There is one thing that all business owners, managers, and shareholders have in common, no matter where in the world we are from, we all want to make money! The methodology and the understanding of how to make money varies widely however, as a consequence my experience is that less than 20% of businesses really make an acceptible profit, which is bankable!
This article summarises a succinct process to help executives, managers and supervisors improve profitability within their own companies.
Business is no different to a professional sporting venture in that it requires;
The very foundation of good performance in any company comes down to structuring your financials properly. From this solid foundation, you can then build a far more profitable business. We will now bulletuss in more detail the elements that set a solid foundation.
For some unknown reason the profit and loss statement is invariably structured to suit statutory compliance criteria rather than structured for efficient management process.
The P&L is made up of six major parts:
Sales do not reflect the profitability of the company, but rather reflect the base on which to structure the company's costs, and consequently, the company profits. (See graph 1 for a typical, commercially sound structure.) Sales need to be:
Value adding costs are made up of
These costs often referred to as overheads. These costs are made up of:
Gross profit is calculated as the Sales less the value adding costs and the costs assisting the value adding costs.
The gross profit is the primary ‘financial’ key performance indicator, as it determines how much of the sales revenue is left to maintain the operations of the company and final profitability.
Operating Expenses are all those expenses required to efficiently operate the business and are made up of
Operating profit is the secondary 'financial' performance indicator and determines the overall performance of the company. It is not the final profit (or loss) the company makes but rather the profit after all core business sales and expenses are taken into account. The operating profit is calculated from the gross profit less all the operating expenses.
In some cases where companies have a reasonable amount of ‘non core’ expenses and income (such as school fees, private flying lessons, sale of assets, government grants etc.) we would list these AFTER operational profit but BEFORE calculating our profit before tax (PBT.) The question is then “Why bother to have an Operating Profit?”
There are 2 main reasons for this;
Notice how in Graph 1 we have included percentage figures. These are percentage to sales and serve as a good basis for setting benchmarks.
In Table 1, we have set out an example of how to structure the Profit and Loss statement in a simple way. THIS IS A GUIDE ONLY!
It would be worth the effort to set out what your P&L should look like, no matter what industry you are in.
Table 1
Why is it that when one asks an executive “What size is your company?” the answer is almost always “We have sales of $xxxx!”
Well whoopy doo, however it tells us nothing about how the company performs or about its efficiency or lack thereof!
Why can’t we say “We are a company that has a profit of 17% of sales?” Now that tells us a lot more about the company, its efficiency etc.
I am sure this “Sales” story has come about from embarrassed business people who can sell heaps but cannot bank any of the profit, simply because profit is a bit like practical business tools, very scarce!
As an exercise, plot out your profit as a % of sales and your cash position at the end of each financial year for the past 5 or 6 years as in Graph 2. You may find it interesting to see what your company looks like!
Bit scary huh?
You will be surprise at how many companies look the one represented in Graph 2!