Thought Leadership presented by Foresight CFO Consulting, Inc.
Common places profit leakage can hide and how to solve it
The dreaded profit leakage: It’s what happens when business is booming. You are closing more sales, delivering more products or services, but profits seem to have gradually or even almost imperceptibly shrunk.
What’s worse as a business owner is then pulling together your VP of sales, COO and controller, and yet there’s still no clarity. Sales are up from last year, but profits are substantially less. Nothing seems to have changed in billing cycles or accounts receivables, so what’s going on?
This was Park Systems Inc. when they came to Foresight CFO Consulting, Inc. a year ago. The first thing we did was adjust billing cycles. Instead of billing customers when they received and activated their purchase, billing was moved up to the shipping date. This gave the company a slight increase in profit but not a total solution.
After further review of the company’s financials, and not pinpointing any specific drag on the profit margins, we recommended our Budget Profit Model to try to make sense of actual results. The Budget Profit Model is ideal in situations when you don’t have any real comparisons, noted issues or dysfunction detectable from previous years.
Over the next week, Foresight CFO dug into a deeper analysis by comparing the company to industry benchmarks. We examined the direct unit cost for each product or service. We picked through payroll and contract staffing with a fine-toothed comb. We compared payment levels over the last several years to uncover any trends. And reviewed all contracts and procurement practices to identify any improvements and compliance. We looked for all the usual and unusual culprits who may be hiding.
After much analysis, it boiled down to two main culprits: decreasing prices and increasing costs. The sales team was steadily offering discounts beyond the company’s pricing schedule to close more deals. Over time, this lowered the average point of sale. They were selling more units, but not increasing overall revenue at the same rate. These finer points weren’t obvious in the monthly reports.
The second culprit was that costs were on the rise because negotiated contract discounts from suppliers went up in the second year of business and the company’s engineers were buying increasingly better equipment outside of the company’s original business model.
To add insult to injury, accounting wasn’t correctly depreciating equipment purchases by spreading it over a 7-year period, instead it was always hitting the current revenue in full for some equipment.
Overall, there was a lack of a financial plan and monthly review process making it impossible to detect these changes and deficiencies without a deep and time consuming investigation.
Our goal: Get the business on plan by identifying profit leakage monthly. This equips managers with the analysis needed to calibrate operations as proactive leading indicators.
Plugging the profit leaks
Foresight CFO worked directly with P&L managers to put an appropriate Budget Profit Model in place that reflected the business expectations and informed managers on how to authorize financial resources for each activity that were clear and easier to manage day to day.
We also put in place a monthly operational update and financial statement review. For just 30 minutes, once a month, each P&L manager provided an operational update and compared financial results to approved budgets, so any red flags could be seen and adjusted for as needed. This allowed managers to make relatively small operational calibrations month to month to land results identified in the budget profit model.
Lastly, the sales department’s ability to discount was curbed with new pricing controls and they were trained more on selling based on value, not price. Discounting is troublesome for business in more than one way, as explained in this article “6 Reasons Why Discounting is Destroying Your Sales (And What to Do Instead).”
Further, we were able to reclaim over $212,000 in overpayments to suppliers. Supplier relationships can make or break your business, check out the four tips from Harvard Business Review on “How to Negotiate with Powerful Suppliers”.
Within the first year, profit increased from 2.4% to 11.9%. The next year, it exceeded 15% putting the company in the top percentile for their industry.
Growing a business is complex. Even the smallest adjustments like discounting a couple dollars here or there; overlooking contract price increases or decreases and not having a system of checks and balances against the budget can be detrimental. The Budget Profit Model is just one way to ensure price and profit leakage stay at bay.
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