In previous posts we defined profit and the factors which affect it, and discussed ways to increase profit in general, how to improve your gross margin, and how to improve productivity. Today let’s put it all together with a case study.
A Profit Improvement Case Study
Before After Change See Note #
Sales $242,750 $279,462 15.1% 1
Gross Profit Margin 36% 39% 8.3% 2
Fixed Overheads $61,358 $67,886 10.6% 3
Capital Employed $194,885 $201,179 3.2% 4
Net Profit $26,032 $41,104 57.9% 5
Return on
Capital Employed 13.4% 20.4% 52.2%
Analysis of the Profit Improvement
Increased sales volume and prices $14,317
Improved gross profit margin 7,283
21,600
Less Increased overheads 6,528
Increase in Profit $15,072
Analysis Notes:
1. Sales
Strategies:
More effective advertising: A budget was established, the market was segmented and targeted, an analysis of advertising effectiveness was undertaken, and ads that “pulled” more were developed.
Attention was devoted to team training (with respect to product knowledge, selling skills, and customer courtesy).
Performance standards and targets were established and closely monitored.
Result:
15.1% increase in dollar value of sales (some of which was due to selective price increases on key products).
2. Gross Profit Margin
Strategies:
A detailed analysis of the major profit contributors was undertaken (with regard to both the product lines and customer segments).
Products that weren’t achieving required margins and/or which didn’t fit the business were dropped.
Team members were acquainted with the major profit contributors.
More selective purchasing was established, and greater attention was given to quantity discounts.
Selective price increases improved margins and enabled better service to be delivered at the point of sale.
Advertising and selling was directed to higher profit lines and targeted to properly qualified customers.
Result:
An 8.3% improvement in gross margin.
3. Fixed Overheads
Strategies:
All costs were analysed as a percentage of sales over the last 3 years using available information—the major cost areas were identified.
Each cost area was examined on a cost/benefit basis to determine whether the same result could be achieved at a lower cost from an alternative source, or whether it was appropriate to increase costs to deliver more customer-oriented service value.
Detailed cost budgets were prepared on a cash flow basis.
Actual costs were monitored against monthly budgets, and detailed reviews were undertaken quarterly.
Result:
Fixed costs increased by 10.6%, which was in line with normal inflation at the time—in real terms, fixed costs remained constant (even though sales increased by about 5% in real terms and 15% in nominal terms).
4. Capital Employed
Strategies:
A post-sale credit control was put in place. Customers who failed to pay within the prescribed term were politely brought into line. Some customers left, and that was an added bonus. (They were the ones that increased servicing costs).
As part of gross margin analysis (see #2, Gross Profit Margin), inventory lines that were not achieving turnover targets were evaluated, and some duplicate lines were dropped.
Tighter control was instituted for inventory and the lead time for inventory purchasing orders.
Old, slow-moving inventory was disposed of quickly. (This released valuable space and increased cash flow).
Result:
Inventory levels and receivables were reduced relative to the increase in sales. This released cash was then used to reduce bank loans and payables. Relationships with the bank and creditors improved significantly.
Although actual capital employed increased by 3%, the volume of sales it supported increased by 15%. In other words, a 3% increase in resources supported a 15% increase in sales volume.
5. Net Profit—The Final Result
The net profit improved by $15,072—a 58% increase over the previous year. This example illustrates how small marginal changes, though modest in and of themselves, can combine to result in a huge difference.
Profit turnarounds of this magnitude cannot be achieved year in and year out, but every business has room for improvement. The choice is up to the owner/manager.
It is worthy to note that on the basis of a capitalisation rate of 20%, the business’s improved profit increased the value of its goodwill as a going concern by $75,360. (Not bad for a year’s work and certainly worth the management consulting fees that were charged).
But there’s something important to remember: The advice and assistance that was given would have been absolutely useless unless the client had been prepared to make a total commitment to the task.
In the final analysis, it’s up to you!
This was part five in a series.
Part 1: What Is Profit?
Part 2: How To Increase Profit
Part 3: Improving Your Gross Margin
Part 4: Improving Productivity
See more at: http://www.egconley.com/blog
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