Just because you have money in your bank account at the year-end doesn’t mean you are profitable. How to determine if your nursery really is profitable, how to calculate your margins and set the correct price, what you can do to increase profit, what expenses you should not cut in an attempt to increase profit (and why), the power of the 1% rule, process inefficiencies, understanding the numbers, and creating a profit bank account.
Not Focusing On Profits
A profit-focused setting will work out how much profit it intends to make on its income. Then make every effort to ensure this profit target hits the bank account.
Making a profit is the financial point of your Nursery – without it, all your deeper purpose of changing the lives of the children will not be possible unless you are profitable. Yet, in my experience, far too many childcare providers don’t really understand or focus on profit. And the accounting model of Income less Expenses = Profits does little to help matters.
In his book Profit First, Mike Michalowicz makes a compelling case for opening another bank account and transferring your profits before you make payments to anyone. So, if you’ve worked out that your net profit on every sale is 10%, then a safe way to see and secure those profits is to transfer it straight away to your “profit bank account”. That way you are forced to make do with the remaining 90%.
Margins are an important indicator to profitability, but it’s vastly ignored or misunderstood among most settings. Is your childcare making the level of profit margins you want? And how does that compare with the industry averages? The next time you get your accounts, take the direct labour costs and direct expenses (food) out from the revenue. Then divide that number by the revenue. That is your gross profit margin. Let’s say your revenue is £12,000 and direct labour or direct expenses are £8,000. The difference of £4000 divided by £12,000 revenue gives you a margin of 33%. This means that for every £1 of child income, you are making 33p in gross profit. This tells you how profitable you are at the gross margin level. You can also compare this 33% to the industry average to gauge where you are at. If this margin is so low, then you’re unlikely to be making net profit because there won’t be enough to cover your overheads.
Wrong Calculation of Price
Whether you charge per hour or per session, how do you determine this rate? And has that rate been profit tested? Let’s say you’re happy with the 33% margin above. If your hourly cost to serve a child is £10, then a common mistake I see apply 33% on the £10 to get £13.30. If you take your £10 costs from the £13.30 price you get £3.30. Now divide that by £13.30. You now get 25% margin. You’ve just lost 8% profit margin without even blinking.
And this mistake will make its way down to the net profit figure causing you to be less profitable year after year.
Price Increase Procrastination
Having realised that your hourly or session rate are low, or that the minimum wage and pension costs have gone up, another classic mistake is to put off price increases for fear of losing parents. Yes, you might lose some parents but let’s do some maths.
Let’s say you have 20 Children and your annual fee per child is 12,000. (£240,000 revenue) If you put prices up by 5%, your new revenue will £12,000. If you lose 5% of your parents (1 parent x 12,000 = £12,000), your revenue will drop to £228,000 but you now have one less child and less resources needed to service the remaining 19 children. And depending on how you approach the price increase and how you communicate it, you might be pleasantly surprised that no parents will leave. . Will they take their kids elsewhere due to 5% rise to cover increase pension and minimum wage cost?
Cutting The Wrong Expenses
Ok, your setting needs to cut costs to make profits. Where should you start? Not all expenses will have a greater impact on your profits. A study by McKinsey and Co (global consulting firm) revealed that whilst a 1% reduction in fixed costs can have around 2% increase in profits, the same reduction in direct costs has a bigger 7% increase in profits. So instead of going for cost cutting at all cost (no pun intended here) conduct a cost benefit analysis and focus on direct costs first.
Ignoring the power of 1
Incidentally, the same studies also revealed that increasing pricing has a bigger influence over your profits than reducing costs or increasing sales volumes.
But here is what most nurseries do not consider doing: Assessing the power of a mere 1% increase in price, 1% increase in sales, 1% decrease in variable costs and 1% decrease in fixed costs. The impact can be huge.
Would you lose a lot of parents due to a mere 1% increase in fees? When was the last time you considered whether costs could be reduced by 1%?
Admin, planning and procedures take long in the childcare industry and they appear to be in the top 3 concerns for the sector. How efficient are your processes? Are you using the latest technologies? Have you carried out a review of the seven wastes (Transportation, Inventory, Motion, Waiting, Overproduction, Over-processing, and Defects – Google ‘MUDA’ for more on this) that exist in all businesses and considered how they apply in your setting?
“When it comes to finances, nothing is more dangerous than flying blind”(Michael Hyatt) When it comes to profits, the biggest mistake is not knowing the profit numbers that matter in your nursery. Your gross profit margin, profit per staff, profit per child, net profit margin, breakeven number and your occupancy rate. If you currently speak to your accountant once a year only to be told how much tax to pay with no access to your key numbers, then it is unlikely you will be able to improve on your results.
The good news is that with so many online accounting apps on the market, (FreeAgent, QuickBooks and Xero), owners should no longer be flying blind in their settings.