Tag Archives | profit

Why Don’t I Have Cash?

See Also:
Cash Cycle
Cash Flow Statement
Free Cash Flow
External Sources of Cash

Why Don’t I Have Cash?

I was involved in a meeting with a prospect a few weeks ago who we will call Don. Don owns a manufacturing company which is presently experiencing a growth rate of thirty percent annually. He is showing a profit, but his bank will not increase his line of credit. As a result, Don’s company is having cash flow problems. He told me that he has to extend payments to his suppliers, but they are not happy with him. Don also told me he is unable to call most of his customers for payment, because they are within their credit terms; he feels he would be harassing them. He asked me “Why don’t I have cash?”

Operating Cycle Trap

I told him he was caught in what I call the operating cycle trap. Don looked at me and said “What is that?” I told him his operating cycle is; 1) the time from when he first purchases raw materials, 2) converts the raw materials to a finished product, 3) sells the finished products, 4) converts the accounts receivable to cash. I continued by saying your problem arises when the operating cycle is greater than the credit terms you receive from your suppliers.

The operating cycle problem is increased when your bank, being a historical lender, bases your line of credit on what your company has done in the past, not the opportunities in front of you. They will not increase your line of credit. Finally, your profit margin is not large enough to fund your current growth rate. Don looked at me and said “Is there anything I can do?”

Alternatives to Improve Cash Flow

I said, “Yes, Don you do have some alternatives.” If possible, the way to solve this problem, at no additional cost to the company, is to get your suppliers to give you longer credit terms. Then, give your customers shorter credit terms. This will shorten your operating cycle, and a goal for any business should be to minimize their operating cycle. Don said “I know that will not work because my creditors are asking me to pay faster and the competition within my industry will not allow me to shorten my credit terms to my customers.”

Another way to solve your company’s needs is to consider approaching another bank that may take a more aggressive approach to increasing your line of credit. He then told me that he has been to three different banks. They all said they think they will be able to increase his credit line. The end result has been every bank has either a) they want Don’s business, but the line would be the same as his current line of credit, or b) the increase was so small it really wouldn’t solve his problem. I told him that is what I would expect. Bankers’ underwriting policies for lines of credit are similar.

A third solution would be to get an equity partner. A person or entity would invest the amount of cash to pay the bank off and to fund your projected growth for three to five years. He looked at me and said “The last thing I want is a partner.”

why don't I have cash

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Segmenting Customers for Profit

Segmenting Customers for Profit Process

Market segmentation is the process of dividing up the total market based on identifiable characteristics, which have common needs. You can also apply the concept of market segmentation to your customers. For example, you can segment your customers based on the cost to service, the size of the average sale or the number of transactions.

Though segmenting customers for profit or customer segmentation is a simple concept, it is not simple to implement in any meaningful way. The difficult part is identifying the various segments so that you can identify profitable customers versus those that can cost you time and money.

Customer Segmentation – Vertical or Horizontal

Customers may be segmented either horizontally or vertically.

Horizontal segmentation is where you divide customers by industry, geographic location or revenue size.

Vertical segmentation is where you might sell numerous services or products to just one particular type of customer.

For example, you might sell to customers in the construction industry numerous products, such as, steel, lumber and doors to that customer. Though segmenting customers based on market characteristics is useful, you might also segment your customers based on servicing characteristics (i.e.: size of order number of transactions or total sales volume).

Profitability Analysis By Customer

Once you have identified the various segments that apply to your customers you then perform a profitability analysis by customer. Take your annual sales by customer and break it out into various segments. Identify any patterns or relationships which might indicate opportunities for improvement. For example: a large number of small customers or concentration of large ones.

Customer Profitability Analysis

Next, perform a customer profitability analysis by subtracting your estimated relative cost to service from the revenue for the various segments. Estimating the cost to service may be done in general terms on a scale of one to five or in specific terms using activity-based costing. By relating your cost to service to your revenue streams, you can often identify “profit drains” that can be restructured. This restructuring might involve raising prices on select customers, implementing price discounts, sales incentives or firing customers.

If you want to learn how to price for profit, then download our Pricing for Profit Inspection Guide.

segmenting customers for profit

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segmenting customers for profit

 

Recommended reading: The Strategy and Tactics of Pricing, Fourth Edition, by Thomas T. Nagle and John E. Hogan

See Also:
Segment Margin
Activity Based Costing vs Traditional Costing
Implementing Activity Based Costing
Profitability Index Method
Net Profit Margin Analysis
Gross Profit Margin Ratio Analysis

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Segment Margin Example

See also:
Segment Margin
Margin vs Markup
Prepare a Breakeven Analysis
Budgeting 101: Creating Successful Budgets
Cost Volume Profit Definition
Variable vs Fixed Costs

Segment Margin Example

Segment Margin is important to a company because, most obviously, companies make profits off of their services and products. To acquire revenue from these services and products, a company would use a segment margin in order to determine whether the product has enough economical worth to continue producing. Therefore, it makes sense to provide an example so that segment margin can be viewed in a real life situation. An segment margin example is provided below.

Example And Explanation of Segment Margin

A shoe company, Fastbrink Shoes, has many different lines of shoe products and memorabilia that they sell to the public in order to make a profit. Because there are so many products, Fastbrink decides that they are going to trim down the number of products so that the most profitable and marketable products are getting the most attention. At the same time, they also want to eliminate the products that do not earn as much revenue as the more popular models and products. In one such case, Fastbrink has a line of basketball shoes that comes in two different colors, blue and black. Fastbrink wants to decide which shoe to keep and which shoe to scrap. Fastbrink will do this by calculating the segment margin for each shoe to determine which is the more profitable.

Segment Margin Calculation

It must be noted, first of all, that segment margin is calculated by taking the segment revenue of a product. This is essentially the revenue that is produced by a single product by itself. You then subtract the variable costs from the segment revenue and finally subtract the total avoidable fixed costs from that number to decipher the segment margin of a product. For this situation, the segment revenue for the blue shoe is $40,000 for the quarter while the revenues for the black shoe total $35,000. The variable costs for the blue and black shoes are $13,000 and $10,000 respectively. Finally, the avoidable fixed cost for both shoes is $10,000 for labor, parts, and machine maintenance. When calculated completely, the segment margin for the blue shoe comes out to be $17,000. Whereas, the black shoe segment margin totals $15,000.

Because the blue shoe rakes in $2,000 dollars more revenue that the black shoe, Fastbrink decides to discontinue the black shoe. As a result, profits on the blue shoe (more profitable model) can be maximized.

If you want to learn how to shape your economics to result in profit, then click here to download the Know Your Economics Worksheet.

segment margin example

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Revocable Trust

See Also:
Pension Plans
Keogh Plan
Credit Life Insurance
401k
Individual Retirement Account (IRA)

Revocable Trust Definition

A revocable trust is an agreement between a grantor and trustee where it transfers profit generating assets to the trustee. However, the grantor is still able to generate income from the assets. The grantor is also able to change the terms of the agreement at any point during his/her lifetime. This last point is the difference between a revocable trust and an irrevocable trust.

Revocable Trust Meaning

Many use revocable trust estate planning to pass on a family company or perhaps some other part of the grantor’s estate to a revocable trust beneficiary. Beneficiaries are usually the grantor’s immediate family, but it can be anyone established within the contract. The main benefit is that the assets will be transferred to who the grantor desires. The grantor can still generate cash flow from the assets as well. Another primary benefit is that the grantor can change the terms at anytime to accommodate the grantor’s changing needs.

Revocable Trust Example

For example, Bob owns a bicycle shop chain named Pedal Bikes Co., which is a Sole Proprietorship. He has two sons and would like them to take over the company whenever he has passed away. Bob talked to his lawyer. The lawyer advised Bob that he should start up a revocable trust. The assets are then transferred to the newly formed Pedal Bikes Partnership under the revocable trust agreement. The two sons start running the chain while Bob comes into help them every now and then and provide oversight. Bob also receives payments from the company under the trust agreement.

When Bob passes away, the assets are then considered permanently transferred and are completely absorbed into the newly formed partnership. However, if one of Bob’s sons or both of them do not want to run the chain then Bob has the ability to change the terms of the contract to one of the sons or another party. This also insures that Bob receive payments in his later years and that his legacy lives on through his bike store chain.

revocable trust

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Return on Asset

See Also:
Financial Ratios
Internal Rate of Return Method
Net Present Value Method
Net Present Value vs Internal Rate of Return
Required Rate of Return
What The CEO Wants You to Know

Return on Asset Definition

Return on asset (ROA) reveals how much profit a company earned in comparison to its overall asset. The value of ROA varies from industry and company. In general, the higher the value, the better a company is.

Return on Asset Formula

Return on Asset = Net income ÷ Average asset

Or = Net profit margin * Asset turnover

Return on Asset Calculation

Example: a company has $2,000 in net income, and $20,000 in average asset. Return on equity = 2,000 / 20,000 = 10%

This means that has $0.1 of net income for every dollar of asset invested.

Applications

Return on assets measures profit against the assets a company used to generate revenue. It is an important indicator of the asset intensity of a company. A lower ratio means a company is more asset-intensive, and vice versa. Additionally, a more asset-intensive company needs more money to continue generating revenue. Return on asset ratio is useful for investors to assess a company’s financial strength and efficiency to use resources. It is also very important for management to measure its performance against its planned business goals, or market competitors.

If you want to increase the value of your organization, then click here to download the Know Your Economics Worksheet.

return on asset

Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

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return on asset

Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

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Retained Earnings

See Also:
Accounting Income vs Economic Income
Realized and Unrealized Gains and Losses
Operating Income
Overhead Definition

Retained Earnings

Retained earnings (RE) refers to the portion of a company’s net income that is reinvested in the company. It is also the amount of profit left over after the company pays dividends to its stockholders.

Record RE in the owners’ equity section of the balance sheet. The account is cumulative. So, add profits and subtract losses from the account each accounting period. The RE account links the income statement and the balance sheet. If the account is negative, then it is either accumulated deficit, accumulated losses, or retained losses.

Calculating Retained Earnings

To calculate retained earnings, start with the value of the RE account from the previous period. Then add net income for the period and subtract dividends paid. In conclusion, the result is the new value of this account.

New RE = Prior RE + Net IncomeDividends 

If you want to add more value to your organization, then click here to download the Know Your Economics Worksheet.

retained earnings

Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

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Put Option

See Also:
Call Option
Synthetic Stock
Future Value
Intrinsic Value – Stock Options
Purchase Option

Put Option Definition

A put option is the right for an investor to sell an asset at a pre-determined exercise price on a certain date known as the put option expiration.

Put Option Explained

A put option gives a holder or investor the ability to make an essentially risk free profit if the market fluctuates correctly. The holder of an option can simply look into the market without taking any real part in it. The benefit for a put option holder comes if the stock price does not exceed the put option price. Therefore, the lower the better for the put option holder because he is selling into the market. A put is exercised only if the holder can deliver an asset that is worth less than the exercise price.

Put Option Example

Jim has received a put option with the right to sell 100 shares of Wawadoo Inc. at a price of $35 by December. The current month is January, and the current stock price is $32. Jim could exercise the put now, but he believes that the market will drive the Wawadoo stock further down. By November, the stock has dropped to $28. Jim exercises his option and makes a profit of $700 (($35*100) – ($28*100)). If the price had increased throughout the year and went above the put option exercise price then Jim would have simply let his option expire. By doing this Jim has not gained anything or lost anything, except the potential where he could have exercised the put at the beginning of the year.

put option definition

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