Last month we covered the 9 specific performance indicators
that you need to consider in building a profit plan for the new financial year.
This month, we'll examine how you build a profit plan,
utilising those indicators.
I'll go through two simple approaches - one based on
targeting a desired profit level and the second aimed at devising a profit plan
based on what you might consider an achievable sales target. The second approach
may be one that you may wish to consider in a changing market where sales may
be reasonably expected to drop. Of course, this second approach may be
considered a little defeatist and would only be considered if a full strategic
analysis of the business determined that there was no scope to increase or
maintain sales in the environment the business operates in - this is unlikely!
Approach 1
Let's say that your business profitability in the previous
financial year looked something like this:
Sales $1500000
Less Cost of Sales 975000
Gross Profit 525000
Gross Profit Margin 35%
Less Overheads 250000
Net Profit 275000
Less Cost of Sales 975000
Gross Profit 525000
Gross Profit Margin 35%
Less Overheads 250000
Net Profit 275000
Number of Sales 60000
Av. $ Sale 25
Number of Opportunities 80000
Conversion Rate 75%
Av. $ Sale 25
Number of Opportunities 80000
Conversion Rate 75%
Note: Refer to Part 1 of this article for definitions of the
above terms.
Gross Profit Margin = Gross Profit/Sales
All figures GST exclusive
Gross Profit Margin = Gross Profit/Sales
All figures GST exclusive
Now, say you wish to target a profit of $350000. You believe
this be feasible within your existing cost structure. You also believe that
your gross margin will fall to 34% (for a more detailed discussion on
strategies for managing your gross profit, refer to my previous blog post
"Maximising Your Gross Profit")
Your target sales will now look like this:
Overheads $
250000
Target Profit 350000
Target Gross Profit 600000
Target Sales @ 34% GPM 1764705 ($600000/34%)
Target Profit 350000
Target Gross Profit 600000
Target Sales @ 34% GPM 1764705 ($600000/34%)
So, you need to find an extra $264705 in sales. Now,
discounting in order to boost sales generally fails, unless you have lower
costs that your competitors or are able to cut your costs. According to Reed
Holden of Holden Advisors, US based pricing specialists, you need to innovate
for growth.
So let's look at what you could do:
So let's look at what you could do:
1.
Improve effectiveness of your marketing, to increase
the number of opportunities (or store traffic). If you were able to increase
the number of opportunities by, say 1%, there would be 800 more opportunities.
If 75% were converted in sales, there would be 600 extra sales at $25 = $15000
extra sales
2.
If you were able to improve your merchandising and
customer service and increase the
conversion rate on sales to 80%, together with the increased
opportunities in 1) above, there would be 80800 opportunities converted at 80%
at $25 per sale = Sales of $1616000 - an extra $116000 in sales
3.
If you were able to improve your merchandising, product
range, customer experience and sales systems so that you were able to increase
your average $ sale (by add on sales and/or up selling) to $27.30, your sales
would be 80800 opportunities, converted at 80% at $27.30 per sale = $1764672 -
your targeted sales level!
Put simply, a 1% increase in the number of opportunities, a
5% increase in your conversion rate and 9% increase in your average sale has
produced the required increase in sales and a $75000 or 27% increase in profit!
Of course you can explore variations in each of the 3 factors above to work out
your profit plan. You could also consider increasing your prices! The challenge
is, of course, to develop and implement strategies aimed at improving each area
- much easier said than done. Which is why some businesses do much better than
others - they are continually working on their business, building strategies,
testing them and implementing those that are successful - then starting the
whole process again!
Approach 2
Let's say that you have undertaken strategic planning and as
a result, you believe that sales next year look to be around $1600000. The
gross profit margin (GPM) predicted is around 34.5%. You wish to target a
profit of $290000. To achieve the
desired profit, what must you budget your expenses to be?
This is calculated as follows:
Sales $1600000
Less Cost of Sales 1048000
Gross Profit @ 34.5% GPM 552000
Less Target Profit 290000
Target Expenses 262000
Less Cost of Sales 1048000
Gross Profit @ 34.5% GPM 552000
Less Target Profit 290000
Target Expenses 262000
You would then closely review all expenses and assess each
on their effectiveness in delivering value in accordance with your business
model. Be very careful as costs can be cut that much that you deliver
insufficient value to your customer - as a result, you don't deliver the required
number of customer opportunities, don't convert them at the required rate and/or
don't sell at the required av. $ value to achieve your target sales.
My preference is to work under Approach 1 as it is a much
more positive approach which can lead to the development of innovative
initiatives that can take your business to a new level.
I wish you the best in your development of your financial
plan for the new year. I am happy to answer any questions that you may have -
you are welcome to email me at the following address:
chris.foster@greentaylor.com.au
2 comments:
Nice Blog and great post your post is very helpful for me and others.
accountancy services uk
Hi Chris
Thanks for your kind feedback
Cheers
Chris
Post a Comment