A lack of accurate Cost Estimation and analytic thinking results in Profits of unknown amount and often Loss. Some Companies who are profitable still fail. Why? Profits are not necessarily in the form of cash, such as Accounts Receivable, which may presently be uncollectable. Focusing just on Net Income can be a mistake unless contingent variables are watched. It is vital that a Company sets and monitors certain Benchmarks in its Strategic Planning from which performance can be measured and tracked.
Understanding Profit Relationships and Profit Components
Net Income (Profit) = Revenue (Income) minus Expenses (Costs)
Revenue comes in the form of Cash and Accounts Receivable.
There are Two Types of Expenses: Fixed and Variable
Fixed Expenses: incur periodically, regardless of operational effect and include items such as Rent, Insurance and Depreciation.
Variable Expenses: Vary according to the level of Operations. This includes items such as Product Labor and Material, Sales Promotion and Cost of Delivery.
Types of Profit Expressions:
Gross Income = Net Sales minus Cost of Goods Sold (COGS)
Operating Profit = Gross Margin
Net Income Before Tax
Net Income After Tax
All of these different expressions of Profitability understandably show a relationship between a company’s Revenues and Expenses. Declining Profit Margin should be the sign to search for a cause, which could include: expenses going up, a discounting or pricing error, or a change in the company’s operations.
Planning for Profits
Important Fundamentals:
Liquidity provides maximum flexibility.
Income Statement is viewed in relation to the Balance Sheet and the Cash Flow Statement.
Managed, under control Growth leads to Planned Growth.
A Short and Long Range Business Plan which has clearly unified relationships between Product Development, Market Planning, Strategic Planning and Financial Management.
Profit Planning Steps:
Step 1: Profit Goal
A target value based on the realistic, developed results of your Company’s Strategic Plan.
Step 2: Planned Sales Volume required to make the Profit Goal.
Utilize Operating and Sales Budget Forecasts
The Forecasts influence decisions on Materials Purchasing, Production Schedules, Financial Resource Acquisition, Plant and Equipment Procurement, Personnel Enumeration, along with Employment and Inventory Planning.
Forecasts derived from well developed, realistic determinations of Market Conditions, Market Trends, Industry Trends, Competitive Analysis, Competitive Edge, Market Segmentation, Promotion Strategies, Pricing Strategies, Distribution, Inflation and so forth.
Sales Volume Forecasts which are realizable and accurate come from the previously prescribed development relationships between:
Product Development
Strategic Planning
Picking arbitrary numbers for steps 1 and 2 will result in faulty Sales Forecasts, tainting the process from the beginning.
Step 3: Expenses Estimation for the Planned Sales Volume
Be sure to use the previous years figures if you are an existing business. If you are a start up, it is smart to analyze similar type companies in your industry and use the published research to establish realistic estimated Expenses.
Adjust Expense Projections based on:
Change in Economic Conditions
Ratio of Expenses to Sales Level Change
Production Methods Improvements and Efficiencies
Reasonable salary levels
Materials to produce your goods
Labor to produce your products
Establish a Cost of Goods and liken it to the industry average for accuracy.
Figure in expenses which vary directly with changes in Volume.
Step 4: Estimated Profit
Estimated / Projected Sales Income minus likely Expenses
Step 5: Compare your Estimated Profit with your Profit Goal (step 1)
If there is a wide discrepancy between estimated profits and your profit goal, continue with the subsequent steps.
Step 6: Determine Alternatives to Improve Profits
Change Planned Sales Income:
Increase Sales Promotion
Improve Product Quality
Improve Access to Product’s Availability
Alternative Product Uses
Analyze Unit Pricing Strategy to determine Best Pricing Policy for your outlined Target Markets
Better Service
More Product dependability
More Integrity in your Sales Process
Better Updating / Upgrading Strategy
Better After-Market Sales Strategy
Decrease Planned Expenses:
Better Control Systems for Product Development
minimise Losses
Increased Productivity of People & Machines
Product Re-Design, Re-Branding, Re-Packaging
Product Improvements
Cost reducing Analysis and the resulting integrated strategy
Better Budgeting Control Mechanisms
Reduce Unit Costs:
Add other products in the mix to offset costs
Using idle capacity and assets innovatively
Make certain parts internally if more efficient than purchasing from Vendors
Kaizen Costing: The advanced cost targeting in all the aspects of product development, design and production. Every company division and cost unit will set specific plans for cost reduction on a quarterly expectation basis.
Subcontract Certain Work and Outsource
Step 7: Determine how Expenses vary with Sales Volume Changes
Experiment with Expense levels in selling fewer or more units with the information obtained in Step 3, understanding the relationship of Fixed and Variable Expenses to find the optimal mix of Products and the Unit Sales of those Products.
Beware:
Analyze Limited changes in Sales Volume as High Sales Volumes are costly and expend a lot of effort and Low Sales Volumes results in extra costs due to idle capacity, lack of volume discounts, underutilized highly trained and expensive labor force, and so on.
Changing conditions: Economic shifts, Inflation, Deflation, Customer Shifts, Competitive Products, Market Shifts and other Factors causing changes in Unit Costs.
Step 8: Understand how Profits vary with Sales Volume Changes
Use different Sales Volumes to determine the resulting Break Even Point and the Profitability Vector.
Step 9: Analyze Profit Alternatives
Using the information generated in Steps 6, 7 and 8 consider profit increasing alternatives, such as:
Sales Price Changes
Change Advertising / Promotion Strategy
Reduce Variable Costs
Increase / Decrease Quality of Products
Find the right mix of Products
Eliminate Low-Margin Products
Bundle High Margin Spare Parts with New Equipment
Step 10: Finalize the Strategic Plan and Implement
Measure the Strategic Plan’s execution over time to keep track of your Company’s resulting Pre-Tax Return on Equity and Pre-Tax Profit Margin.
Implement Tax Savings Strategies to hold back more Earnings for future Opportunities and Expansion.
About this Article Writer
Frank Goley is a business advisor, business turnaround consultant and business plan consultant for ABC Business Consulting. Frank is considered an expert in writing, developing and implementing business plans, business turnaround plans, business funding plans, marketing plans, strategic plans and web marketing plans. Frank offers comprehensive business consulting, business coaching, business turnaround consulting, along with web seo, web development and web marketing consulting, to small and medium size companies.. Frank is the author of a business plan book, The Comprehensive Business Plan Workbook – A Step by Step Guide to Effective Business Planning, and he has over 50 published articles on business success strategies. He also writes the Business Success Strategies Blog.
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