‘Compounding interest is the most powerful force in the universe’
This quote is often attributed to Albert Einstein. Compounding is the process of earning interest on your interest. Initially, the interest earned will seem insignificant. However, if you are patient and continue to reinvest the interest, your money will start growing at an exponential rate. You will receive a return on investment that is multiple times higher than if you received the interest instead of reinvesting it. For example, let’s say you invested $10,000 at 15% for 15 years. If you reinvested the interest each year you will have received $71,371 in interest by the end of the 15 years. However, if you received the interest at the end of each year you will only have received $22,500 in interest over 15 years.
Compounding is the most powerful force in your business.
If your business isn’t experiencing the growth that you would like, start applying the concept of compounding in your business. By making small improvements to the profit drivers in your business and being patient you can start to grow your profit exponentially. As you continue to make small improvements to your business a snowballing effect will start whereby there will be improvements on your improvements.
The three ways the power of compounding can be applied to your business…
The single profit driver
There may be a specific profit driver in your business that needs improvement. The best way to improve this profit driver is to break the process down into small steps, i.e. to develop a critical path that has clearly defined steps. To harnass the power of compounding in this profit driver you start improving the first step before moving on the next step and so on. If you are able to improve each step of the process, it won’t be long before you will experience the compounding effect i.e. improvements on your improvements. For example, the sales process.
Your sales process may be placing an ad, receiving phone calls from potential clients, booking an appointment and converting to a client at the appointment.
The process may look like this
1. Attract more leads by improving ad headline. By changing the headline and testing which headline is more effective you improve the number of calls by 5%.
2. Attract more leads by improving ad copy. By changing the ad copy and testing which copy is more effective you improve the number of calls by 5%.
3. Make more appointments. By trialling and testing different phone scripts you improve the number of appointments set by 5%.
4. Convert more clients. By trialling and testing scripts and products you improve the number of client conversions by 5%.
If you are able to increase each stage by 5% the result will be a compounding effect on your business that will grow profits exponentially. The key to growth is testing and measuring your results. Always start with a small test and measure the results. This is applicable in all areas of your business.
Multiple profit drivers
By making little improvements to a number of different related profit drivers you will experience the power of compounding. For example, by increasing your prices by 3% and reducing your cost of sales by 3% will increase your gross profit greater than if you increased prices by 6%. You may find it easier to increase prices by 3% and reduce your costs by 3% then to increase your prices by the 7-8% needed to make the same gross profit.
Creating synergy between two or more profit drivers
Synergy is simply when the total is greater than the sum of its parts. Creating synergy can be the best way to create competitive advantage over your competitors. The best way to create synergy is to improve the links between the processes in your business. For example, improving the relationship between sales and the collection of unpaid invoices (debtors). A sale is not a sale until the money is in the bank. Not all sales are created equal especially if the accounts department has to continually chase certain customers for unpaid invoices. If the sales department could work together with the accounts department to develop a system that focuses on acquiring quality customers who pay on time. This may not generate the greatest sales revenue but it will increase the profitability of the business and increase cash flow.
Start applying these principles in your business today
- Small Steps – Break down the processes in your business into small steps.
- Small Improvements – Try to improve each step by a small amount.
- Test and Measure – Always use a test sample and always measure before making changes in your business.
- Create Synergy – Improve the links between the profit drivers of your business.
Below is an example how little 2% changes in the main profit drivers of a business can impact on the profitability of the business.
of Active Customers
number of times they purchase per year
of Sales Transactions
Value of a Sale
Variable Costs in $