Profit Margins

Jason · 00:00Welcome to episode 243 of the Numbers Game. I'm Jace. I'm here with Nick and Marty. And Marty. I wanna know how the hell a cheese shop is more profitable than a builder. What is going on?

Marty · 00:11Well, Nick sent me on a course after the last episode we were talking about, uh, well last, when the last episode was, but we were talking about, uh, what we would do for money in, uh, enhanced, uh, sports.

Marty · 00:23I was thinking, should we be considering a little bit more about gross profit margins when we're looking to buy a business or entering a business? I know a lot of the times. You know, we, we sort of come out of alignment of what we do through uni and fall into a job. And, and sometimes those jobs are capped at a certain level of income.

Marty · 00:43Like I've always thought, you know, nurses should get paid a hell of a lot more, you know, teachers that are looking after our kids' future should be paid a hell of a lot more than what they do, but they're not, you know, and they're, they're kept to a certain living. It's not to say that it's bad what they earned, it's, but.

Marty · 00:57But at the end of the day, the expenses of living are the same for everyone. So should we be thinking about what type of businesses we are going into, because that's like a future investment in our income and also our future asset and career as well. Um, initial thoughts, Jace? A

Marty · 01:17hundred percent. It, it, it absolutely, it's mind blowing when we start to work with small business owners who are early stages of their journey.

Marty · 01:25And you ask the question about how much they're expecting to earn from being a small business owner. Maybe they've left a, a salary where they're earning a certain amount and they're partway into the journey. And it's not until you kind of go, cool, well let's, let's just go to the end game. How much money does this business need to make you, for you to have the lifestyle that you want or for you to be able to cover the living expenses you've already got?

Marty · 01:46And quite sometimes it's actually, it's, it's quite upsetting to, to be in that position or, or to kind of. See them realize what they've got themselves into that their business model doesn't quite stack up. 'cause if they turn around and say, look, yeah, hey, hopefully in the next couple of years I'm making 300,000 or 3 million.

Marty · 02:05And when you reverse that out and go, cool, well for that to happen, your gross profit margin needs to be this and you need to keep your fixed cost down to this number for that to happen. And often the gross profit margin doesn't get to where it needs to be to even get anywhere near the net profit thereafter.

Marty · 02:19And it's this whole moment of going. You know, geez, what have I done? How can I change this? And, and it leaves them going, you know, maybe, maybe I need to change my whole business model and do something different altogether.

Jason · 02:29Can we quickly explain the difference between gross profit and net profit?

Marty · 02:32Yes, certainly.

Marty · 02:34I've got, yeah. Gross profit is, um, the percentage of revenue a company retains after deducting the direct costs of purchasing the goods or services. So it indicates how efficiently a company can de deliver a product and service. So this is before all other expenses.

Jason · 02:50Does service have a gross profit?

Marty · 02:53Potentially. So if you, yeah, so if you've got, uh, people that are involved in earning, so, you know, let's say, yeah, your, your people might be a cost of goods sold. So for example, accounting, professional service income, less the cost of the accountants to do that equals gross profit. And then below that, you might have your general admin team, for example, that aren't directly involved in completing the tax return or selling a particular service.

Marty · 03:19Um, think of it, let's say plumbing. Plumbing. You might have the. The plumbing job that was done, less the plumber's, wages and the materials equals gross profit. Then you've got all the other costs below the gross profit line, and then you get your net profit.

Jason · 03:32Yeah, and, and, and look, I, I, I bring it up because I was, um, I was at Mill Grove Cheese.

Jason · 03:38I'll give 'em a shout out at the Arrow Valley. Um, beautiful aged goda, white, lotus chaon, bears, and, you know, salamis, boutique salamis, buffalo, Italian cheese, all artisan produced by themselves. And I just, I just thought the product was just so delicious. Like we drive half an hour. To go, you know, to go to the shop and Nikki and Peter a shout out to those guys, fantastic people.

Jason · 04:03And they love what they do. Like they have a real passion. And you know, when they talk about the cheese, they can tell you how long it's been aged for. Where it's been aged. It, it's just incredible. They, they stamp print every, everyone, they win awards. And I said to him like, you, you're just so passionate about what you do.

Jason · 04:23What's, what's the profit margin you actually make on the cheese? Like to, to produce it and then what you sell it for. And they say, look, we'd make about 30% off the, you know, af after the cost of producing it. And that's not taking into account their time to produce it as well. And I just thought to myself, wow, once you start putting wages, rent, mm-hmm.

Jason · 04:46Um. And it's not a massive operation. And I said, geez, is it a bit, is it a bit tired? And they go, well, yeah, it's tight. But we love what we do. And we do okay. We make enough to get by, but we can't scale it because we can't take it to the next level. 'cause the cost would just be exponential and um. And the return's not guaranteed.

Jason · 05:07'cause the bigger you get, the costs will increase as well on other expenses apart from the cost of goods as well. So, so it was, it was really, really. Interesting that, um, there was not much, that there were not many variables that could go wrong for them really in producing what they love. And I thought to myself, now I want them to keep making that cheese.

Marty · 05:31There's no doubt about it. And this is fantastic when people have pursuits that they're passionate about, um. But if you are buying a business, like I said to him, did you think about that prior to starting the business? Like in regards to what the No, we just love what we did. You know, we just wanted to share it with the world.

Marty · 05:49We didn't, you know, they, they, they started to get more business acumen as they went, you know, and they were in the trenches and they, you know, adjusted as they needed to, which a lot of business owners do. But I thought it's a really good example of the importance of understanding what your gross profit margins are.

Marty · 06:06In a business is your first point of call. What does it take? What's the cost to produce what you do, either a service or a product? And the higher the margin, the more opportunity for net profit as well, and the expenses, apart from the cost of goods, I. Are more adjustable, like you can make plays on that.

Marty · 06:24So the higher the profit mar the gross profit margin, the more opportunity you have to scale, the more opportunity you have to manage expenses outside of the cost of goods. But I think it's an important thing, and not many people I think, would be considering that when they buy a business or you know, even running a business.

Marty · 06:42So, um, yeah, I, I think it's an important factor and, um. I had some, I had some numbers, and this is just to give you some reflection points. And Jace, you said it well, you've gotta match in your personal ambitions and your financial realities of what you want to accomplish outside of what you do, uh, as a, as an important factor.

Marty · 07:03But for instance, Michael Hill Jewelers, uh, their gross profit margin, they're a high luxury end jeweler. Um. And their profit margins are reported around 60%, six 60.6 gross margin. So you've got a lot more to play with there than in, uh, boutique cheese, which is around about 30% growth profit margin. Now, interestingly enough, with Michael Hill, they still only had a $15 million.

Marty · 07:32Um. Profit before tax and other things. So they ended up virtually being, I think, pretty much even for the, for the last financial year. So it shows you the high level of other expenses. So net profit's still important, but they had more, uh, ability and flexibility to be able to play with that in a more challenging year than, you know, than someone with a lower gross profit margin.

Marty · 07:57You'd imagine their rents at big shopping centers are through the roof, massive. And if they're not gonna put traffic through the door, you could, you can make. The best gross profit margin on selling the jewelry. But if all of your other, uh, fixed costs or operating costs are through the roof, there's not much left over at the end of the year.

Marty · 08:11So, you know, these levers that we talk to business owners about pulling and business owners of all sizes, um, just obviously the bigger, the bigger it is or the more gross profit you've got up top, the more options you've got to try and retain some of that. But it's not always the case. You can have fixed costs that are through the roof.

Marty · 08:25Like for example, the Michael Hill jeweler at Chadstone might absolutely have the biggest rent going, and they don't make a lot of money in that location. So yeah, good, good one to look at and good way to think about it.

Marty · 08:37Construction industry, gross profit margins are 15% really slim, let alone what they're making.

Marty · 08:43Net right. So if something happens in the economy and there's a shift as it has happened, um, during COVID and expenses going up dramatically, there's just no flexibility to be able to survive that type 'cause. 'cause in business and life things happen. Like we know there are. Times when you ride the wave and everything's going really well and you've gotta enjoy those moments.

Marty · 09:05And there are times of real challenge that, that sometimes you're not in control of. So again, having a higher gross profit margin gives you flexibility to be able to maneuver and gives you more time in the game if something does go. Am this,

Marty · 09:18and this is a prime example. Why, if you look at uh, liquidations and voluntary administration statistics, why the construction industry is one of the highest.

Marty · 09:27Kind of, uh, ma makes up the most numbers in that area. If you've got extremely slim margins, even at gross profit level, before you even get to the bottom line. And something goes wrong on a job site where you've got relatively fixed contract to deliver a service or deliver a a, a, a construction project.

Marty · 09:46Um, even at a small business level, we, we were dealing with a, a business, I won't even say the industry, but in construction, they took on a $3 million contract, which was quite a solid contract for them and. As the project went on, this business month, on month was in the red, negative, negative, negative, and spoke to the business owner and said, wha, what happened?

Marty · 10:04Oh, well, the, the costs on this project blew out the way we did. The contract didn't leave a lot left for us. So I said, well, what was, what was your expected profit on this? And it was a $3 million contract, and at the end of six month project was meant to be 150,000 profit. I said to this business owner, I'm like, mate, it sounds like you've taken on a lot of stress.

Marty · 10:24You've got a lot of employees and contractors. Like, was it worth it? Like, I mean, even if it had gone right, like would you do it again if, if it meant 150,000 at the end of six months? And, and the answer was no. Like this, this guy had it nearly destroyed his, his marriage and destroyed his livelihood and he ended up having to reinvest back in this company to close out the project so that he didn't have to become another liquidation statistic.

Marty · 10:46But this is how easily it can go wrong if you don't know. The numbers well enough to be able to project and forecast and map out, you know, the, the upside of something going right, but also. Other side of that, if it goes wrong, what's your exposure?

Jason · 11:00Yeah. You gotta have your margin of safety in it. You need, you need a decent upside for that level of commitment, guaranteed.

Marty · 11:06And that, uh, I don't think a lot of people think about that upfront. I, I think a lot of people go, some do, but a lot of people go into it and it becomes a pain point on the back end of a project like that. And, um, yeah, it's, yeah. Even, even those basic examples, like for every a hundred. K. Michael Hill Jewelers make, they keep 60 in the gross profit margin.

Marty · 11:26You know, the boutique cheese company keeps 30 out of the a hundred and the construction company keeps 15 out of the a hundred. And I would think that's probably the most risky. Mm-hmm. You know, the higher, higher type builds, you know, speed, timing is everything. Weather like there's, there's a lot of things that can go amiss and a lot of costs so.

Marty · 11:45Interest rates, interest rate rises. You think about when, when some of the bigger construction companies went under the, the cost to fund projects was, was quite, was cheap, the cheapest it had been. They went all in. And then, uh, very quickly, what do we have, you know, bajillion interest rate rises over a couple of years and, and project costs were cooked.

Marty · 12:02Yeah, and that's, that's why these tech companies do so well. Like the Microsoft has 69% growth profit margin. You've got Google at 58% 'cause they've got softwares. People keep buying again and again and again. So it's just, you know, lower, lower labor costs than that. And, um, you know, they're keeping a lot more of their money, which obviously is then affecting the bottom line as well, where they're making substantial profits.

Marty · 12:24So all, all I'm presenting this is to say. Have a think about this upfront, like rather just falling into something. You know, if you have a capability around business, you can always have experts support you around that. But think about the industries you're entering into and making sure that you have significant upside in that decision.

Marty · 12:45And I know. There'll be people thinking about their careers as well. Like I think people do very honorable careers and then don't get paid as much for them, and they get frustrated. And I think you need to make those considerations and, you know, people who have natural skill sets in certain areas, but I think it's wrong to just discount, you know, your, your potential upside out there and take a wider view of what that future could look like for you and where you're gonna place your focus and energy as well.

Marty · 13:13Nick?

Nick · 13:14Yeah, I think the thing that I pick up. Here is that, um, well the first thing I pick up is, you know, lower margin, high scale, um, more risk, but you can probably make more money. And, you know, we've mentioned the builders, but I don't think this should deter people from doing what, what they love. I guess if you're lucky enough to be in that position or what they're good at or they want to do, they just need to think about how they're going to do it.

Nick · 13:41So, um. I guess what I'm trying to say is you don't look at a cheese business and say, oh, the margins aren't big enough, so I'm out. It's, well, how do I, how do I change that narrative? So if I'm a builder, what, what am I gonna go into? Um, and this is on a, you know, nowhere, nowhere near the scale that, um. The, the builders we're referring to that have gone to liquidation.

Nick · 14:05But, um, I've got a, a client in the past who just did, uh, decks and he was a qualified builder, and he just did, he just did decking because there was no risk, high margin. There was just him and one other, one other person, and. In, in and out in a day hypothetically, or in and out in two days. So I think look at your craft and look at what you can do and then decide, okay, well what am I gonna attack?

Nick · 14:31So with the cheese business, maybe there's certain cheeses that they make that are. Uh, that, that are harder to make and that are less margin. Um, are they, um, are they putting it online and trying to ship it? How are they selling it? Um, I'm not sure, Jay. She'd have far more examples than I would, but, well, the

Nick · 14:48salamis and stuff have a higher margin.

Nick · 14:50So they've introduced those, you know, other products within the business that's creating more of a margin. So it's like, you know, it's, what are you laughing, Jake? Oh, I'm

Jason · 15:00just laughing. 'cause the more we mention cheese and salami, you get hungry. I just get hungry. It's like, you know, I've got some age

Jason · 15:05guta in the fridge.

Nick · 15:06I'm ready. Have a crack at

Marty · 15:08I. And look, look, I love these conversations because it actually forces you to think. Beyond, you know, as you said Nick Mo, most people who start a cheese business and make cheese, they do it 'cause there's a passion and a love. It's mine have come from family, uh, legacy. Someone in the family taught them the trade.

Marty · 15:25Um, or it's something they've gotten into through working a job somewhere. But you know, if you get to a point where then this is the stuff you start to explore because. You can be the best cheese maker, but if you can't run a business, you, you're in a bit of strife. Just like you could be the best plumber or the best accountant.

Marty · 15:40Yeah. But if you're gonna own and operate a business, then this stuff is the fundamentals. But you know, just, you know, you then start to go, well. If there was a cheese business out there, I can't remember the names of the people, but shout out to them and thank you for the cheese hamper that you sent to, uh, the numbers.

Marty · 15:53Game level two, uh, 65 Dover truck. Um, you know, we go, okay, if you can't improve the gross profit margins, what else can you do? So I di diversify product range, you know, add some different cheeses that may be a lower cost to make so you can, you know, level out and balance it out. The ones that are on the shelf.

Marty · 16:09Aging for years, you know? Okay, cool. How can we brand them with a premium brand separate to our daily brand, like day-to-day brand that people come and buy. You know, you think of Penfolds Grange, what they've done with Penfolds Grange. Um, so, you know, I'd be looking at that cheese business going, cool, okay.

Marty · 16:24Once we've diversified our branding, you know, do we have a, you know, a wholesale business where we can do the, the volume stuff through the supermarket down the road? Or that's not our brand, we're high-end, low, um, volume boutique. Then do we go direct to customer the hamper that's gonna be delivered to the numbers Game office, you know, they do.

Marty · 16:43Beautiful hampers, not that many of 'em. You've gotta get in early every month and order in advance at a high margin for a particular hamper. Full of Yarra Valley's best local produce that they go and source themselves. Fuck. All of a sudden like this, this cheese business is sounding like a good high margin, you know?

Marty · 16:59Well, even, even ideas that come out of like, and you're exactly right in the way you're thinking about it. Like we always go, oh, let's get a traveler. Like when we go home because we, you know, we have the cheeses wrapped and the damn thing tastes so good and the taste testy. So we get a little sandwich traveler each, and it's like, I'm going charge five, six bucks for that.

Marty · 17:18You know what I mean? Because the people want to have a taste sensation when they're in there and they do have tasting. But these are the sort of things that's like Nick was talking about with the builder. I was talking to a builder and he was saying that he purely moved his business into renovations.

Marty · 17:33Because he doesn't have to worry about council approvals. He can get in, get out, he can do a hundred grand jobs, and his profitability on that is so much higher than actually going through the process of doing a brand new build. Smart.

Marty · 17:47Yeah. And, and, and you should be. I've, and I've got another really good example on that.

Marty · 17:51Um, we have another client who is a builder but only does make goods. So make goods is going into a, you know, you've leased the commercial, uh, office. You've spent a lot of money on the fit out and then you have to leave the office and in most cases you have to get it back to its original condition. So that means if you've got walls, up, petitions, desks, it's all gotta be stripped back.

Marty · 18:13So I've got another client that only does make good, so all he is doing is going and ripping things out in and out in a couple of days. No stress, you're not dealing with people. You just gotta get it back to a bare shell charges great money for it. And it's high margin. And yeah, we, even in our business, we do this, like we've, and I'm happy to, um, share this.

Jason · 18:34We've recently been in, through a process in our financial planning business where, um, a big part of our financial planning bus business is insurance and risk insurance, so income protection life, TPD, we've spoken about this stuff, but we've determined that there's a certain amount of cover. We actually can't deliver that to the client and be profitable.

Jason · 18:57So we're basically, um, giving that advice at, at a loss for our business. So if someone comes to us and just wants a million dollars in life insurance policy in, in life insurance policy, we will lose money delivering that service based on what, uh, the market expects to pay, which is zero. It's a commission based product.

Jason · 19:15So for us, we, we either need to charge to do that advice. Um, or we do it and lose money. So we've determined that there's actually a better option out there for the client to get that kind of, um. Insurance if it's solely, that's what it is, and we're not the best option, and that's more than okay. Um, but there's no point in us trying to put that business on the books at a loss because that just has so many impacts.

Marty · 19:42And I know, Josh, you always look at this stuff in your business, so Yeah, it doesn't mean you don't have, you can't do what you are doing is what I'm getting to. It's just understand what makes your money and what. Doesn't, and how can you tweak things to make sure that you're, you're focusing in the right areas.

Jason · 19:56That

Jason · 19:56that's a great example. Even on mortgages, Nick, you look at the timeframe from, and the, it's very relevant and still very profitable, but the timeframe of execution on that could be, you know, four months from when you first see a client do a good job and get paid. Where you look at some of the, the business cash flow.

Jason · 20:12Type of products where you could, you know, assess a solution in 48 hours, uh, have the client with a result within three days and, you know, be paid on it the following day. Like just the, the return on time and effort is, uh, is incredible. Now you're gonna have variances in a business that delivers so many solutions, which, you know, it's gonna be a winner across the board overall.

Jason · 20:34But it's just even interesting on that sort of stuff where like, you think about that renovator going. I can be in and out, do a great job, clients delighted, utilizing all my skills, maximizing my return, and um, so people were making, you know, street smart, smarter decisions as they go within their businesses as well.

Jason · 20:53And that's certainly what, um, Nikki and Peter were doing as well in real time. And I think a lot of people were doing that. But I think, yeah, I, I think you can, you can do both. And I think that's, uh. You, you, you want to give thought, like some people buy a business purely because they want to run a business and they do want to make money.

Jason · 21:14And I think it's those people, if they're coming in and they're looking at it as a strategic investment for the future, then that's. A real key component to make sure that the gross margins are strong in, um, you know, looking to take that on board and be careful too, because, um, like you look at cafes, they sometimes run at a 60% gross profit margin, but their expenses are so high, they're notorious for having.

Marty · 21:39Five to 9% profit, you know, once all expenses are drawn out. So that's not a great situation as well. So you need to be industry specific and dig deep into the numbers. So you're making a quality decision if you're gonna spend all this time, um, growing a business as well. Um, so what, what are some of the things we can do like.

Marty · 22:01Again, premium branding and storytelling. I think, uh, yeah, we, we talked about Liquid Def, which was, uh, a war Water branded well, and they charge probably about 30% more than everyone else on water. So it's amazing with jewelers how that perception of quality they can present in their marketing and, you know, based on what they get the product for to what they sell it for.

Marty · 22:26It's highly emotive, you know, there's not one. There's not one partner that sits across from that ring that they're trying to buy without there being a deep emotional connection to paying, you know, top dollar for that, for that opportunity. So again, it might be like you said, Dick, for the cheese shop, it might be like.

Marty · 22:46That aged cheese, that's three years, that's gotta have a 50%, you know, premium on it because it's so significantly good, you know, so again, like wine does as well and various different things. I think they're the sort of things maybe. Direct to consumer, like you said as well. Maybe people don't have the shop fronts, even though I think the shop front's a good fund.

Marty · 23:07Um, but you know, they, they start to think about having an online presence where they're collecting more gross margin. And the easiest thing is also to look at the current efficiencies of how something's being developed to see whether there's any optimization of expenses within that. That's probably the.

Marty · 23:23The easiest to, to first attack. But again, you wanna maintain the quality of what you are delivering in order to make sure you can still charge that price to the market or even increase the, uh, price to the market for, for quality. And it's like the insurance. Like what? I'll ask the question to you there, Nick, on the million dollar cover, what would you have to charge to make that feasible?

Jason · 23:48And is that like, is it that ridiculous that it's just no point? Uh, two, $2,000. Yeah.

Marty · 23:56Yeah. So, so again, we're not the best. We're, we're not the best option for the client. Yeah. Um, they're best off to, to, um, go, I can't imagine really any advisors that would be profitable riding just that policy. Yeah. Um, so yeah, again, it doesn't make sense for the client.

Jason · 24:16Yeah,

Jason · 24:16yeah, yeah.

Marty · 24:17Makes sense. But they're the sort of things, I just wanted to throw it open to our audience, to, um, you know, to consider what you could do to optimize in your business, but also if you're making a strategic play, make sure that the margins are there, you know, gross profit margin, net profit margin, and you know, and then we work on optimizing from that.

Marty · 24:36Point, but really important. 'cause I see so many people, uh, fall into businesses just based on their passion and that's great. We don't want to deter that, but we just wanna make sure that the numbers stack up to back that passion so they can keep, you know, building brighter futures for themselves. And, uh.

Nick · 24:52No doubt you would see a lot of financials ja, that come through with people buying businesses, and it's great to get another set of eyes over, uh, over something that you're looking to do and get some relevant advice. And future advisory are fantastic around that. So yeah,

Marty · 25:07a hundred percent. And the, the, the mindset there is you don't know what you don't know.

Marty · 25:10You can do, you know, online research and looking at everything else, but sometimes this helps to unpack in real time and, and talk to someone about, you know, what the numbers actually mean and then what the opportunities are too. So. Yeah, just don't feel like you, or don't feel like you can't reach out to myself or Marty or Nick where we're definitely here to have these conversations.

Marty · 25:28I mean, this is why we're here today having, having this conversation. It's what drives us and what, what makes us happy.

Jason · 25:33Fantastic. I. Well know your burn. Know your return game over

Jason · 25:39this podcast is for educational and informational purposes only. The conversations are of general nature and do not qualify as financial or tax advice.

Jason · 25:48We recommend before you make any financial decisions, you consult a licensed professional. Individuals on the podcast may hold positions in the companies discussed. ---