The 80 20 principle is likely a phrase you’ve heard before. But have you ever heard it be applied to bookkeeping practices? Maybe not. For those of you that aren’t familiar with the 80 20 principle, also referred to as the Pareto principle, here’s what Wikipedia has to say about it:
“The 80 20 principle was suggested by management thinker Joseph M. Juran. It was named after the Italian economist Vilfredo Pareto, who observed that 80% of income in Italy was received by 20% of the Italian population. The assumption is that most of the results in any situation are determined by a small number of causes.”
Joseph M. Juran made some apt conclusions about Italy’s income, but what does that have to do with bookkeeping? Turns out, everything!
The 80 20 principle and bookkeeping
Chances are, 20% of your products/jobs/service lines/activities generate 80% of your profits. I want to emphasize that we are talking about profits, and not revenues. Just by looking at the top line, you are missing a wealth of data that will help you make better business decisions. One way to think about this is: Revenue is vanity; profit is sanity; cash is king.
For example, a large revenue job may require extensive resources, thus leading to lower profits than a combination of your small jobs. Similarly, you might have 2000 SKU’s in your inventory. It’s likely that only 20% of those products are generating the majority of your profits.
Unless you track your profits and costs, how would you be able to apply the 80 20 principle to your company?20% of your activities generate 80% of your profits. Click To Tweet
How bookkeeping figures out the 80 20 principle
Let’s imagine you’re running a project or job based company, like a design firm, painting company, electrical company, where your income and expenses can be directly traced to a job.
All income and expenses will be tracked by project, and at the end of the quarter, we can analyze all the jobs all at once. We’ll sort each job by profitability. Then we look at the top 20% of the most profitable jobs. What do they all have in common? Can we replicate these results? Then, we review the bottom 20% of the least profitable jobs. What do they all have in common? How can we prevent these things from happening again?
Investing in your business’ bookkeeping allows you to get into the details of your company. Do more of the activities that increase margins, and reduce the activities that decrease margins. Quarter over quarter, year of year, the disciplined process of analyzing your project profits will allow you become much more profitable.
How would you like to generate the same amount of business next year, but be way more profitable? Why work harder when you can work smarter!
- Similar to “Working smarter, not harder,” the 80 20 principle is the idea that 20% of your efforts contribute to 80% of your profits.
- Understanding your profits vs. costs can help you determine which activities are significantly adding to your profitability.
- Once you’ve understood how this principle works for your business, then you must rigorously apply those learnings. You need to put this information to work.
- Detailed bookkeeping services can help unveil this information.
The 80 20 principle is a powerful way to reach your business objectives. Our bookkeeping team will identify the 20% and provide insight into what to do next. Let us help you grow your business, contact us today!