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January 20th, 2016
Before achieving profit improvement, you need to be able to measure it. Here’s how. Profit is the difference between revenue and expenses. Investment represents the assets required to generate profit. Profit improvement should be measured in terms of return on investment plus consideration of financial risk.
Our job as business coaches and advisors is to help businesses increase profitability without exposing them to unacceptable levels of risk. The first step is understanding that there are two elements of profit improvement:
Put these elements to work by making some basic calculations. The first calculation is determining margin which is equal to net profit divided by sales (NP ÷ Sales). Productivity is sales divided by total assets (Sales ÷ Total Assets). Now we have a basis for determining profitability improvement.
Profitability is equal to the net profit ratio (NP ÷ Sales) times the rate of asset turnover (Sales ÷ Total Assets). The objective is helping businesses improve their net profit margin and/or their productivity. Improvement involves making changes in what’s being done. The changes need to impact either margin or productivity, or both.
There are six variables to consider in achieving profitability improvement:
- Selling prices
- Physical volume of sales and the mix of products or services sold
- Variable costs
- Non-variable costs
- Amount of asset base needed to support the business
- Risk and how the asset base should be financed
Businesses can grow themselves into trouble unless careful consideration is given to financial management. This is where skilled CFOs can make a difference.
There are three ways to achieve increased profitability:
- Maximize the sales price charged per dollar cost for products or services provided.
- Minimize the cost incurred per dollar of revenue generated.
- Maximize the volume of products or services sold per dollar of revenue and per dollar of assets employed.
These steps are not easy fixes. Change is tough, especially when struggling with the complexity of financial challenges. A virtual CFO can be the difference between success and failure. They have the skills to guide you safely through the process of change and achieving profit improvement.