Somebody wants to hire me. We have an introductory Zoom, and the individual talks about the fact that they don't have resources to perform the customer acquisition work they want to perform. At some point, the Professional says ... "My CFO is a bean counter. She doesn't operate in the real world."
Maybe she doesn't operate in the real world, but she operates in a world of cash flow and profit and shareholder/owner value.
Y'all know how a profit and loss statement works, correct? Allow me to give you a brief example:
- Gross Sales / Demand = $50,000,000.
- Return Rate = 15%.
- Net Sales = $50,000,000 * (1 - 0.15) = $42,500,000.
- Gross Margin = 50%, or $42,500,000 * 0.50 = $21,250,000.
- Pick/Pack/Ship Expenses = 10% of Gross Sales, or $50,000,000 * 0.10 = $5,000,000.
- Contribution Prior to Ad Cost = $21,250,000 - $5,000,000 = $16,250,000.
- Ad Cost (what you spend on marketing) = 20% of Gross Sales, or $10,000,000.
- Fixed Costs (your salary, costs to run business that don't change as sales increase/decrease) = $5,000,000.
- Earnings Before Taxes = $21,250,000 - $5,000,000 - $10,000,000 - $5,000,000 = $1,250,000.
Ok, I know you are bored.
Let's focus on a couple of key metrics. I calculate something called the "Profit Factor". Simply defined, it is Contribution Prior to Ad Cost divided by Gross Sales (what some call "Demand").
- In our cases, this is $16,250,000 / $50,000,000 = 32.5%.
Why do I care about the "Profit Factor"?
Because your CFO cares about the "Profit Factor".
A complicated profit and loss statement can be reduced to this simple equation:
- Earnings Before Taxes = (Gross Sales or Demand) * (Profit Factor) - Ad Cost - Fixed Costs.
- $50,000,000 * 0.325 - $10,000,000 - $5,000,000 = $1,250,000.
Now, if your ad costs are generally constant and your fixed costs are generally constant, then your Profit Factor is the lever that gets manipulated.
Your CFO is sitting in her office, spreadsheet on her laptop. She's already decided that somebody in merchandising needs to improve gross margins, because she adjusted her Profit Factor from 32.5% to 35% and learned the following:
- $50,000,000 * 0.35 - $10,000,000 - $5,000,000 = $2,500,000.
Did you see what happened there? Your CFO figured out that if the profit factor can increase buy just 2.5 points, Earnings Before Taxes double. They DOUBLE!!
Your CFO goes back to the merchandising team, and the merchandising team tells the CFO that margins can't increase because they either have to cheapen the product or raise prices and they're already raising prices because the cost of goods is increasing. The merchandising team tells the CFO that the profit factor isn't going to change.
This is where your CFO starts counting beans. If the profit factor doesn't change, then there are only two pieces left in this equation. The CFO can look at fixed costs ... which are FIXED and do not change ... or the CFO can look at that $10,000,000 lump of ad cost and openly wonder what might happen if that $10,000,000 number was $8,750,000?
Either way, the CFO is counting beans, trying to improve profit from $1,250,000 to $2,500,000.
The CFO knows that your advertising budget is inefficient ... in other words, she knows that if you cut $1,000,000 you don't lose sales at a proportional rate.
Tomorrow I'll spend time explaining how a former marketing director turned the tables on the CFO.