Over the years, we have asked our clients what business issues keep them up at night. Consistently, realizing profit potential was one of the top issues that kept business owners up at night. Is there money left on the table that hasn’t been realized? Is there potential that hasn’t been capitalized on yet? As a financial leader, it’s your job to maximize the profitability of your company.
What is Profit Potential?
Profit potential indicates the capacity for a company to make more money in future business and trading transactions. I like referring to it as the monetization of your total capacity to drive earnings. Furthermore, profit potential measures the profit a company can achieve if all their operations are at peak efficiency. This includes pricing, efficiencies, operations, turnover, etc. Also, look at profit potential as the maximum revenue with the lowest possible costs. It’s important to keep in mind that “potential” hints at what a company can accomplish with ideal conditions. But most companies do not meet these conditions in reality. Also, be realistic about peak performance. For example, a manufacturing plant simply can not run at 100% capacity. There is down time for things like maintenance.
Steps to Realizing Profit Potential
What are the steps to realizing profit potential? While I could probably write hundreds of different ways to realize a company’s profit potential, I have compiled a few steps that every small to medium size company can focus on first.
Focus on Throughput
Throughput is “is the number of units of output a company produces and sells over a period of time.” Remember, only units both produced and sold during the time period count. Profit potential lies between producing X number of products while simultaneously reducing operating and inventory expenses.
Do not forget to take into consideration your Total Units produced must consider down time for routine maintenance.
To calculate throughput, use the following formulas:
Throughput = Productive Capacity x Productive Processing Time x Process Yield Throughput = Total Units x Processing Time x Good Units Processing Time Total Time Total Units
Analyze SG&A
Another step to realizing profit potential includes analyzing your company’s SG&A expenses. SG&A stands for Selling, General, and Administrative expenses. It is also known as overhead. When a company analyzes SG&A, they will realize this is the easiest place to looking for unrealized profit potential. Does your company have a large number of non-sales personnel? Are those employees needed to operate? If not, then merge responsibilities for those employees into the roles of essential personnel. Do you carry a lot of expenses that if cut would not disrupt either the manufacturing or sales processes? If so, then analyze whether those expenses are necessary or required. Do you have sales people that are compensated with a base salary when it should be commission based? How did you build your budget for SG&A this year? Did you just take last years budget and add 5%, or did you really analyze SG&A?
Know What Is Valued
Companies are giving away more value per dollar of revenue than ever before. That’s what marketing teams are being taught to do. However, many companies are giving value away without being able to actually afford it. Look at your minimum viable product. Is all the extra bells and whistles you are adding to your product and service actually adding value to your bottom line? Ask yourself whether customers would leave if you cut those extra “value-adders”. If you determine that they would not leave, then streamline your product and/or service.
Of course, I am not saying to decrease the quality or tear away value that is actually valued. However, companies should know what the company values. Then, they should focus on that. For example, Tesla offers an incredible experience with its technology. It’s no doubt that they have found value in their vehicle. But what if Tesla started including a fuzzy steering wheel cover? Their customers would probably think that the fuzzy cover is tacky and does not add much value. They want to feel the leather under their finger tips. Therefore, Tesla should stop spending money purchasing the unwanted fuzzy steering wheel covers for their customers.
Address Your Culture
Another thing that may be impacting your profitability is your company’s culture. When you address your culture, look at productivity, efficiency, accuracy, moral and the people.
For example, a sales driven firm knows they could be more profitable. They have reduced their costs and priced their products for profitability. However, there is still something missing. The financial leader walks through the sales department, factory floor, and ends up in the customer service department. There are no smiles, yelling, and phones slamming. Unfortunately, no matter how hard sales and operations worked, customer service representatives were loosing more customers than normal. The financial leader discovered that their culture was all about making the sale and delivering it. They did not value servicing customers or continuing to build a relationship with those customers.
In another example, a company noticed they were only focusing on the unprofitable or lower margin clients. The profitable customers did not have the same level of attention. Instead of loosing the unprofitable clients, they chose to pull back support and created a paid support program. If those needy customers wanted more support, then they were going to have to pay for it.
Analyze Pricing
Are you pricing for profitability? By now, you should have looked at your COGS and SG&A (or operating expenses). If you have already reduced those costs as much as possible, then determine if you are profitable or not. If you are still not profitable or as profitable as your shareholders want, then you need to make changes at the top – pricing. Access our Pricing for Profit Inspection Guide to learn how to price profitably.
