Finding the Profit Dynamic
In my experience with successful businesses I have found that they all have three elements that make them successful.
- A passion for the business
- A true talent for the business
- A Profit Dynamic for the business.
Unfortunately many small businesses although they definitely have the first two they lack the third.
What is this Profit Dynamic? How do we find it?
To try and discover more information about the Profit Dynamic lets look at the world of art. First lets look at some of the great artists of the world for instance Vincent Van Gough.
He had the passion and the talent. His paintings today are almost priceless.
He lived a meager lifestyle and died at his own hands impoverished.
He never found the profit dynamic. In fact in can be argued that in those days there was no Profit Dynamic in the art world.
In today’s world there is an artist from Toronto Canada named Robert Bateman. His paintings of wildlife are world renowned. He has a passion for his work as he is still painting today. He definitely has a talent for his art. He is a very wealthy man.
He found the Profit Dynamic.
He used the technology of our time and turned his originals into Lithographic copies. Then to add value he signed a limited number for each painting. I was at a framing shop the other day and they were displaying his newest signed lithographs. The prices ranges from $ 1,000 to $ 1,400 each.
How much do you think it cost him to sign those copies?
He found his profit dynamic.
So how does a company find it’s profit dynamic?
Some actually stumble on it but this is rare.
Some copy other similar companies. This can work often.
Far too many do not find it and spend years underachieving and then going broke.
We have designed a method to find and establish the profit dynamic for many companies.
We have seven steps. These are:
- Start with sound financial statements with relevant information.
- Create a corporate report card.
- Have comparable industrial standards.
- Identify key financial indicators.
- Identify areas for needed improvement.
- Produce and act on a strategic plan.
- Lock in profitable habits.
What does this all mean?
I have a real example with of course a change of name.
Grease Monkey Auto Repair had been in business some twenty years. In the past it had been quit profitable but lately it had been losing sales and has become unprofitable. A new owner took over and immediately hired us to assist him in attaining the profit dynamic for the company.
The first thing we did was gather three years of financial statements which were prepared by a qualified accountant. The statements were fairly presented and we believe showed the true financial picture of the company at that time.
We then produced a Corporate Report Card showing all the fundamental ratios with comparisons to other similar industries. We analyzed this data and determined that we had the following problem areas:
- Sales were eroding.
- Cost of goods sold was too high
- Inventories were too high
- Accounts receivables were too high
- Labour costs were out of line
- Many other costs seemed high
Based on the above findings we determined that the following Key Financial Indicators drove the Profit Dynamic of this company.
- Gross Margin
- Inventory turns
- Days sales outstanding in the accounts receivable
- Labour efficiency percentage
Based on what we could now see about the company operation we felt that there might be many areas of cost improvement. We hired a cost reduction specialist to come in and analyze our cost structure. He worked on a commission bases so there was no net cost to the company. He identified several areas of cost reduction such as professional fees, bank charges and interest, leasing costs and some supplier cost opportunities. In all there was an annual cost saving of about $ 8,000.
The next problem attacked was the eroding sales revenue of the company. To assist in solving this problem we applied the process of “ Strategic Market Planning”. This is a set process which took about a week and considerable research to identify the marketing problem faced by the company. We identified that the company was putting all of it’s energy into old dying auto technology . We identified several areas of new technology in the transportation industry which were growing and had a more profitable potential. We also identified several vertical markets in the transportation industry that the company could market itself into. We produced a new marketing plan to shift the resources of the company and engage in these new areas.
Now it was time to work on the key financial indicators.
1. Gross Margin
We updated the the materials markup policy. We found that the newer high tech parts were not being marked up enough. We also implemented a supplies charge on larger jobs.
2. Inventory Turns
The company had an inventory module in it’s computer system that was not being properly used. We showed the appropriate people how to use the system and results were immediate. Slow moving inventory was identified and some of it was sent back for credit. Stop purchase flags were set on all slow moving inventory. New accounts were set up with vendors who would hold inventory and deliver same day on many jobs. In a short period of time we were able to reduce inventory and more importantly increase the inventory turns. This has a positive effect on cash flow.
3. Aged Receivables.
The most effective way to improve the receivables aging was to design and implement a proper credit and collection system. Most jobs were now treated on a COD basis and large jobs required a deposit. Instead of the company acting as a bank to others we encouraged the customers to create their own financing using their own credit cards.
4. Labour Efficiency.
The proper utilization of labour was a key element in bringing profitability to the company. The labour efficiency is the ratio of labour hours charged and labour hours paid for. In doing the corporate report card we determined that the industry standard was 80%. Although in the past they did not really track these numbers we did analyze past historical data and came up with a historical efficiency rate of 71%. Herein lay the key to the corporate profitability. We instituted a time tracking system using the current computer system with several small upgrades. Workers tracked their own efficiency rate and weekly meetings were held to assist each worker to improve the ratings. One of the older workers quit stating he could not work within this new system. He was replaced with a younger worker who although lacked experience did have a great attitude towards learning the new system.
We were changing the working culture of the company.
After six months the efficiency was at 78% and by the end of the year it was at 80%. By the end of the second year the rate was 83%.
At the same time that we were putting together our strategy to improve the key financial indicators we also began putting together our Financial Model for profit. This was a three year financial plan that took into account historical financial data with our future conservative expectations. It showed how the profit dynamic of the company would be realized with the improvement of the operation as we saw it.
As we began improving the company we analyzed current financial data and compared to our Financial Model. We made adjustments to our model as we changed the profitability of the company. As we did this we taught management how to use this planning model to manage the financial outcome of the operation.
We were now confident that we had a strong financial model of the company. We now had to lock in those excellent work habits that were essential to the new profitable model. We used four tools to do this. They were:
- Weekly meetings
We held short weekly meetings to review issues and opportunities with a view to our key financial indicators.
- Job responsibilities
These were one page documents for each job.
- Position objectives.
- Position accountability and responsibilities.
- Standards of evaluation.
The manual was put on the computer system so all had access. Most of the information in the manual came from the participating workers.
Monthly financial statements
We hired a qualified bookkeeper to produce monthly statements due by the middle of the following monthly. With these statements available to compare with our financial model we were armed with the information we required to successfully run the business.
This whole process took over a year. Some of the positive results were immediate while some took more than a year.
The final result was a growing profitable company.