While there is no magic bullet, a simple strategy can help you plan and optimize to a goal.
The 50/30/20 rule for a business owner is a strategy that helps maintain a healthy balance between direct costs, overhead, and profits.
While each business is unique, we have seen this help business owners over the years in any industry.
Cost of Sales (50%)
Cost of Sales (also known as Cost of Goods Sold - COGS) includes all the direct costs associated with producing your product or service. If you are a B2B or B2C services based business owner, labor will be your highest cost here. If you produce a good/widget, the materials and supply cost will be crucial here.
Our goal is to keep these costs at no more than 50% of revenue.
Components of Cost of Sales or COGS:
- Raw materials and supplies for the product
- Direct labor costs (for example - if you run a marketing agency, your office manager wages would not be included here. Only the direct project labor).
- Production facility costs
- Shipping and logistics costs
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Packaging
If these costs account for >50%, what can you do?
- Supplier Negotiations: Regularly negotiate with suppliers for better rates or discounts. Consider bulk purchasing if storage costs are manageable.
- Process Improvements: Implement lean manufacturing principles to reduce waste and inefficiencies in production.
- Technology Integration: Use automation and technology to streamline production processes, reducing labor costs and errors. Automation can greatly reduce manual tasks for B2B service based businesses.
- Outsourcing: Consider outsourcing parts of the production process if it's more cost-effective. For example - can you hire a virtual assistant vs a full time assistant who does not utilize all of their capacity?
Overhead Costs (30%) - Sales, Marketing, G&A
Overhead Costs include all the indirect costs associated with running your business. These are not directly tied to the production of goods or services but are necessary for the overall operation.
Components of Overhead Costs:
- Rent or mortgage for business premises
- Utilities (electricity, water, internet)
- Salaries and benefits for non-production staff
- Office supplies and non direct tech subscriptions
- Marketing and advertising
- Insurances
Strategies to Track and Optimize:
- Budgeting: Budgeting can help keep these total costs in line with our 30% goal. However, we often say "you will not get rich in the middle of the P&L". Optimization is great, but do not go crazy here.
- Cost-Benefit Analysis: Evaluate the return on investment (ROI) for each overhead expense. For example, calculate your Return On Marketing Spend (See our KB articles).
- Outsourcing and Contracting: Consider outsourcing non-core activities like IT support, payroll and HR support.
Profit Margin (20%)
A 20% profit margin is a healthy target for many businesses. Of course we can desire to beat this but this is a healthy target, after the owner has paid themselves.
What is the Net Operating Profit?
- Revenue minus cost of sales and overhead costs
- Net income BEFORE income taxes and other deductions such as depreciation
Recap of Strategies to meet the 50/30/20:
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Revenue Growth:Increasing pricing OR sales volume generally will produce the highest ROI. Most businesses underprice their product or service since they are "comparing" to others. Find your unique selling proposition and stick to it.
- Focus on strategies to increase revenue without proportionally increasing costs. This could include upselling, cross-selling, expanding product lines, or entering new markets.
- Cost Control: Continuously monitor and control both COGS and overhead to maintain margins. Focus MORE on the COGS/COS versus the middle of the P&L.
- Efficiency Improvements: Invest in technology, outsourcing of functions and process improvements that can increase productivity and reduce waste.
If you'd like to discuss this more, please let your Anomaly team member know!