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Determining your True Cost of Sales

January 24, 2014

I was recently discussing with Cindy Gordon, CEO of Culture Shock Coaching how to get business owners and sales people to understand how important Sales Culture is in generating revenue and profits for a company. I really enjoy speaking with her. NOT only because she is a trained coach and an expert in sales-culture and team development, but also because she is a certified Canadian CPA.  I have invited her to share some of her insight here.

Consider this common scenario – Joe is the top sales person at ABC Company.  He has built strong relationships with his clients and annually meets or exceeds his sales quota.  Joe has proven to his customers that he cares about them by being attentive and polite and making sure their needs are met.  Let’s look at the financial impact his work brings to ABC Company. Joe generates $2,000,000 of revenue at a 50% gross margin.  His salary and commissions total approximately 5% of his gross revenues. Therefore for every dollar of revenue earned by Joe, the company nets 45 cents before other overhead costs.

                                                                   $                     %

Revenues                              2,000,000             100

Cost of sales                         (1,000,000)             50

Gross margin                       1,000,000               50

Joe’s salary                            (100,000)                5

Joe’s contribution to net

income                                900,000              45

 

Therefore to generate $2,000,000 of revenue, the cost to the company is $1,100,000 (55%)

 

 

 

 

 

 

 

 

 

 

Or maybe not- 

Before Joe came along the employees were highly motivated.  The culture and leadership behaviors spurred that.  The employees worked at 100 – 125% effectiveness.  This meant that the annual payroll dollars of $500,000 generated up to $625,000 of productivity.

What changed?

When Joe speaks to his co-workers he is rude and demanding.  He insists that his clients’ needs are a top priority.  He is insensitive to the range of responsibilities his co-workers have. Some people have become fearful of Joe and try to work quickly to get his work done.  This has resulted in numerous errors being made and twice the effort needed to get the task done properly.  Other people have put his demands as a low priority causing a slow-down of work.  Joe’s behaviors towards his peers have changed the team dynamics and level of moral.    Productivity has sagged to 75% effectiveness.  The same $500,000 of annual salaries would generate $375,000 of effort – a decline of up to $250,000 (i.e. $625,000 – $375,000).

Companies in this type of situation are more likely to experience higher than normal employee turnover.  Research has found that employee turnover can cost as much as 150% of an employee’s salary.  If a person earning $50,000 per year leaves due to Joe’s behavior the cost of replacing them would be approximately $75,000.  This cost would include recruiting, training and on-boarding (from both internal and external sources). The impact of turnover of staff could also impact costs in customer relationships and add workload to remaining staff until a replacement is found and able to handle their responsibilities independently.  Many of these costs are never taken into consideration by management when assessing the cost of turnover.  Taking these costs into consideration, the true contribution to net income by Joe is:

Joe’s contribution from above                    $ 900,000

Decline in motivation                                       (250,000)

Cost of turnover of one employee                 (75,000)

            Impact on net income                               $   575,000

 

Therefore on $2,000,000 of revenue, Joe’s cost of sales totalled $1,425,000 (71.25%)

 

 

 

 

 

 

 

What can be done to keep from losing money from declining motivation and high turnover?

1.  Set a standard of performance that stems from your corporate values.  Don’t make concessions for top revenue generators.

2.  Ensure employees feel safe to report any departure from expected behaviors.  Honor these people as heroes not squealers.

3.  Reinforce team effort rather than individual effort.

4.  The modeling of behavior has to start at the top.  The actions of the business owners speak volumes and will set the tone for the level of employee motivation.

To find out how to improve your profits by keeping your employee motivation levels high and turnover low, contact Cindy Gordon, owner of Culture Shock Coaching, LLC

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