It’s not just about selling more products. Best practice commercial operations focus on profitability in every area of their business. When you scratch the surface profit is easy to explain – Revenue less expenses equals profit. However the greatest financial business success comes when leaders implement an organisation wide profitability strategy. To do this not only do you need to become an expert in the numbers but you will need to help your managers and employees become experts as well.
Knowing the numbers is a great indication of how well you know your business. You should also hold your business unit managers or team members to the same standards. Push them, prod them and test them on knowing their business. If you sat down at a meeting with all of your team tomorrow morning, most would know their targets for the month (“I need to sell 120 widgets”) but how many could tell you their revenue month to date, expenses month to date and accurately predict the selling gross for the end of the month?
A mentor gave me a great tool to focus all of your managers on the importance of knowing their numbers – Implement two forecasting meetings per month, one around day ten and one around day twenty. You will very quickly have a clear understanding of where the business stands,
The 8 Important Numbers Every Business Leader Should Know
- Think of it as a funnel. At the top of the funnel enters Sales Revenue (GST Exclusive). This would include all sales revenue, discounts and over allowances. Sales Revenue can give you an indication of how the market is reacting to your offering at any point in time.
- Then Cost of Sales goes against it including any product costs and delivery costs.
- Sales Revenue less Cost of Sales gives you Retained Gross Profit. When you have Retained Gross you can then Divide the result by the revenue to calculate the gross margin. This is the starting point toward achieving healthy bottom line. When you have a high gross profit margin, you are in better position to have a strong net profit. For a newer business, the higher your gross profit margin, the faster you reach the break-even point and begin earning profits from basic business activities. Your gross profit margin also impacts your cash flow. Most organisations spend significantly on inventory costs to make or acquire products. When you sell inventory for a significant gross profit, you convert each unit into much greater cash than what you invested. This can give you confidence to invest extra capital into business expansion.
- Variable Expenses are costs that change directly and proportionally with changes in production or sales volume, they can include sales commissions and shipping costs.
- Semi-fixed Expenses are costs are fixed for a set level of production or consumption and become variable after this production level is exceeded including salaries, advertising and training.
- Retained Gross Profit less Variable Expenses less Semi-Fixed Expenses gives the Selling Gross. This is the ideal measure to determine a departmental or business unit manager’s performance and incentives. They tend to have some influence or control of both the revenue and expenses up to this point.
- Fixed expenses include rent, rates, administration salaries, insurance and depreciation.
- When you take Selling Gross less Fixed Expenses you get your Net Profit also referred to as the bottom line, net income, or net earnings and is the measure of the profitability after accounting for all costs. The net profit before tax after subtracting the total fixed overheads of a business (most of which is outside the control of departmental or business unit manager’s control) is normally expressed as a business total and not by department unless a very accurate allocation of this fixed expense can be determined. The Net Profit Margin can be calculated by Net Profit divided by Sales Revenue and this tells you something about how well the business is able to convert sales into profit. It is an important measure of relative profitability and can be used to compare over time and also against competitors and industry benchmarks.
The Main Causes of Profit
Profit can can come from two main groups – External Factors and Internal Influences:
External Factors include – Brand, Location and the Economy
Internal Influences include – Process, People Behaviour, Training, People, Efficiency/Productivity and Customer Retention.
The important thing to note is that you have little to no influence on the External Factors however you should assess, question, and drive your entire organisation to increase the bottom line. Every business is different and so the weightings for these factors differ significantly just don’t fall into the “Its just the market downturn” trap. The economy plays a significant role in sales revenue however through management of the Internal Influences not as significant in profit.
Some Ideas To Profitability Success
- Goal Setting – Bench Marking – Budgeting.
- Understanding the numbers means knowing your business.
- A well balanced business with diversity in business units (when some are down others are up and vice versa).
- Department gross profit retention. Including manager accountability.
- Forecasting meetings that provide a timely and accurate result.
- Expenses controlled to a % of gross profit.
- Extremely strict management of liquid assets.
- Accurate comparison and benchmark data.
Where to go from here
All of the transactions from all your business units flow into your accounting department and they prepare your financial statements. Go and grab these and put them on your desk. Spend some time each day just focused on understanding these and looking for ways to increase the focus on profit throughout every area in your business one area at a time.
Implement two forecasting meetings per month, one around day ten and one around day twenty to see where the business stands. Include units, revenue, expenses and selling gross.
Work to support your team. Show them the numbers, help them understand profit, remove obstacles and excuses, deliver focused and strategic direction, find resources and simplify processes.
Struggle, push, contest, wrangle and endeavour for an organisation wide focus on profit.