Meet Alice
We met a second-generation owner who inherited her parent’s small manufacturing business some years ago. For the sake of anonymity, we’ll call her ‘Alice.’ When we first met Alice, she lost complete control of her business.
Alice’s business generated about $6MM in sales year after year, but the company was losing money hand over fist.
The cost of running her business was out of control, and she had no idea why.
Like so many of the business owners we’ve worked with, Alice was overcompensating for rising business costs by focusing on sales.
But, no matter how many new clients she brought on, the company struggled to get ahead. Rather than taking responsibility for how she was running the business–failing to control costs and margins, she blamed the economy and her employees.
She ignored serious profit leaks and didn’t put in any effort to find the source.
Her main problem, outside of taking responsibility, was Alice lacked an ironclad fiscal and operational plan.
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Most, if not all, of the business owners we work with want one thing more than anything else: To increase sales.
We’re not saying sales aren’t essential to growing your business, but we stress the importance of maximizing margins and profitability.
Having a clear financial and operational plan for your business to increase profit is crucial. This starts with writing out a business plan and quickly moves into developing a profit plan.
A plan for your business and profit? While your business plan may include potential profit, they vary. Let’s discuss this further.
Pre-Determined Profits
Most of the owners we meet with estimate sales, usually optimistically, then go by department to figure out the cost of those sales before arriving at the bottom number—the profit. Profits become the leftovers from sales. This is what is referred to as ‘residual profits.’
We advocate putting profits above all else.
Small business owners must look at what their profit margin should be based on–a realistic estimate of sales–and then bank that money at the beginning of the financial year. This method is called pre-determined profit.
If your business is realistically (we can’t stress this enough) set to earn five percent profit on $10MM in revenue, then $500K should be moved to the side. The remaining $9.5MM should be used to run the business.
We like to break this down to the penny. For every dollar your business generates, how many pennies should you deem as profit? Per the example, five cents is skimmed off the top for every dollar, and the remaining 95 cents is put back into the business.
It’s a simple explanation but complex in practice.
How Alice Turned Her Business Around
Back to Alice. Of the $6MM in revenue Alice’s company generates, through our business analysis, we determined profit should sit at $600K. That means for every dollar of revenue, ten cents is banked.
The remaining $5.4MM is the money Alice has left over to operate her business, and she absolutely cannot spend more.
She then implemented airtight departmental budgets. Department heads who go over budget are held accountable, and those who manage to save money will be rewarded.
To sustain profitability, Alice underwent changes herself. Her guestimations and passive management style were put to an end. When it comes to a pre-determined profit plan, there’s no room for assumptions.
Throughout our consulting phase, we worked with her to ensure she kept a close watch on margins and cash. She found leaks in her purchasing department, habitually over-ordering the most expensive paper stock, even as demand for the fanciest stationery dropped.
In that first year, we grew confident that with a clear profit goal in mind, Alice would find more ways to save on costs and even exceed her 10% profit margin.
For instance, her offices were too big. Staff and supplies could easily manage a space a third the size.
Having negotiated with her landlord and relocated to a smaller space in the industrial park where the company is based, she was able to shave almost $35K off her operating costs.
No Excuse for Failure
With a pre-determined profit plan in place, the excuse for failure diminishes quickly. Along with a proper business plan, your business’s financial and operational goals are laid out by the numbers at the beginning of the year.
Employees have their goals written in black and white, which you can refer them to from time to time. It’s all about discipline. Hold yourself and your staff accountable for profits and adjust costs daily.
Without a doubt, having a pre-determined profit plan is the key to success. By having this plan in place, you can track your progress and ensure that you are on track to hit your targets. This level of accountability is essential in any business.
If you do this, there is no reason why your business shouldn’t be able to improve and keep profits high, just like Alice.
