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
however, as a consequence my experience is that less than 20% of
businesses really make an acceptable profit , which is bankable!
Business is no different to a professional sporting venture in that it requires;
- Working as a team.
- Having flexible game plans. (strategies)
- The ability to conduct detailed analysis.
- Sound administration.
- Choosing good support. (Suppliers, employees and professional advisers)
- Respecting and knowing your opposition.
- Introducing plenty of training.
- Playing to win.
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.
- Core business sales 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:
- Within the core business of the company.
- Quality sales.
- Paid for within a reasonable time.
- A good mix across customers and product groups.
- Value adding costs Value adding costs are made up of
- Direct Labor plus on costs.
- External costs.
- Costs supporting the value adding process These costs often referred to as overheads. These costs are made up of:
- Indirect Labor
- Supervisors and managers.
- Stores personnel.
- Truck / forklift drivers.
- Factory Overheads (Burden)
- Workshop consumables.
- Motor vehicles.
- Factory administration.
- Rent and associated outgoings (rates, water etc.)
- Gross profit
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 Operating Expenses are all those expenses required to efficiently operate
the business and are made up of
- Administration costs.
- Marketing costs.
- IT costs.
- Financial costs.
- Operating Profit
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
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;
- To conduct proper analysis of the company it is important we do not contaminate the core business information with non-core data.
- In most medium to large companies, the major share holders are not running the company on a day to day basis, but do have a significant amount of control. The day to day running is left to managers and executives. In these instances, you want to measure their performance on core business income and expenditure, not on income and / or expenses over which they have no control.
Why is it that when one requests 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 performances
or about its efficiency or lack thereof!
Why can not 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 can not bank any of the profit ,
simply because profit is a bit like practical business tools, very scarce!