Profit Improvement

Business and managers don’t earn profits they earn money. Profit is an abstraction from the true, underlying movement of cash in and cash out. It could be argued that profit is the result not the objective of an efficient management.

On its own, as shown in a balance sheet, is not necessarily an accurate measure of the success of a business. Profit figures are normally influenced by factors quite distinct from the trading performance of a company. These for example could include how research and development is treated in the accounts, how stocks and work in progress are valued and how the flow of funds resulting from investments and realization of investments are considered.

If we simplify, all you have to do in business is to make some stuff and sell it to someone else for more than you paid for it. Indeed we are in business to make money. Money earned with ethic, integrity and focused on the social responsibility.

Profit improvement is about increasing the flow of money into the business and reducing the flow of money out. It is not about maximizing an abstraction called “profit” subject to many different influences.

So, the question is, which are the most important factors affecting profit improvement? Experts working on managerial roles know very well:  sales, costs and effectiveness.

The maximization of sales revenue depends first on good marketing. There are two approaches to marketing. One is to assess the market in terms of what existing and potential customers will buy. This means an analysis of the existing wants and buying patterns along with possible future needs. The other is to assess the scope for creating wants which does not exists at the moment, by developing, for example, new product or services. Good marketing also ensures that prices match what customers can be persuaded to pay with the objective of maximizing contribution to profits and direct overheads. Maximizing profit means getting the right balance between high margins and high sales volume.

The second factor is the cost. Cost, after all, does not exist by itself. It is always incurred. What matters therefore is not the absolute cost level but the rates between efforts and their results.

The approach to cost reduction should therefore be to distinguish between those which are producing results and those which are not. Indiscriminate focus and attack to all costs might be counter-productive. On a selective basis it may be better to cut something out in one go and not series of marginal cost reductions. Why trying to do something cheaply if actually it should not be done at all.

On the third factor just to say the objective should be effectiveness rather than just efficiency. To do the right things rather than merely to do things right. This is something which is well-known.

But what would be the areas to be focused on? On my view, as follows:

·   Productivity- getting more for less, for example, return on investment, or manpower, output per head.

·         Finance- tightening credit policies, cracking down bad debts, controlling quantity and settlement discounts, optimizing cash holdings etc. But most importantly the management team has to work as a real team in all finance areas that might affect the business before taking any decisión.

·         Inventory, very typical- keeping the amount tied up in working capital to the minimum consistent with the need to satisfy customer demand.

·         Buying-ensuring competitive bids are obtained for all new or renew contracts, specifying to buyers how they should do to get good terms, resisting the temptation to over-order and having clearly laid down policies on mark-ups.

Profit improvement should be a continuous exercise. It should not be left until crisis forces you to think about it. Start with an analysis of your current situation by doing a typical checklist. Look at the whole product range for each market and assess the relative profitability and potential of all products and markets. Use, for example, 80/20 rule to suggest the 20 percent of your product/markets which generate 80 percent of your profits. Concentrate on maximizing the effectiveness of the 20 percent of areas where the impact will be greatest.

Identify those factors within the business which are restraining its potential and, very well-know as well, convert into opportunity what everybody considers dangers. So build on strengths rather than weaknesses.  Then look ahead. Project trends, anticipate problems and, where needed, innovate so that your company can challenge the future rather than being overwhelmed by it.

Your checklist should include:

·         corporate analysis

·         strategic plans

·         marketing

·         product mix and development

·         sales

·         distribution

·         production

·         buying

·         inventory

·         productivity

·         people

·         finance

Finally remember, the best business survivors are, (honestly I don’t think this view will be changed in the near future), first, those which can deliver their products at the lowest cost and/or second, those which have the highest differentiated position therefore having the product which the customers perceive most clearly as being different from the competition to satisfy their needs.

 

 

 

 

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