Do you know the way to profitsville?

An International Profit Associates Consulting Article

Most people would never embark on a journey to a new destination without planning the trip and periodically checking their progress. However, many small business owners start a trip every year to Profitsville hoping that desire and hard work will get them there. Unfortunately, many end up in a familiar locale--Lossville.

Sales and Marketing and effective management of the business are crucial for the success of any business. So is the selection of the products and/or services that are offered. However, the financial component is frequently relegated to a low priority until tax returns have to be filed. Sadly, the tax returns are often the only financial statements that many business owners truly examine during the year.

The business owner must have a plan to get to Profitsville. Then the plan must be executed through effective marketing, sales, and management. During the execution of the plan, proper monitoring of the progress is crucial because Lossville is never far away.

The Plan. A well thought out annual financial plan is the natural starting point. Once these projections are determined, they should be broken down into monthly, or even weekly, amounts allowing for seasonal fluctuations in sales, expenses, and cash flow.

Most business owners have a goal for the year, even if it is not in a formal plan. However, they often fail to incorporate these goals into their pricing/estimating structure. For instance, the owner may wish to have profits of $100,000 on $1,000,000 in sales. However, when they do their pricing/estimating, they will add an arbitrary markup to cover overhead and provide the desired profit. Unfortunately, this markup factor is often insufficient. Accordingly, having a pricing/estimating process that is tied to the financial plan and the financial statements is imperative.

One very important factor must be remembered during the planning and the pricing/estimating stages‹THE MARKET. Competition and perceived value by the customer are very important. Therefore, business owners must not forget the market during the planning and pricing/estimating stages. For instance, the owner of a small café can not charge $20 for a hamburger, even if it is the best burger in town.

Monitoring the Plan
Once the goals have been established, the owner must track the progress being made toward those goals. Judging success by the bank balance is generally not effective because cash can be manipulated by not paying bills, payroll taxes, etc. Therefore, accurate periodic financial statements are a must to effectively manage a business.

Most accounting programs provide a variety of formats for the Income Statement. These normally include budget vs. actual comparisons and monthly and year to date statements.

The budget vs. actual statements are very important because they enable the owner to compare the actual results to the plan. In essence, this comparison enables the owner to see how the business is progressing toward the annual goals. These statements are very useful for tracking sales progress and for managing fixed expenses, e.g. Operating Expenses, because they enable the owner to manage dollars.

The monthly and year to date statements are also very important because they allow the owner to manage the variable expenses, e.g. Cost of Goods Sold. For instance, assume sales are projected to be $100,000 and direct wages are projected to be $30,000 (30%). If actual sales were $120,000 and actual wages were $36,000 (30%), the budget vs. actual statements would show a $6,000 negative variance for wages. However, since sales were 20% higher than projected, the direct wages should have also increased. In this case, wages increased in the same proportion as the sales. Accordingly, there was not a variance when comparing percentages. Had direct wages been 38% of sales, the owner would know where a problem occurred so that the cause could be determined, e.g. excessive overtime, and corrective action could be taken immediately to alleviate the problem in the future. Conversely, had direct wages been 22% of sales, the owner should not be euphoric. It would be premature to buy the new BMW. The owner should investigate significant positive variances as vigorously as the negative variances.

When properly formatted, the Income Statement is the easiest of the common financial statements to understand and use. And, when combined with accurate financial projections, the business owner will be able to manage the company much more effectively. For the small business owner, simply remembering to manage sales, fixed expenses, and net income by dollars, and managing variable expenses and net income (also) by percentages will allow the owner to get to Profitsville and beyond.