Knowing Your Business (Profits)

This report gives suggestions that should help an owner-manager to zero in on profit. It points out that you must keep informed, make timely decisions, and take effective action. In effect you must control the activities of your company rather than being controlled by them.

A beginner rarely shoots a hole in one, hits a bull's-eye, or hooks a prize winning trout. Topnotch performance in golf, shooting, and fishing requires knowledge, practice, and perseverance.

Similarly, in small businesses, year-end profit comes to the owner-manager who strives for topnotch performance. You achieve it by knowing your operation, by practicing the art of making timely, balanced judgments and by controlling the company's activities.

The time-honored truth "Knowledge is power" is especially pertinent to the owner-manager of a small business. To keep your company pointed toward profit you must keep yourself well informed about it. You must know how the company is doing before you can improve its operation. You must know its weak points before you can correct them. Some of the knowledge you need you pick up from day-to-day personal observation, but records should be your principal source of information about profits, costs, and sales.

Know Your Profit. The profit and loss statement (or income statement) prepared regularly each month or each quarter by your accountant is one of the most vital indicators of your business's worth and health. You should make sure that this statement contains all the facts you need for evaluating your profit. This statement must pinpoint each revenue and cost area. For example, it should show the profit and loss for each of your products and product lines as well as the profit and loss for your entire operation.

It is a good idea to have your profit and loss statement prepared so that it shows each item for the current period, for the same period last year, and for the current year-to-date. For example, a P&L statement for the month of November would show income and expenses for the current month, for November last year, and totals for the eleven months of the current year. Many corporations publish their annual reports with several previous years so stockholders can compare earnings.

Comparison is the key to using your P&L statement. If your accountant is not already furnishing figures that you can compare, you should discuss the possibility of having them provided.

Financial ratios from your balance sheet also help you to know if your profit is what it should be. For example, the ratio of net worth (return on investment ratio) shows what the business earned on the equity capital invested.

Know Your Costs. An owner-manager should know costs in detail. Then, you can compare your cost figures as a percentage of sales (operating ratio). Be certain that your costs are itemized so that you can put your fingers on those that seem to be rising or falling according to your experience and the cost figures of your industry. When costs are itemized, you can spot the culprit when the overall figure is higher than what you had budgeted. Take advertising costs for example. You can catch the offender if you break out your advertising expenditures by product lines and by media. In addition, a thorough check of inquiry returns from advertising will help to avoid unproductive publications.

In knowing your costs, keep in mind that the formula for profit is: Profit equals Sales minus Costs.

Know Your Product Markup. Be certain that the pricing of your products provides a markup adequate for the kind of profit you expect to achieve. You must keep constantly informed on pricing because you have to adjust for rising costs and at the same time keep prices competitive. Knowledge about your markup also helps you to run close outs with your eyes open. Continuing to make a product that only a few customers want is an effective merchandising tool only when you use it on purpose - for example, to hold or attract buyers for other high markup products. Don't hesitate to drop a loser from your line.

Garbage-In, Garbage-Out. An owner-manager should not fudge the records. The acronym GIGO that the computer industry uses is true with manually kept records as well as with machine-processed ones. If an owner-manager allows "garbage" to go into the records, the reports will contain "garbage." Reports need not be extensive but they must be accurate.

Look For Trends. Try not to look at a single month's sales or profit picture by itself. The figures on your operating statements are meaningful only when you put the picture in the right frame - that is, look at your figures in the context of what has happened and what is likely to happen. In that manner, you catch a downward trend before it gets out of hand.

Don't use a crystal ball to make forecasts of your business. By carefully analyzing the historic trends of your business, as shown in your records for the past five years, you can forecast for the year ahead. Your record of sales, your experience with the markets in which you sell, and your general knowledge of the economy should enable you to forecast a sales figure for the next year.

Without action, forecasts and decisions about the future are not worth the paper they are written on. A decision that does not result in action is a poor one. The pace of business demands timely as well as informed decision making. If the owner-manager is to stay ahead of competition, you must move to control your destiny.

To be effective, the owner-manager must be able to motivate key people to get the results planned for within the cost and time limits allowed. In working to achieve results, the small business owner-manager has an advantage over big business. You can be fast and flexible while many large firms must await committee action before a decision is made. You do not have to get permission to act. And equally important, bottlenecks to implementing new practices can receive your personal attention.

One of the secrets is in deciding what items to control. Even in a small company, the owner-manager should not try to be all things to everyone. You should keep close control on people, products, money, and any other resources that you consider significant to keeping your operation pointed toward profit.

Manage Your People. Most businesses find that their largest expense is labor. Yet because of the close contact with employees, some owner-manager of small businesses do not pay enough attention to direct and indirect labor costs. They tend to think of these costs in terms of individuals rather than relate them to profit in terms of dollars and cents.

Here are a few suggestions concerning personnel management:

1. Periodically review each position in your company. Take a quarterly look at the job. Is work being duplicated? Is it structured so that it encourages the employee to become involved? Can the tasks be given to another employee or employees and a position eliminated? Can a part-time person fill the job.

2. Play a little private mental game. Imagine that you must get rid of one employee, If you had to let one person go, who would it be? How would you realign the jobs to make out? You may find a real solution to the imaginary problem is possible to your financial benefit.

3. Use compensation as a tool rather than viewing it as a necessary evil. Reward quality work. Investigate the possibility of using raises and bonuses as incentives for higher productivity. For example, can you schedule bonuses as morale boosters during seasonal slacks or other dull periods?

4. Remember that there are new ways of controlling absenteeism through incentive compensation plans. For example, the owner-manager of one small company eliminated vacations and sick leave. Instead, this owner-manager gave each employee thirty days annual leave to use as the employee saw fit. At the end of the year, the employees were paid at regular rates for the leave they didn't use. To qualify for the year-end pay, the employee had to prove that sick leave was taken only for that purpose. Nonsick leave had to be applied for in advance. As a result, unscheduled absences and overtime pay were reduced significantly. In addition, employees were happier and more productive than they were under the old system.

Control Your Inventory. Don't tie up all your money in inventory. Use a perpetual inventory system as a cost control rather than a system just for tax purposes. Establish use patterns or purchase patterns on the materials or items you must stock to keep the minimum number required to supply your customers or to maintain production. Excessive inventory, whether it is finished product or raw materials, ties up funds that could be used to better advantage, for example, to open up a new sales territory or to buy new machinery.

Centralize your purchases and avoid duplications. Be a comparative shopper. Confirm orders in writing. Get the price and amount straight right away.

Check what you receive for condition and quality. Check bills from suppliers against quotations. You do not want to be the victim of their error.

You should, however, keep one fact in mind when you set up your inventory control system. Do not spend more on the control system than it will return in savings.

Control Your Products. From control of inventory to control of products is but a step. Make sure that your sales people recognize the importance of selling the products that are the most profitable. Align your service policies with your markup in mind. Arrange your goods so that low markup items require the least handling.

Control Your Money. It is good policy to handle cash and checks as though they were perishable commodities. They are. Money in your safe earns no return; and it can be stolen. Bank promptly.

Use credit wisely and take advantage of discounts. One of the hallmarks of a successful business owner-manager is knowing how much credit you can afford to extend over any period and how much you have already extended. Grant credit willingly, but keep it on a systematic basis. Insist on a written credit application and see that the credit application contains a promise to pay according to the credit practice in your industry.

Get your monthly bills out to customers on time, and be certain that bills show date of purchases, what was purchased, how much it cost, and how much was paid, if anything, and then how much is owned. The statement should also show your customer any overdue balance and for how long it has been overdue.

It is good practice to use your outside advisors as you go along rather than calling on them only in emergencies. For example, your accountant can help you analyze the financial position of your business to help you avoid problems rather than to get you out of them.