Synopsis
You don’t need an MBA to know that your business succeeds or fails based on the amount of surplus cash after total costs are deducted from net sales. What you do need is knowledge of five core concepts that make planning for profits easy.
You don’t need an MBA to build a plan for making more money
Planning for profits is made easy through four core concepts that have been proven to have the greatest impact on small business growth and profitability:
- The most critical number you profit plan for is monthly sales for the next twelve months.
- What do I need to know to project my sales revenue?
- With monthly revenue projections in place, it’s time to plan your COGS.
- After determining gross profit, it’s time to plan for your operating income.
The most critical number you profit plan for is monthly sales for the next twelve months.
The key to understanding this most significant profit planning number comes from Thomas Watson Sr., the president of International Business Machines (IBM), from 1914 to 1956. Mr. Watson, one of the greatest capitalists to ever live, coined the phrase “nothing happens until a sale is made.” This business truism is the cornerstone of your profit plan too.
Your profit plan should not include any expense or profit targets until you are 100 percent clear on what you will sell by the month. It is impossible to set your profit plan target until you identify your core product and service sales goals. Knowing how much you plan to sell and how much you expect to make on those sales is how you protect yourself from incurring too many expenses before a sale is even made.
What do I need to know to project my sales revenue?
At a minimum, projecting sales revenue involves knowing the following numbers for your business:
- Gross sales by product.
- Number of orders by product.
- Average transaction dollar value by product.
Ideally, you will have access to these three essential sales projection numbers by month for the last forty-eight months. At a minimum, you need these numbers for the past twelve months to accurately project your Gross Profit.
It is necessary to have the results for gross sales and the number of orders so that you can calculate the average transaction value by product for the last four years. These average numbers will help you know what you’re generating on gross sales on every transaction in real terms. If you are generating less on each sale year-over-year, that puts greater and greater pressure on your operations. If you are generating more gross sales per transaction, congratulations are in order: You are on track.
If you only have gross sales numbers, then you can back-calculate the number of orders. Then determine the average transaction value from the total gross sales by estimating your average per product transaction. You need to know the number of units and the average transaction value because this information will shape your operating volume. Knowing these details will significantly influence how accurately you will be able to plan for your Gross Profit.
If your business doesn’t often use sales discounting to generate sales nor has substantial write-offs for uncollectible accounts receivable, then your net sales will closely approximate gross sales. If so, you’re good to go on to the next step.
If you do frequently discount sales, handle quite a few returned goods, and have to write off some sales, then you need to project these numbers as well to establish your net sales accurately.
Now you can confidently set your “most likely,” not your “best case,” net sales number into a twelve-month seasonalized view segregated by core product and month. This is the starting point for your profit plan. Next, it’s time to plan for your first measure of profitability.
With monthly sales projections in place, it’s time to plan your COGS.
In building a profit plan, less is more. You don’t need to project out every cost of goods sold (COGS) line item in your P&L Statement. Instead, your goal in projecting your gross profit is to focus on the most significant COGS category totals. The most common areas to consider for COGS are the following:
- Sales Commission
- Direct Labor
- Subcontractors
- Materials
- Equipment
- Shipping
- Other Direct Costs
Again, the goal is not to achieve decimal point accuracy by profit planning for every variable cost item. The goal is to plan for your total COGS so you can subtract that number from your planned revenue by month to calculate your monthly planned gross profit and your projected year-end gross profit.
Profit Planning around COGS is best determined by considering your historical percent of sales for each major expense category. For example, if your goal is a 40 percent gross profit margin, that means you can’t have COGS totaling more than 60 percent, no matter how many COGS categories you plan for.
Download your historical P&L data into a spreadsheet to easily calculate your major COGS areas as a percent of projected revenue. This allows you to establish the COGS profit plan budget by major area, by month. Remember, your cost of goods sold should always vary according to how much your business produces and sells. As a result, you always build the gross profit component of your profit plan as a percent of projected net revenue by month and year.
After determining Gross Profit, it’s time to plan for your Operating Income.
Your P&L statement aggregates all revenue and expenses into categories that allow you to determine where you are making and losing money. This is why you must profit plan at both the gross profit and operating income levels.
You plan for your selling, general, and administrative or fixed expenses differently than you do for your variable expenses. The fixed costs flowing through your business will either be close to an average number by month or will occur in a regular, often predictable pattern for any given month of the year.
Knowing your fixed costs and how much you have paid out by the monthly average for the last forty-eight months is the best way to establish your SG&A expense targets within your twenty-four-month profit plan. Again, your goal is to stay focused on totals by major expense categories versus wading through hundreds or thousands of transactions over the last several years. Your P&L statement will summarize these expenses into the assigned expense category based on your chart of account logic for revenues and expenses. The most common SG&A expense categories are as follows:
- Marketing and Sales
- Travel and Entertainment
- Office Expenses
- Office Payroll
- Insurance
- Outside Fees
- Property Expenses
- Utilities
Most of the above SG&A expense projections will be a fixed number by month, resulting in a more manageable number to project. Some overhead expenses will more closely mirror sales and will be projected similar to COGS. Either way, it’s good to look at each SG&A expense category as a percent of revenue for the total profit plan year. You should do this to ensure that you don’t have an over or understated expense number in any one month.
Remember, your SG&A expenses are supposed to be fixed costs that are easily identified. So this should be the most straightforward aspect of building your profit plan. Once your total indirect operating expenses are established for the profit plan period, you can now project your Operating Income by month and year.
A profit plan positions you to start measuring your actual to planned profit performance. Each month of P&L results gives you the ability to compare what you did to what you planned to do. Having this information enables you to how well you are managing your business for profit? Without a plan for profits, you have no targets to measure your performance against, leaving you without the ability to determine if you are better or worse than where you had planned to be.
Would you like help positioning your business for higher profits?
The most effective way to position your business for higher profits is to assess your historical P&L Statement results to appreciate what’s happened. Should you be overwhelmed in working with your historical P&L Statement data and want help setting that information up to build a twelve-month profit plan, click here to learn how a certified BusinessCPR™ Business Scientist can help you.
Within three days of receipt of your P&L Statement and Balance Sheet by month for the last four years, you will receive back an example of how your historical P&L results can quickly be turned into a twelve-month profit plan for your business.
Want help planning for higher profits?
The most effective way to position your business for higher profits is to assess your historical P&L Statement results to appreciate what's happened. Should you be overwhelmed in working with your historical P&L Statement data and want help setting that information up to build a twelve-month profit plan, click the link below to learn how a certified BusinessCPR™ Business Scientist can help you.Within three days of receipt of your P&L Statement and Balance Sheet by month for the last four years, you will receive back an example of how your historical P&L results can quickly be turned into a twelve-month profit plan for your business.
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