How to Apply Business Profit Analysis and Planning Principles

In my previous articles, I have discussed in detail the fundamentals of the income statement and how to analyze an income statement to maximize profits, along with a step by step process on how to plan for profits. To pull this all together, I will give some examples of how good profit analysis and planning made for a company’s success and the flip side of that scenario (and the reasons why the companies were unprofitable). I will present three scenarios of manufacturing companies which had good profitability, mediocre profitability and one which failed. All three companies are in the same industry.

Successful Company: Company A

In examining Company A’s Income Statement, there are many clues as to why it was a successful company:

– Market: Established a market by determining a market need and effectively filling that need. In a five year period sales grew from $11K to $60m in relation to a market that grew from $413M to $510M.

– Expenses: Expenses were reduced as a percentage of sales over the years, with Engineering and Sales Expenses at year 5 three percentage points below the industry average. The lower engineering costs were attributable to high caliber engineers who designed a superior product which required fewer development changes and allowed employees to concentrate on innovation in the subsequent years.

– Marketing Costs were low due to using a network of Distributors to sell the products rather than using a large sales force and manufacturing reps. The small sales force was used to concentrate on high volume accounts, giving the company a big return for its investment in its sales people. This alone added 7 percentage points to its bottom-line profits.

– Cost of Sales was maintained at 62% of sales during the 4th and 5th years of operation which provided a 38% Gross Margin. This GM is about 10% above the average Break Even Point for similar companies, giving Company A a good cushion of profitability.

Mediocre Company: Company B

Company B was a six year old company and located in a region of the country that offered lower labor and overhead costs.

– Sales Success: Company B had very aggressive pricing strategies and undercut its Competitors to achieve large volume orders. Profit was not the motive; dominance was the underlying strategy.

– Aggressive Pricing: In relation to its closest competitor, Company B’s sales were three times larger, material costs 15 percent lower and labor 5 percent lower.

– Overhead: This is where Company B made its mistake. Overhead expenses were 27%, causing Cost of Sales to increase to 76%, leaving a Gross Margin of only 24%, which was Break-Even in the best of circumstances when accounting for Engineering, Marketing and G&A. This was a ripple effect which greatly reduced Company B’s profitability, causing the parent company to sell it. An acquiring company quickly corrected the Overhead issue and installed a new General Manager to institute better profitability controls, which helped it recover over time.

Company Failure: Company C

Company C captured 27% of its market, yet failed to stay profitable.

– Management: Plagued by severe management problems.

– Spending: Flamboyant and expensive habits.

– Product: Poor Design and low manufacturing quality.

– Staff Reduction: As a result of poor management, financial losses and product failures, Company C reduced its staff of 600 to 400 employees. The Company subsequently fixed its design issues, increased its market share from a significantly lower share of 2% to 4% and grew employment to 150 employees. The Company was climbing back and barely keeping its head above water.

– Turnover: Company C experienced severe top-management problems, and as a result, lower-management, along with the technical and production ranks, suffered from excessive employee turnover. In a year period, employee turnover was over 100%. Company C as a result experienced a bad reputation in the Region’s labor pool causing it major difficulties in attracting quality employees. As a result of its low quality labor force, Company C’s product quality declined and customers were lost. The high employee turn-over created a situation that made it impossible to reduce product costs. Company C was constantly in the training mode and the domino effect of catastrophic events forced it to cease operations.

– The Numbers: COGS amounted to 84%, leaving only 16% for Engineering, Marketing, G&A and Profit. This is clearly out of whack by 20%. Material Costs totaling 53% could not be reduced due to high employee turn-over, which created a loss of purchasing continuity and poor procurement strategies. Slow payments to Suppliers contributed to higher material costs since the suppliers increased their prices to compensate for the added costs of doing business with Company C. Company C strove to make improvements, but the improvements were made in the wrong places. Labor Costs were reduced from 8% to 4% and overhead from 10% to 5%, using the same products and predicting inflation rate of 13%. G&A at 3% was reduced dangerously low. The combination of indiscriminate cutting of costs, poor labor quality, poor product quality and very expensive material costs ultimately combined to doom Company C.

What can be Learned?

By applying Profit principles I have previously discussed (namely, Income Statement Fundamentals, Profit Analysis and Profit Planning), I showed companies successfully and unsuccessfully applied these profit principles. The Income Statement is a good place to start your Profit Analysis as it shows how a company has spent its money in years past and what it projects its spending to be in the future, along with whether the proportions of its revenue streams and expense / cost levels were healthy or unrealistic.

By understanding what an Income Statement is telling you, how to properly Analyze it for maximum Profits and how to successfully and realistically plan for Future profits, you can significantly increase and sustain better Cash Flows. However, the process should not stop here. As you have planned to Maximize Business Profits and implemented it successfully through your company’s Strategic Plan, Cash Flow Management becomes the next step in the Profitability process.

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Small Business Profit – Why Small Businesses Lose Profit – Top 5 Reasons

Being a qualified accountant, speaking with business owners every day and having run businesses of my own, I have identified the top reasons as to why small businesses especially owner managed businesses are either failing or not making as much profits as they can.

And here I am not talking about strategies of how to increase sales and save costs which off course leads to increased profits. In this article, I am more concerned with the fundamental reasons for small businesses not doing as well as they could.

1) Being a Jack or Jill of all Trades

For anyone running their own business, cash-flow is always scarce especially when you are starting off and therefore the business owner tries to do a lot of the tasks him/herself. Tasks such as writing sales letters, designing websites, writing marketing materials, designing campaign leaflets, bookkeeping and so on are all done by 1 or 2 people and this can actually dig into your Small Business Profit.

You will actually be wasting money rather than saving money. Why?

The business owner has to identify clearly his/her areas of strength and areas of weaknesses. The focus has to be on the area of strength as this would generate the highest rewards and take the business forward. The other tasks that are necessary but which you are not very good at or is taking up a lot of your time has to be out-sourced. And this need not be expensive in this day and age.

If you really want your business to grow, then from the very beginning you need to build a strong team around you and not try to do everything yourself.

A Small Business Consultant could help you identify your strengths and weaknesses and show you how and where to out-source and how you can actually get other business tasks done by joint ventures.

2) Not Setting Goals and Targets

I have found that one of the major reasons for small business owners to struggle is Lack of Focus. They are doing too many things and juggling too many hats.

And this is as a result of not having a clear goal or target to aim for and a timescale that it needs to be done by.

Most business owners have a rough idea but this is not good enough. Why, because you will not know clearly what you need to do on a day to day basis, week by week basis. For example, if you required an increased monthly turnover of £20,000 and your product sales value is £50, then you would need to sell extra 400 widgets per month or 100 extra a week or 20 extra per day (assuming a 4 week, 5 day per week month). This analysis will give you a clear idea of the practicality of what you want to achieve, a measure of whether it is happening and a strategy of what needs to be done.

And most importantly it will make you FOCUS on profit creation activities.

3) Not Having an Eye on the Profit and Loss Account

Leading on from point 2 above, in order to ascertain the way forward, you need to know what your current position is. Most small business owners operate on a whim and think they know what sales, costs and profits are but again it is a guess. Accounts for Inland Revenue purposes are produced months after the year end and knowing what you made 1 year ago is no good as it is too late to take corrective action.

Nowadays there are accounting packages out there that are very easy to use and if you are able to input the right information, you can get up to date sales figures, cash flow position and also profit and loss position which is at worst only a month old.

A Small Business Consultant could be able to identify the important figures you require and implement the software and reporting functions to give you the figures in a cost effective and affordable manner.

4) Not Having A Marketing Strategy

Marketing is the fuel your business needs to push it forward. However most small business owners are weak in this area and make matters worse by doing it themselves. They follow the traditional methods or what the competitors are doing and are mostly following one or 2 strategies and hoping for the best.

The problem here is that a lot of time and money is wasted on marketing that does not work.

Point 2 above has to be linked to this point as your goals and targets will only be met with the right marketing strategy in place.

A Small Business Consultant will help you to devise a marketing strategy that is within your budget and which will take into account your Profit targets and timescales.

5) Not Measuring Results

In order to greatly increase your Small Business Profit, it is vital that you learn to measure the effectiveness of the actions you are taking.

If you have a website, then how many visitors do you have and what keywords are your most important ones. Is your marketing increasing visitors or not.

If you are using ads in local directories, then are these ads paying and making a profit for your business. If not, then you can stop and use your funds in other marketing strategies.

Marketing should be an investment and not a cost. I.e. for every £1 you spend on marketing, you need to get say £2. This can only happen once you measure the marketing activities and TEST your marketing to find out what works and what does not.

As a Small Business Owner, try to build a strong team around you and do not attempt to do everything your self. Get good advice which will actually save you money and quicken your results so that you can have more of your 2 precious resources, Time and Money.

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