There’s a piece of maths I use with business owners that tends to change the conversation fairly quickly. If your business makes a 10% net profit and you lose $50,000 through a bad debt, unexpected cost, pricing mistake or something else you failed to recover, you need $500,000 in additional sales to replace the profit you just lost.

That’s half a million dollars in new revenue just to recover a $50,000 hole, which puts the old “we’ll make it up in sales” response into a rather different perspective. Sometimes you absolutely can make it up in sales, but before setting the sales team loose or pouring more money into marketing, it helps to understand exactly how much additional business you need to win, deliver and get paid for before you are actually back where you started.

Turnover has a very good PR department

Revenue gets an enormous amount of attention in business, particularly because it gives us nice, simple milestones to talk about. We turned over $2 million. We’ve grown 30%. We just won a $400,000 contract. All potentially excellent news, but none of those statements tells me whether the business is actually making money.

A $2 million business making a 15% net profit produces $300,000, while a $3 million business making 5% produces $150,000. The second business is 50% bigger if we measure it by revenue, yet it produces half the profit and may require considerably more staff, stock, equipment, debtors and working capital to generate it.

Growth can absolutely make a business stronger, but if the underlying economics aren't working, it can also make an inefficient business inefficient on a much larger scale.

How much additional revenue does it take to recover a business loss?

This is where the numbers become useful. At a 10% net margin, a $10,000 unrecovered cost requires $100,000 of additional sales to replace the lost profit, a $25,000 mistake requires $250,000, and a $50,000 bad debt requires $500,000. Lose $100,000 somewhere across the business and you need another $1 million in revenue simply to get back to where you started.

The calculation obviously changes according to your margin. At a 20% net margin, replacing a $50,000 loss requires $250,000 of additional revenue, while at 5% it requires $1 million. Once you understand that relationship, the more useful question often isn't “How do we sell more?” but “Where are we losing the money we've already earned?”

The money usually doesn't disappear in one spectacular mistake

Most businesses don't wake up one morning and accidentally lose $100,000. More often, the money leaks out through dozens of perfectly ordinary decisions that don't look particularly alarming on their own.

A quote goes out using an old supplier price, a job takes 46 hours when you allowed for 38, freight isn't properly recovered, someone gives a discount because the customer asked nicely, overtime creeps up, stock gets written off, equipment downtime costs more than expected, or customers take 60 days to pay invoices that were priced on the assumption they would pay in 30.

Across hundreds or thousands of transactions, those small discrepancies become margin, which is why a business can become busier while the owner becomes increasingly convinced there should be more money in the bank. There probably should be, and the useful question is working out where it went.

Why doesn't increasing sales always increase profit?

Imagine a business with $3 million in revenue and a 5% net margin. It makes $150,000 in net profit, but improving that margin by just two percentage points to 7% increases the result to $210,000 without adding a single dollar of turnover.

That additional $60,000 is where the maths becomes interesting. To generate the same $60,000 while remaining at a 5% margin, the business would need another $1.2 million in sales.

Generating another $1.2 million in revenue may require more staff, vehicles, stock, premises, administration and working capital, all of which introduces additional cost and operational risk. If the underlying margin problem hasn't been fixed first, the business has also created another $1.2 million worth of opportunities to repeat exactly the same mistakes.

This doesn't mean businesses shouldn't pursue growth. It means improving the economics of what you're already doing can sometimes create considerably more value than simply doing more of it.

Before chasing another dollar, understand the one you've already got

This is where revenue growth and business growth stop meaning quite the same thing. A business with better pricing, stronger margins, improved productivity and tighter cost control can become substantially more profitable without a corresponding increase in turnover, while another business may have an existing cost base with plenty of unused capacity and therefore generate very strong margins from additional sales.

Neither strategy is inherently better. The answer depends on the economics of the individual business, which is precisely why looking at turnover alone doesn't tell us very much.

This is why I ask annoying questions

When someone tells me they want to grow their business, I'm interested in what they actually mean by growth. Are we trying to create more revenue, more profit, more employees, another location, a business that's worth more, more cash in the owner's pocket, or perhaps a business that can operate without the owner being involved in every bloody decision?

Those are very different objectives and they require different strategies, because revenue is one measure of business performance rather than the objective by default.

At Helix Planning, the work is often about getting underneath those headline numbers and understanding what is actually driving the result. Pricing, margin, capacity, productivity, cash conversion, cost structure, systems and the decisions being made inside the business all interact, and improving performance means understanding those relationships rather than simply reaching for more revenue.

Sometimes the answer is absolutely to sell more, while sometimes it's to charge more, change the way something is delivered or stop doing something altogether. Occasionally, the most profitable piece of work available to a business is fixing the $50,000 hole before going looking for another $500,000 in sales.

You can grow your way out of plenty of business problems, but bad maths usually isn't one of them.

Frequently Asked Questions

What's the difference between revenue and profit?

Revenue is the income generated by a business before its expenses are deducted, while profit is what remains after the relevant costs of generating that revenue have been accounted for. A business can therefore increase its revenue significantly while making less profit if costs, inefficiencies or pricing problems cause its margins to deteriorate.

How much extra revenue does a business need to recover a loss?

The basic calculation is to divide the amount lost by the business's net profit margin. At a 10% net margin, for example, a $50,000 loss requires $500,000 in additional revenue to generate $50,000 of replacement profit, while at a 5% margin the same loss requires $1 million in additional revenue.

Is increasing profit better than increasing revenue?

Revenue growth can create significant value when additional sales are profitable and the business has capacity to deliver them efficiently, but increasing sales without understanding the margin generated by those sales can increase workload, working-capital requirements and risk without delivering a corresponding increase in profit. The useful measure is therefore not growth for its own sake, but what that growth contributes to the financial and strategic objectives of the business.

How can a business improve its profit margin?

Pricing, purchasing, labour productivity, quoting accuracy, discounts, waste, freight recovery, debtor management, product or service mix and operational efficiency can all affect profitability. The starting point is identifying which of those factors materially affect the individual business rather than assuming that more sales will compensate for a margin problem.

About Sarah Eifermann

Sarah Eifermann is the founder of Helix Planning and has more than 20 years' experience across finance, business strategy and advisory. Helix works with businesses to understand what is actually happening beneath the headline numbers, identify the commercial issues affecting performance and turn that analysis into practical action.

Based in the Clarence Valley and working with businesses across the Northern Rivers and Australia, Sarah's approach combines commercial thinking, financial acumen and a tendency to ask the questions everyone else was hoping she'd leave alone.

Helix Planning
Business Strategy | Commercial Thinking | Practical Action

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