Is profit the reward for risk-taking?
I was struck, recently, by the definition of ‘profit’ on the BBC education
site: “Profit is the reward for risk-taking” it claims. Thankfully, it prefaces this rather stark conclusion with something a little more rounded: “Put simply, profit is the surplus left from revenue after paying all costs. Profit is found by deducting total costs from revenue. In short: profit = total revenue – total costs.”. The equation is still blunt though the focus has shifted from ‘risk’ to ‘costs’. I like this idea of getting down to basics and not messing around. So that’s what this blog’s about.
When I work with owner managers, business directors and leaders, I encourage them to find the profit by concentrating on 4 key areas. As you’ll see, it’s not all about sales growth.
1. Increase profit by price differentiation
Businesses can often improve net profit by 2-3% through effective pricing strategies and differentiation. For a company with sales of £10m, this can be an additional £200-£300k net profit per annum. I know this for a fact because I’ve done it countless times for my clients and, in my last blog
, I demonstrate how important it is to have a pricing strategy that reflects the business and the value you offer.
Purchasing managers base their buying decisions on perceived value: how you take their pain away and make their job easier is more important to them than the lowest price. That’s not to say that discounts and promotions don’t have a part to play – they do (see later in this blog) but as carefully planned tactical activity not knee-jerk reactions to a customer’s rejection of your proposals.
Use a price vs performance
matrix to identify what your target market really values. Is it product quality, order lead time, delivery options/logistics, technical support, customer service? Once you know, be sure to communicate this value so they know what they’re getting for the price you’re asking.
Identifying what your customers regard as a value proposition is part of a much bigger profiling function of the marketing strategy. It’s too big a topic to cover here but, even on a basic level, segmenting your customers and understanding their needs is always going to be better than a ‘one size’ fits all approach – whatever the exercise.
2. Increase profit by improved cost efficiency
If your business is underperforming, you clearly have a disconnect between your cost structure and sales activity. Here are some areas to address:
If your cost structure encompasses raw materials, you should be chasing some positive price variants from your suppliers.
For example, some large organisations will buy in pack quantities/multiples on the basis of a discount for a minimum order. Let’s say, you’re persuaded to order 250 units but during Month 1 you only need 15. You’ve paid for the other 235 units, or 94% just to sit in your inventory (maybe for months) which, depending upon the industry, could depreciate within 6 months.
Processes such as Kanban
will help you maximise the best price as well as reduce the stock of ‘unwanted’ units in your inventory. By all means agree a ‘blanket order’ with your supplier but negotiate delivery (and therefore payment) when you actually need the units. For example, you and your supplier commit over 12 months to an order of 200 units, calling off a planned quantity of 16 or 17 with every single one earmarked. This means you’re building a strong but mature relationship between you and your supplier.
This will only work if you both have efficient processes in place so a leaner operational function becomes your next priority – one capable of working with the application of Just In Time (JIT) techniques to ensure that production, and other processes, are not interrupted.
An inventory full of redundant components is not the only drain on finances. It’s easy to let overheads build up from poor deals with utilities, stationery firms, the landlord even. Then there are the little ‘luxuries’ such as fresh flowers and board room refreshments – many FTSE 250 firms have saved a fortune by buying artificial plants and reducing the carb intake of their board directors. If you have water coolers, would a plumbed-in dispenser be more cost effective than deliveries of bottled water?
Keep on the case with costs in every part of your business.
3. Increase your profit with joined up working
Inter departmental communication and co-operation is so important.
• Make sure the sales team help you solve inventory problems with special promotions. Better to lose 5% on redundant stock early than as much as 50% 5 months later. Better to have some cash in your bank account than stock sitting in your inventory and the possiblility of losing, say, 50%.
• Get processes in place so the finance team works with customers to get payment in ‘on time’. Conversely, they need to pay bills on time to avoid getting blacklisted, paying interest and having JIT interrupted. The ratio is: longest possible credit with suppliers, shortest for customers.
• Line up purchasing to make sure they are getting best possible price, ordering the right quantity and selecting the optimum quality
• Review monthly – each department being aligned and talking to one another is critical to a profitable company
4. Increase profit by managing your money
Finally, your management accounts is the best way to identify where your profit is lacking and how to fix it. As soon as possible after the month closes, you/the board need to see the management accounts for that month (the longer you leave it, the less relevant the numbers become). This is the kind of information I would expect the finance team to prepare:
: on just one page, pull together all the key items from the rest of the pack.
• Summary narrative: one liners on the main highlights and lowlights in the month, showing the forecast and variance so it’s easy to see if you’re on track.
• Actual turnover, gross margin, overhead, and operating profit: for the last 3 months, broken down by product or service lines with % growth (or otherwise).
• Aged Debtors: in £ and %.
• Headcount: a summary of numbers by department for the last 3 months to see at a glance any movement.
• Cash at bank: bank balance for the last 3 months including any overdraft facility.
• Capital expenditure: any material asset purchases in the period.
• KPIs: sales and overhead per head and, if you’re losing money, your ‘cash zero month’.
• Inventory and components level of finished goods
Then the detail:
• P&L forecast v actual: show right level of detail so important movements and trends are clear.
• Budget: same P&L format broken out by month/quarter for the full year. This is a good exercise to help refine future budgeting because it shows how far off you are in your planning.
• Balance Sheet: the monthly balance sheet with key headings such as fixed assets current assets, current liabilities, debt, shareholder funds, etc.
• Detailed aged debtors listing: ranked by customer and sorted by largest, oldest debt first so you know exactly who owes the business how much money (with commentary on the oldest debt).
• Cash flow forecast: a summary of monies in and out for the next 6 and 12 months.
So those are my 4 key areas on how to increase your profit:
1. By price differentiation
2. By improved cost efficiency
3. With joined up working
4. By managing your money
Is a lot of this obvious? Yes, mostly. And certainly none of it is new or overly ‘technical’. In my experience, it’s a matter of adopting some of the more traditional working practices and applying them to the environment in which you are trading today.