Every company has potential to improve results. Most of the time, sub-optimal performance is the result of not focusing enough on the most effective areas of their business. There can be many reasons why this happens, but short-time priority overriding long-term goals; too many projects given to staff, and lack of time generally are the main culprits.
As such the theory for managing for profit is simple.
Profit being the difference between the company revenue and its costs, many think that it is all about cutting costs and selling more. Well, it is not quite that simple, either. The key is management. It is the ability to organize, to motivate and to lead an organization in such a way that the P&L account be optimized.
Let’s have a look at the P&L account then, and let’s keep it simple.
- Cost of Sales
= Gross Margin
From this, you can see one very important thing: money comes into a company from only one end: the revenue generated by sales.
Further, you can see that your gross margin must exceed your OPEX in order for your company to make a profit.
These are 2 extremely important points to always remember.
As a manager, you must work to maximize the gross margin while operating with the lowest possible fixed costs possible.
Read this very carefully! I did not say cut the costs and make as much gross margin as possible. This latter statement only leads you to the vicious circle of commoditization of your product, lower quality and service and eventually a mediocre reputation and definitely sub-optimal results.
So let’s get back to the proper statement: “maximize the gross margin while operating with the lowest possible fixed costs possible”.
This means that your focus is on 2 main areas:
- Maximizing the gross margin
- Keeping the OPEX at the lowest possible level, yet allowing you to achieve the highest margin.
To achieve this, your business plan is the basis. And your business plan must start by the sales plan, since this the area that will bring you the money to pay all your bills. The reason why your business not only exists but also stays alive and thrives is that you have satisfied customers who want to buy more from you. If you think differently about this, just imagine your company losing customers or getting bad publicity. Ok, now you agree with my statement.
Maximizing the gross margin
Here, too, just let’s have a look at what influences the gross margin:
- Revenue = Volume x Unit Price
- Cost of sales = variable costs needed to produce what you sell
To maximize the gross margin, you need to make sure that the selling and the costing are part of the same, since your sales force causes the cost of sales.
The gross margin is the indicator of the performance of your marketing. On the contrary to what many seem to think, it has very little to do with your Production department. This latter one just produces the orders on request of the Sales department.
And this is exactly where general management plays a crucial role: you must make your sales people accountable for the costs they create and for the consequences of their actions, and for them to justify their existence inside your company they must sell for profit, not just move volume, like unfortunately it is the case in many companies.
Sales people must be able to calculate a price that generate profit, and make sales plans that meet this very same objective. Too many sales people tend to prefer to say yes to the customer, because they are afraid of losing them. Loyal customers will not leave you if you disagree on the price, they will negotiate, and that is another area where you must train your sales people to be superior.
That is why any new contract also needs approval of other departments, such as Production and Procurement. This approval is not necessarily a recurrent act, but can also be determined for each line of product, for instance, no sale allowed for a price lower than so much. Deviation from this must be a concerted decision at management level.
Another extremely important item that must be the responsibility of your Sales department is the collection of accounts receivables. Since a transaction is an exchange of goods or services against money according to agreed terms, these goods and services are sold only when they are paid on time. And the best way to make sure that you have solvent and disciplined customers is to make sure that your sales people have done all their due diligence in this area before making a sale.
Minimizing the costs
As well for the cost of sales as for the OPEX, you must minimize the financial impact they have on your P&L account. To do so, you must focus on the following:
- Negotiate the purchase of your materials and services at the lowest price possible for the quality you need to buy.
- Buy what you need to have in inventory, but as much as possible try to limit your inventories at the lowest level possible.
- Have efficient processes and operations. Beware of hidden costs such as too high maintenance and operational costs such as energy consumption
- Have an efficient organization with as few and as talented people as possible. Do not go in any fancy expensive project unless it will bring you a profit return of at least 50% per year.
- Offer a fair and motivating salary and benefit package to your employees. Motivated and satisfied employees are more efficient, get sick less and work harder than employees that are not, and this pays off.
To manage for profit, your sales department must be the driving force, they must focus on generating profitable business (“margin before volume”), they must act like entrepreneurs who have a responsibility to the activities they create in other departments, must keep a close eye on accounts receivables, and most of all know how to price what they sell.
To manage for profit you must set up and manage a lean and efficient organization. You must be cost efficient before being cheap. This latter will only work adversely on the efficiency of your company and will cost you a lot more in the end.
Copyright 2009 The Happy Future Group Consulting Ltd.