are at 50% and you are at 35%, you have an uphill climb.
Fixing Your Business Model
If you are operating at a gross margin lower than your competitors, there are two ways to make up ground. Either raise your prices or decrease cost of goods sold. Look for unique ways to convey your business' value and customers will not mind the price increase. Remember, you are in business to make a profit!
Summary
Your company has its own business model. That business model produces revenue and incurs costs. By understanding the relationship between these figures you can evaluate whether your business model works or not. Evaluating your business model can be a daunting task, but well worth your efforts. Take the time to to do this drill and watch as your bottom line grows!
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