“We have two or three very big customers who pay rock-bottom prices, and I suspect we’re actually losing money on their business. However, my sales people insist these accounts ‘pay for our overhead’ and they point out that fixed costs like rent and payroll wouldn’t go down much if we got rid of these customers. Is there a simple way to measure customer profitability?”
Mike: Sure. Most accounting systems will let you set up separate profit-and-loss reports for each project or customer, which show you how much gross profit (revenues minus direct costs) you’re earning on each account. If the numbers show that there’s no profit from an individual customer that account is obviously not making any contribution toward your overhead–no matter what your sales people believe.
Once you’re collecting data on customer-level profitability, incidentally, you might want to start paying sales commissions on gross profit rather than gross revenues. Right now, your sales folk have an incentive to keep cutting prices to win big deals, even if you lose money on those deals. That’s a bad situation.
The ASK MIKE is a weekly column providing answers from finance and small business expert Michael Gonnerman. Mike has served as a trusted advisor to hundreds of technology CEO’s and investors as well as served on more than two dozen corporate boards.
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