Posted by Lloyd Wilky on Wed, Jul 07, 2010 @ 12:26 PM
I was recently reading a post that talked about the importance of knowing key financial terms. Yes you need to know your operating profit and current ratio. There is another very valuable way to describe and work your business and that is with algebra.
Can you describe mathematically how profits are generated from each of your product or service lines? You might be able to look at your financial statements and assess your sales, expenses on the profit and loss statement. That is very different from a working knowledge of the operation of your business mathematically.
Unless you work your business mathematically, you could be making flawed or weak operational and strategic business decisions resulting in lost sales, the wrong sales, and lower profits.
The financial performance of any business can be represented at a basic level in the form of an equation.
The equation is:Profit = Revenue(Contribution Margin %) - Fixed Expenses
Formula Definitions:
Revenue = Sales realized from providing products and services to customers. This would not include one-time payments like licensing or other nonrecurring items. All sales aren't equal, right?
Contribution Margin % = Revenue as defined above minus only the direct costs to produce these products and services. Direct costs are ones that become part of the product or are incurred based on services being provided. To get the percentage of contribution subtract these direct costs from revenues and divide the difference by revenues. This is your contribution ratio or for every dollar of sales how much do you have to cover fixed costs or produce profits?
Fixed Expenses = Theses expense are required by the business but don't vary directly to increases or decreases in sales volume. I am not saying at some point you might have to hire more customer service people if sales go up but the two decisions aren't directly related to the immediate sale when compared to say raw material or assembly labor in manufacturing.
So can you do it for your business? If not, I can help.
Play around with various equations and get a feel for the math. What contribution margin do you think a Walmart has? How about a Whole Foods Store? What about Tiffany's?
It is very valuable to understand the contribution margin for your business and the level of fixed costs. Think about the sensitivity of fixed costs to increases in volumes. How much can you increase sales while holding fixed costs constant? Not all fixed costs are the same. For example, marketing or training are potential investments for your business. Payroll and office supplies are pure expenses. Working with the character of your business in a model can be a very powerful way to make more profitable business decisions. And these days, who has enough profits.
For help with the math of your business, contact us for a no obligation conversation.
Posted by Lloyd Wilky on Wed, Jul 07, 2010 @ 12:22 PM
A recent economic report that the recovery is stalled. Increased consumer and business equipment sales and software spending fueled strong growth in the spring, but tight credit, high debt and continuing high unemployment will slow growth in the second half of the year. If you're like most business owners, the revenue losses during this recession were painful and any slowdown in the recovery makes it a good time to examine your competitive strategy.
I read Seth Godin's book Linchpin. While written for individuals I found many applications to business enterprises as well.
1. The best individuals in any organization are what Godin calls the Linchpins. They invent, lead, connect others, make things happen and create order out of chaos. They love their work, pour their best selves into it and turn each day into a kind of art. Consider how your team or company could be Linchpins and try it on as a strategy for faster recovery in today's highly competitive global marketplace.
2. He describes what is going on in the marketplace as a full fledged revolution - a hypercompetitive world involving arts, gifts, fear and the ability for you to make an indispensable contribution to something you care about. Again also think of your company or team in addition to individuals as Linchpins. The war is relevant for both. As a business owner you have an opportunity to create the space for individuals and your company overall. How cool and competitive is that!!
3. Average is over. If you want to get profits back you have to pull out all the stops to produce unique, highly valuable "gifts" to your customers. If that is the strategy, then every resource (time, energy and money) must be focused on your core business. For most of you, I am sure your core business is also your talent, passion, gift. Go for it.
4. Linchpins learn to be Linchpins, they aren't born that way. Godin says it's about what you do. As a business owner, focusing everything on your art and being indispensable with your customers is a key competitive advantage. What do you need to learn to do your art even more powerfully in your marketplace?
5. A lot of the book focuses on how your employees can learn to be Linchpins. I challenge you to learn to be a Linchpin and be a boss who attracts one Linchpin after another. Besides having a business that is a Linchpin for your customers and having an organization full of your own Linchpins is a tremendous strategy for recovering your revenue loss and creating the capacity to produce an identity as indispensable to your customers and suppliers.
For more information and a free consultation, contact us. We can help you with a strategy to produce Linchpins. In addition, we can help you develop plans of action to increase your focus on core business activities like sales and product development.