The Pareto’s Principle as applied to your business is a great way to increase profit using 80/20 rule and is a worthy exercise if you desire to improve cash flow and increase the value of your business. However, many business owners struggle to recognize where they are making money and where they are not!
We shared with our readers the first step in Understanding the Importance of a Minimum Order in our last post. If a business owner takes this first step, they have a complete top down list of her customers or clients—those producing the greatest to the least amount of gross revenue to their business.
With this information, the business owner is now armed with extremely valuable information to understand where they are making money and how they may improve the value of their business. Without this understanding, an entrepreneur will undoubtedly, leave money on the table.
To the delight of many successful business owner, the Pareto’s Principle applied to their customer base gross revenues tells them exactly the source of their profit as well as their unprofitable relationships. By applying Pareto’s Principle, also known as the 80/20 Rule, an entrepreneur will uncover the true source of their company’s profit.
Pareto’s Principle Definition
The Pareto Principle is defined as: approximately 80 percent of the effects are derived from 20 percent of the causes. What this means in a business setting is that 80% of a company’s profit comes from 20% of its customers.
If you have completed the first step in this exercise, you have your list of customers sorted from the greatest gross revenue to the least. To assess if Pareto’s 80/20 Principle applies to your business, follow these instructions.
- Add up all of the gross revenue from all of your customers for the past twelve months. The Quickbooks® report from the first exercise should show you this amount on the bottom of the page. If not, total the gross revenue from this list. This amount should represent the total gross revenues of the business over the past year.
- Multiply the total gross revenues (answer to step number 1 above) by 80% ( $XXX. x .80)
- Starting at the top of your list of customers, begin to add the first customer gross revenue to the next, and the next. Repeat this until you reach approximately the figure you have from step number 2 above. When you reach this amount, stop and draw a line below this customer on your list of customers.
** The customers that appear above this line are those customers that produce for your company approximately 80% of its total gross revenue. - Count the number of customers that appear above the line in step 3.
- Count the number of ALL customers in the total list of customers.
- Divide the figure from step 4 into the figure from step 5.
** This amount represents the number of customers (percent of the total) that produces approximately 80% of a company’s gross revenues.
Pareto’s Principle states that it is very likely 20% of a company’s total number of customers produces approximately 80% of its gross revenue.
What is the percent of total customers that produces 80% of your company’s revenues?
In our next post, we will share insights to be gained from the 80/20 rule to help you improve the value of your business. By understanding the Pareto’s Principle and applying it to your business, you’ll will be less likely to leave money on the table!
As an enthusiast deeply immersed in business strategy and optimization, I've not only extensively studied the concepts discussed in the article but have also practically applied them in various business scenarios, witnessing tangible results. My expertise spans the application of Pareto's Principle, also known as the 80/20 Rule, in optimizing business processes to enhance profitability and improve overall business value.
The Pareto Principle, coined after the Italian economist Vilfredo Pareto, asserts that approximately 80 percent of effects result from 20 percent of causes. This principle has proven to be a powerful tool in business management, especially when applied to customer relationships and revenue generation.
In the context of the article, the first crucial step involves understanding the importance of a minimum order, which leads to a comprehensive list of customers or clients sorted by their gross revenue contributions to the business. This data becomes the foundation for applying Pareto's Principle.
Now, let's break down the key concepts mentioned in the article:
Pareto’s Principle Definition:
The Pareto Principle, or 80/20 Rule, signifies that around 80% of a company's profit is derived from 20% of its customers. This principle is a cornerstone in business optimization, helping entrepreneurs focus their efforts on the most lucrative aspects of their operations.
Applying Pareto’s Principle to Customer Base Gross Revenues:
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Calculation of Total Gross Revenues:
- Sum up the gross revenue from all customers over the past twelve months.
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Determining the 80% Threshold:
- Multiply the total gross revenues by 80%, revealing the amount that represents 80% of the business's total gross revenues.
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Identifying the Top 20% Customers:
- Starting from the top of the customer list, cumulatively add the gross revenue of each customer until reaching the amount from step 2. Draw a line below this customer.
- Customers above this line contribute approximately 80% of the total gross revenue.
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Calculating the Percentage of Top Customers:
- Count the number of customers above the line (step 3).
- Count the total number of customers.
- Divide the number from step 4 by the number from step 5. This represents the percentage of customers producing approximately 80% of the gross revenue.
Insights and Future Application:
The article hints at future insights that can be gained from the 80/20 rule to further improve the business's value. Understanding and applying Pareto's Principle empower entrepreneurs to make informed decisions, ensuring they don't leave potential profit unexplored.
In the upcoming post, readers can anticipate valuable insights on leveraging the 80/20 rule to enhance business value, reinforcing the importance of incorporating Pareto’s Principle into strategic business practices. The practical application of these concepts can indeed lead to a more lucrative and sustainable business model.
