Vanessa* had left a well-paying, “safe” job for a shot at running her own business in the SAS (Software as Service) space. Her husband made similar sacrifices and went along for the business ride.
Intelligence and knowledge of what you do as a business is generally not the challenge for business owners: the chef knows how to cook, the builder knows how to build, and the plumber knows how to…plumb?
Vanessa knew what she was selling was a very good offering and she had received some positive feedback from existing clients who were paying Vanessa good money for her services. But it’s not enough to just sell your product; you have to cover overhead, invest in development costs, and, in Vanessa’s case, she had the added burden of providing enough income for her family.
Vanessa made the decision to employ a new salesperson, which so many business owners make and believe it will be the silver bullet to all their problems when it comes to “selling more”, “growing their business” or “achieving their goals”. . Up to that point, she had done all the selling but she thought investing in somebody who had sales experience and could focus all their time on selling would cure all her problems.
So many small to medium business (SMB) owners believe when they employ a new salesperson their fortunes will change and new doors will open to create new opportunities. Anyone could sell the new iPhone to an Apple Evangelist, but it’s another thing to sell in a competitive environment where budgets are tight.
It was at a point in our semi-regular finance catch ups at her office that she mentioned…
Vanessa: “So I have got a new sales guy”
Me: “What’s the package? How much are you paying him?”
Vanessa: “$150,000 package including superannuation”.
I had provided some business advice to Vanessa in the past and I knew her business turn-over was currently $500,000 per year, at the very most (remember that’s revenue not profit).
I knew straight away that hiring an employee was a bad idea financially and what was about to transpire between her and myself wasn’t something which she had considered. This was a relationship she had already committed to, making our next conversation even more difficult. The reality was she had to get out of her commitment to her new salesperson ASAP and I had to explain why.
This is when we worked through the process of whether this investment in a new sales person was really going to work for her business. This is a process which you can use in your business when determining whether or not to invest in a salesperson (and know how well a job they did!).
An important point to remember from a sales and marketing perspective is the vast majority (if not all) SMB’s should focus on winning new clients. Generally, SMB’s don’t have the money for “brand recognition” campaigns that large companies are doing. SMB’s are looking for clients, new juicy clients who will buy your products or services and put cash in your pocket.
This is the process I explained to Vanessa…
Step 1: What is the Average Gross Profit Percentage of Your Business?
Gross profit (GP) is how much money a business makes by selling a product or service after all direct expenses have been paid. For example, if I am selling pens and sold a pen for $2 and the direct costs (cost of the pen and freight to ship the pen) are $0.80, then your gross profit is $1.20, which makes the gross profit percentage 60% ($1.20 / $2.00).
A lot of businesses are not going to be selling everything with the exact same GP% so it is crucial to know what the average GP% is across your whole business.
For Vanessa, she has a mixture of selling software but also some consulting services which were labour intensive in costs. The average GP% for her business was 27%. Up on the whiteboard, I wrote 27%.
Step 2: What is Your Salesperson’s Package/Remuneration?
From our earlier conversation, we knew the salesman’s package was $150,000 per year. I wrote this on the whiteboard as well.
Step 3: The Calculation
This is where math is the key. The calculation is simple. How much does this salesperson need to sell to allow the company to breakeven. As you can imagine, no business is in business to just breakeven; they are in business to make a profit…
For Vanessa, an annual investment in this salesperson at this price would require that they generate $555,555 in revenue just to breakeven!
Vanessa was confused and, to a larger degree, worried by this revelation I had placed in front of her. Now, we began to discuss…
Vanessa: Why did you use gross profit in the calculation rather than sales?
Me: This is where most people make the mistake. Sales is not what the business is left with, gross profit is. I could go out and sell your product for $1 tomorrow and sell millions of dollars of product, but that doesn’t make me a good salesperson. Anyone could do! We need to measure what people are bringing into the business after all the costs have been paid to produce and ship the product.
Vanessa: Explain how you got to that revenue breakeven target?
Me: The salesperson in any business needs to sell enough to cover all the costs of the product just to breakeven. If they are not capable of selling enough product to go beyond covering the cost of the product and their salary, then what is the point in employing them? To work this out, you need the fixed cost (their package) and the GP percentage and divide one by the other.
Let me show you:
Breakeven Revenue Target = ($150,000)/ 27% = $555,555.56
Doing the math on the whiteboard, she could see:
Me: Remember, this isn’t just for the first year, this is every year. And if their package increases, so does the breakeven point. What gross profit would you want to make from the salesperson in a year? Because I am assuming you don’t want to carry all this cost and just have them aim to breakeven.
Vanessa: $100,000 would be a good starting point considering where we are.
Me: To work this out, we add the $100,000 to his package as this would be a fixed number which would need to be covered and the GP% wouldn’t change. The formula would be:
Revenue Target = (Gross Profit Target + Salesperson Package)/ GP%
For Vanessa this was:
Revenue Target = ($100,000 + $150,000)/ 27% = $925,925.92
Vanessa: I knew he wasn’t even going to be able to make the breakeven target let alone the gross profit target.
A moment of heavy silence.
Vanessa: I have to get rid of him…
The decision was simple; she knew she had to fire the salesperson that she had put in place. She realised she either needed to hire someone affordable and/or is willing to take on the risk in terms of lower fixed payments but higher variable for greater GP dollars produced.
But most importantly, you have to do the math. It doesn’t matter whether you are employing your first salesperson or your 20th; the principles are the same every year for every person.
Action Steps and Takeaway Points
- For most or all SMB’s, the most important part of employing a salesperson is to consider what they will contribute in gross profit dollars not revenue. Anyone can sell a brand-new Ferrari for $15,000!
- Work out what the Gross Profit (GP) % of your business is; this is the first part of your calculation.
- The fixed elements which need to be “covered” by the gross profit dollars generated by the salesperson’s revenue are their salary package and their gross profit target.
- At the start of each year (or when you employ them), you need to calculate the salary of your sales team and the minimum gross profit you expect them to contribute to the business.
- To work out a salesperson’s minimum revenue, use the following calculation:
Revenue Target = (Salesperson Remuneration + GP Target) / Business GP%
*Name changed – Surprisingly Vanessa’s name is not Vanessa…