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Kick off the new financial year by discovering who your profitable customers are and gently shed the loss makers. Chris Ridd, managing director of small business accounting software provider Xero, explains how.

In business, we usually think the more customers the better. But that’s not always true. Some customers cost you more in time and resources than you earn back from them.

Tradesmen intuitively know this: think about the electrician who tells you you’re too far out of his area to make it worth his while to do your job. But a lot of other small business owners don’t analyse their best and worst customers.

Kick off the new financial year with a resolution: identify your best customers and those who cost you more than you make from them. You can gently get rid of the costly customers and invest the time in your more profitable customers or in growing your business.

Remember, to tread gently though. Even the customers you’d be better off without are people who have been good enough to choose your business. It’s usually not their fault that their purchasing patterns don’t fit with your business model.

Who are the customer you’d be better off without?

The first thing to do is identify customers who are costing you a lot. To work this out, do some individual customer analysis.

First, look at how much the customer spends over a particular period – say a week or a month (it will depend on your business). Then, for each sale to that customer, work out the cost of goods sold: the cost to you of the goods you sold to that customer or direct costs associated with providing a service.

If you’re using effective accounting software, you already have a lot of this information in your financial records so it can be accessed within minutes.

Already you’ll start to get an idea of who your best customers are. But there’s another very important factor you have to look at: the time it takes to service them.

Look at things like how long you spend on the phone with them before each sale; travelling time if you have to go to their premises; additional time you spend if they return goods or request alterations. If you keep timesheets you’ll probably have all this information to hand. If you don’t, you and your staff can keep a diary for a couple of weeks or a month and jot down how much time you spend on each customer – or each category of customer.

The numbers, but not just the numbers

Now you are ready to discover how profitable your customers are. Look at how much you earn from each customer over a given period compared with how much time you or your staff spend servicing them. You can either assign a monetary value to that time and work out in dollars how much you earn from each customer, or work out how much you earn from each customer for every hour you work.

You’ll be surprised by the results. You might find some no-fuss customers who are very profitable. And you might find some customers who keep you very busy, and who you thought were very good clients, aren’t so profitable after all.

Before you start culling customers from the bottom of the list, there are a couple of other things you should consider. Is a customer’s demand for your product growing rapidly? If so, what is the possibility they could become profitable in the future? Do they refer a lot of other business to you? If so you might want to hold onto them.

How to break the bad news

Once you’ve identified the customers you might be better off without, it’s time to do something about it. This must be done with tact and care.

Firstly, there’s no reason to upset people unnecessarily.

Secondly, there’s also a sound business reason. Today’s bad customer might be a very profitable customer in the future, or the person at that company who you’ve been dealing with might move to a company with a different spending pattern.

Don’t come straight out and tell your customer you don’t want their business anymore. Instead, put up the price you charge them. Take the time to explain it’s because of the extra cost associated with providing them with your goods or services and that you’d understand if they wanted to look for another supplier – this is after all the truth. You might even be able to help them find a new supplier.

If the customer accepts the new pricing, then you’ve now got a profitable customer instead of one who costs time or money. If not, you have parted on good terms and with the prospect of a future relationship.

The information contained in this article is general in nature and does not take into account your personal situation or you business’ circumstances. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from an accountant or other qualified professional.