Profitability is not dependent on any one single factor. The key to establishing profitability is to understand the continuous interplay between factors in three categories: revenue, operations and accounting. For instance, establishing a profitable selling price requires an understanding of all the costs associated with the production of the goods or services, as well as the ability to allocate overhead and utilize breakeven.
Profitable operations also require employees to take an active role in the management of the company. Each day employees make seemingly small decisions, with little or no guidance, which have a substantial impact on the company’s financial health. That’s why business owners must ask regularly, “What do I need to know?” and “When do I need to know it?”
The accounting function is fashioned around this question and the information produced must be timely, accurate and relevant. A correctly designed Chart of Accounts is the road map of the company’s operations. It begins with revenue and breaks it down into specific product or service types. This allows business owners the ability to track sales efforts and assure they are expended in the most profitable areas. Second is cost of goods sold (“COGS”), which rises and falls with revenue. It can include labor by function (i.e., service versus installation, production materials, equipment rental, freight, sales commissions, etc.). Third is indirect overhead. These are the costs associated with the production of goods and services that must be allocated across all revenue activities. They may include: supervisor wages, quality control expense, shop expense, small tools, equipment repair, fuel, consumable supplies, etc. Fourth is general and administrative (“G&A”). These are overhead items that generally occur whether there is any production activity or not. They include bank fees, interest, lease expense, contributions, deprecation expense, office expense, etc. A properly designed Chart of Accounts enables the business owner to quickly identify any areas that are not performing up to standard and to allocate overhead correctly in the pricing process.
Establishing a pre-determined profit requires careful analysis of the company’s revenue streams, COGS and overhead expense. These numbers form the basis for a financial roadmap that dictates direction and pace with benchmarks to be followed. With profit budgeted into the process, the business can make continual and incremental adjustments to operations and tract profitability.
Having the game plan and controls in place that tell businesses what they need to know when they need to know it, allows them to change course as needed without interrupting the forward momentum. That’s the way to win the game.
How To Generate Profitable Sales
While 80 percent of the revenue comes from 20 percent of the customers, it is also true that 80 percent of the profit comes from only 20 percent of the customers. The paradox is that the 20 percent reflected in each statement are often not the same customers. In fact, customers who demand difficult production schedules or unreasonable pricing structures consume production capacity. As a result, they limit the ability to service customers who are willing to pay a fair price for quality and service.
The solution is to motivate sales teams to produce profitable sales, not just sales for revenue’s sake. Profit-based incentives applied to the factors the employees can control are the best way to assure that profitable activities are carried out. Simplicity is key. All employees must clearly understand how and why their actions and those of others around them have a direct positive or negative effect on their pay. Shared responsibility – “we win as a team or we lose as a team” – is the motto.
Finally, incentives, both positive and negative, should be paid frequently enough to maintain morale, but not so frequent as to cause undue administrative strain. If incentives extend out farther than two weeks, the excitement and momentum wear off. Positive and negative re-enforcement through incentives, as well as making certain employees understand what is expected of them individually and as a team, will measurably increase the chances that promises to customers are fulfilled.
J. Michael Rudd is Consulting Services Project Manager with International Profit Associates and Integrated Business Analysis (IPA-IBA). IPA and its related companies provide comprehensive business consulting services and business valuation services to companies in the United States and Canada. For further information, call (847) 495-6786 or visit www.ipa-iba.com.