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Profit Engineering Blogs

Profit engineering is all about managing risk both on the upside and the downside and discovering your target profit goals via cost volume profit analysis.

Although a manufacturing company will face welcome challenges when its sales volume increases significantly, it is usually more difficult to survive periods where major volume losses occur. Both challenges will eventually happen if a business has been operating for several years.

During the good times, owners/management in a growing manufacturing company will seize opportunities to expand a facility, upgrade or replace manufacturing equipment, or open new facilities in other regions targeting revenue growth. These changes will also increase sales volume, general & administrative expense support, and facilities to invest in this future growth. Their decisions in these good times can have a major bearing on profit planning decisions they must make during significant sales downturns or, for example, if their best-laid plans for revenue growth in a new region do not reach their full profit potential.

Making the right managerial accounting decisions during growth periods is a balancing act. Management never wants to come up short on revenue growth potential by not being aggressive enough with cost volume profit and infrastructure investment decisions. Management in financial accounting should also look at ways to go above cost volume profit and invest sensibly. In doing so, they can capitalize on revenue potential and survive inevitable times when there is a revenue shortfall from overly optimistic growth plans or severe economic downturns. The goal for a company should always be to remain above profit point during the good times and the not-so-good times.

Profit Engineering for Growth

The first step is to hold a brainstorming session with your subject matter experts around the unit variable cost and sales growth opportunities and then decide what seems to be the best opportunities for gross margin profit.

The second step is to develop lists by investment area of what would be needed to implement the plan. Develop revenue and volume by individual product sales mix over a 10-year period. Make the same for direct costs, indirect costs, SG&A, and capital investments. This plan needs to be driven down to Net Operating Profit – – both EBIT and EBITDA (Earnings Before Interest and Tax with the DA excluding Depreciation and Amortization).

Developing these figures over a 10-year period + base year will allow for NPV (Net Present Value) of EBITDA and cash flow after tax to determine if the plan supports the investment in time and money.

A discount rate (%) based on your borrowing interest rate and a reasonable expected return on investment (% adder) is needed in an NPV calculation. You can obtain the borrowing interest rate(s) from your preferred lender. Rates may vary based on the level of risk. Smaller investments compared to your current cash flow vs. more significant investments will result in different borrowing rates.

The third step is to put your cost behavior information into a financial model to determine profitability and cash flow to determine if the plans are financially viable. There are various profit equation models in Microsoft Excel available on the internet for purchase or free to assist you in creating these models. They do require someone with financial acumen and moderate spreadsheet and analysis skills.

Below you can download a basic free Capital Investment Model from the Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/templates/excel-modeling/capital-investment-model-template/

A trained accountant or financial person can build more elaborate contribution margin models. The general practice recommends this method for any complex project with many variables.

NPV of Cash Flows at different possible rates (%) of return along with Internal Rate of Return (%), Payback of the investment in years, and break even on cash flow are essential to be reviewed for the final go or no-go decisions. The breakeven profit point is determined when the cumulative cash flow turns positive over time.

After building the financial model, you need to pressure test the assumptions on selling price, volumes, unit costs, and the assumed capital investment. You can determine varying sensitivities on any of these variables and sub-variables that make up these categories by holding all other variables constant and changing one variable, sub-variable high or low. Further, the company may capture results in a separate worksheet for each sensitivity scenario. Discussions should be held with your internal management accounting experts to determine the possible highs and lows that could occur with the different fixed expense variables.

It is critical to fully understand how low the lows can get for pricing, revenue, and volume as well as how high the highs can get from a pricing, income, volume, expense, and capital investment total cost. Always lean towards being slightly conservative vs. overly aggressive when making the final analysis and investment decision.

If you do have access to a trained accountant or financial professional and if they know how to do a Monte Carlo Simulation (multiple probability simulation), this will aid in quickly identifying cost behavior and understanding where the strengths and weaknesses are in your project by analyzing the contribution margin variables through computer modeling.

For those unfamiliar with this mathematical simulation, you can read about it, its use, and how it works in the following link.

In summary, it was developed by two scientists who worked on the Manhattan Project, which developed the first atomic bombs, and the simulation was named after the Monte Carlo gambling destination since, like gambling, this simulation is “used to predict the probability of a variety of outcomes when the potential for random variables is present . . . it helps to explain the impact of risk and uncertainty in prediction and forecasting models.”

https://www.investopedia.com/terms/m/montecarlosimulation.asp

Alternatives to Large Capital Investments

Some companies “bet the bank” and are very successful when their timing is right and their assumptions are rock solid. However, more often than not, the companies that are highly successful at betting the bank (or their company) are in the minority. Alternatives to high-risk / high-reward approaches are first to review your current resources and options to determine if they are being fully utilized. Then, determine how well you can leverage them to meet revenue growth. Some examples follow.

What is your current capacity utilization?

• How many shifts do you run at your plant? If you only run one shift a day, five days a week with some limited overtime, then you are using your facility at around 30% of its potential, which is known as capacity utilization. You have capital invested in the facility, and 30% utilization gives you a poor rate of return on the investment. Your operating income is not optimal. Think of it this way; you could have a facility 1/3 the size at much less investment cost to manufacture and sell the same amount of products. Although this scenario does not give you room to grow, you would increase profitability by leveraging your manufacturing and SG&A fixed costs.
• Alternatively, staffing up and running up to 24 hours / 7 days per week can add about 70% more in manufactured products which equals higher sales dollars. If you have viable growth plans, you can use overtime to meet interim sales demand and then add shifts one at a time when you see that this new demand is permanent.
• Later in the process, add overhead as needed to support the growth. Leveraging overhead increase profitability to the bottom line. Overhead Absorption is one calculation to keep overhead in balance (overhead costs divided by the cost of goods sold). Try to keep this % from growing too much over time. It is actually best for profitability to drive the percentage down.

Upgrade Existing Facilities and Equipment

• If you are behind the times with manufacturing technology used in your industry, a good alternative to a facility’s expansion is investing in new technology that will allow you to manufacture more with less. Updating technology is also beneficial for employees since it will enable them to upgrade their skills. If all goes well, you can bring new employees into your workforce.
• Measure the reasonable potential output, investment, and training cost with a similar investment in a facility expansion or a greenfield plant. As your sales volume grows, these investments can be planned and made over time, so you have money coming in sooner rather than later with the alternative investments.

Consider Outsourcing Non-Essential Functions

• Historically, many businesses have started up and viewed all aspects of their manufacturing process as proprietary. This concept also prevented other companies from gaining knowledge about the company’s processes and inviting competition. However, there are always less value-added processes in a manufacturing company that can be outsourced without the risk of inviting new competition.
• If a manufacturing company’s products require accessory equipment used in conjunction with their product, and if the company can easily acquire these accessories in the marketplace, why detract from your core business by manufacturing them? This extra production is a variable cost you should consider cutting. If a company believes it needs control of these accessories, it can manufacture them as a private label by a competent third party. Another approach would be to act as a distributor for these accessories for a trusted supplier. These situations allow control of core technology so as not to invite competitors into your space.
• Companies can push other non-critical and preliminary manufacturing steps back to suppliers of raw materials needed in your downstream production. This strategy could eliminate equipment and allow labor to be used in other locations in the plant. Always be sure that more than one supplier can easily perform these steps so you are not giving away too much of your core competencies.
• If you are in equipment manufacturing, you can also outsource some minor non-essential parts manufacturing.
• CAUTION: as with any outsourcing, good QC and inspection practices are critical to your product’s quality. If the volume is significant enough, then outsource with more than one supplier in case a supplier has delivery issues.

Lease Space Instead of Acquiring Buildings at Other Locations

• Leasing space for expansion in light manufacturing can be an attractive alternative to a greenfield investment or expansion. If you experience a downturn and have favorable lease terms, you may shut down or mothball the leased facility to reduce your fixed cost expenses more easily than an outright owned facility.
• The same would be true for warehouse space that houses excess but sellable inventory.
  • Look at better ways to manage your production scheduling to avoid these inventory builds. If the inventory build is not part of a seasonal sales revenue drive, consider the unit cost minus the warehousing and see if it is as profitable as you once thought.

Alternatives to Building a New Facility to Service Expansion into Other Regions

• If you can get more production out of your existing facility using the methods described above, you can take a long-term approach to expand into new regions. Leasing warehousing in a low-cost and safe area in the new region will dramatically reduce total fixed cost investment. The warehouse can also house new sales and tech service staff hired or transferred to develop the market in that target region.
• Businesses can develop a low-cost margin investment plan over time to allow for incoming cash flow early in the project, establish a good market presence, build sales revenue and then make a timely decision to expand into that region with manufacturing capabilities. The latter can be planned over time and extended if you utilize a leased facility with options to expand the manufacturing footprint.

Examples of where you may need to invest in greenfield manufacturing even if you have excess capacity at another location:

• Your customer requires production to be in a certain geographic region where they manufacture or sell to keep costs down. Examples are selling to big box retailers like Lowes or Home Depot.
• Another example would be selling road marking materials (paint) to states where they demand that the material is manufactured in their state to employ the local population. Some businesses like mining have to locate their operations and processing facilities in the location where they mine the raw materials. Not seizing opportunities to build a greenfield facility may open the door to doing the same, and they may grow faster than you.

Profit Engineering During a Revenue Downturn

First, don’t panic! Remember, just like when you planned for growth and new investment, you need to do the same when a revenue downturn occurs. However, you need to develop a well-grounded profit equation sooner rather than later. Do a complete CVP analysis and a cost behavior analysis to discover where you can make changes.

Suppose you did take the conservative approach during revenue increases by increasing capacity utilization with existing facilities and resources. In that case, it is much more cost-effective to reduce costs by rolling back the direct labor shift additions you made to increase manufacturing capacity. The same would be true for the additions to overhead. Compare the cost of these actions to having a 100% owned facility and idling the related equipment.

What is Driving the Downturn & Estimate How Long will it Last & Potential Actions?

Economic Recession or Depression / up to 2 years +

• Reduce your fixed cost structure in the plant and office to weather the storm. Use it as an opportunity to move or let go of underperforming employees. You need all your people to perform at a high level during these times. These actions will also give them a sense of urgency, just like you will.
  • You can also consider reducing work hours across the board if you are concerned about laying off people who may not be available for hire once times are better. In most cases, people can file for unemployment for the days they do not come to work.
• As mentioned earlier, outsourcing more aspects of the business. Keep manufacturing your core competency production in-house.
• If you have flexible manufacturing and marketing, you may be able to produce a wider range of products for sale and move into other markets with stronger demand.
• Mothball lower-performing facilities and consolidate production into fewer locations.
• Use this slow period to plan for the future when the market will rebound. Keep your people busy doing value-added work that they always seem to need more time to get done during busy periods. Be prudent in managing costs on these projects as well.

Severe Supply Disruptions / Temporary

• Look for alternative sources or substitutions that will still allow you to manufacture quality products at a lower profit point.
• As mentioned above, reduce your costs both in manufacturing and the office.
• Ride it out. Other competitors are likely facing the same challenges.
• If you have the cash, buy a competitor. The sales price could be attractive.
• Buy a supplier to control the supply side of a critical/limited resource.
• As mentioned above, have your people work on projects that do not require a lot of cash but are activities they never seem to have time to do during busier times.

Act of God Disaster (e.g., fire or earthquake) / Should be Temporary

• Look into private label manufacturing arrangements with other suppliers, DO NOT LET YOUR COMPETITORS gain access or knowledge about your customers!
  • Although it will increase shipping costs, have the private label products shipped to an offsite warehouse and then sent from there to your customers.
• Include the Force Majeure clause in your contracts and ration your remaining supply to your customers.
  • Note: There are strict legal guidelines governing this process.
• Get the plant back up and running, even if it is in stages.
• Follow through with very good communications to the industry publications and your customers. Communication will demonstrate that the situation is temporary and that you are doing everything possible to minimize disruptions during this limited time.

New or Existing Competitors Entering Your Region

& Competitor Aggressively Taking Market Share / Temporary or Permanent

• Take innovative sales & marketing actions to prevent sales loss
  • Try to leverage your current customer relationships and offer innovative deals to entice them to stay with you.
  • If a competitor takes key customers away based on selling price, use the same tactic to go after some of their key customers. Quick action like this sends the competitor a strong message that their actions are not tolerated and may avoid an all-out price war.
  • If the competitor is based outside of the US and has no US production, consider an Anti-Dumping case with USDOC and International Trade Administration.
    • Note: this can be very effective in leveling the playing field on price, but it is an expensive + 1-year process.
• Introduce new products to compete head-on or beat the competitor’s performance.
• Buy a competitor to gain and leverage a superior supply chain, manufacturing, R&D, or pricing position.
• Invest in your operations to significantly reduce the cost to become competitive on price.

New Government Regulations / Could be Permanent or Temporary

• Depending upon the situation, find alternative markets for your manufacturing capabilities or downsize and weather the storm.

Substitution in the Marketplace or Product Obsolescence / Permanent

• Find alternative markets for your manufacturing capabilities or sell the business as soon as possible. Without a successful plan implementation, the businesses’ value will only decline.

Reasons Why the Original Investment Decisions Can Impact Profit Engineering when Experiencing a Loss of Revenue

By now, you may understand the negative outcome of not finding ways to economically leverage your current assets and resources when you need to expand manufacturing to meet growing sales demand. Developing a longer-term plan with triggers that meet key milestones can reduce the risk of going all-in with a bold bet on the company move. However, when you reach trigger points, review and adjust the plan if assumptions need updating for changing market and cost conditions. It allows you to spread the capital expenditures out over multiple years while still generating an increase in sales over the same period of time. However, when the company truly taps out on leveraging existing resources, an “all-in” approach may still be necessary, and you will need to invest in greenfield manufacturing to maintain a leadership position in your industry.

The key to lowering long-term risk is finding innovative ways to leverage current resources or assets as customer needs allow before investing in a greenfield expansion. Having to downsize and reduce costs during a sales downturn is more expensive when dealing with a relatively new greenfield expansion unless you decide to shut down the old facilities and operate your most advanced locations.

Sales revenue is the fuel for your business. The revenue from sales allows the business to generate profit, value, and ultimately freedom for business owners. Do you feel that you are not in control of your revenue from month to month? 

Do you find your business waiting for the phone to ring, an order to arrive via email, or that next customer walking through your door? As business owners, we sometimes feel we are at the mercy of the market. What will it do? How will it affect us? We can all relate to feeling like we cannot control our future because we don’t control our revenue. It is something that we watch on a daily, weekly, or monthly basis. But what can we do to impact it?

The process known as ‘Business Development’ is proactively planning on obtaining business, implementing actions that can affect it, and implementing the proper sales process to obtain the sale. This is traditionally referred to as market research, sales forecasting, marketing, and sales. For businesses that execute projects, this would also include estimating. Business development could also include evaluating and launching new products or new markets. All these together should be aligned to produce the revenues needed to meet the growth and profitability goals of any company. Often, we find them separate, unorganized, and not focused, IF we even have them as a priority.

Most small business owners started or joined a company early in the business. Sometimes it was just you and a pickup truck with some tools and knowledge. In those early days, whether you knew it or not, you were doing business development. 

We define business development as the planning, marketing, and sales of your products or services.

Meaning that is what you do in the early stages of all businesses. The problem is that once you sold something, you had to ‘produce’ the results you sold. There was not someone else to carry out fulfilling the order. The tension that this produced was either selling more than you could accomplish yourself or spending too much time producing, that you could not focus on selling your next gig. As you grew, you either found other people to ‘sell’ your product or service, or you found others to help ‘execute’ or fulfill your orders.  

The problem most Founder-Owner’s face is figuring out at what point we need to quit ‘executing’ and focus on planning and strategy. This is the proverbial ‘working IN your business instead of working ON your business.’ A solid Business Development Plan significantly impacts your business growth and success. 

But even after you have grown, hired Sales and Marketing staff, operations staff, and administrative staff, business development typically falls low on our priority list. There are many other ‘fires’ to put out or crisis to handle. This ‘spiral of death’ where every part of your business is in your hands, and you feel solely responsible for making it successful, is often the very cause of less than desirable sales, profitability, and growth. So, with that hard truth in mind, what are we to do?

As a popular motivational poster once said: ‘Though I can’t control the wind, I can adjust the sails.’ Or is that ‘adjust the sales?’

While we cannot control the economy or the markets we serve, we must take some time to understand them. How are our markets changing? What determines our sales volumes? It can be frustrating to watch actual sales fall below our forecast. While every single forecast is wrong, we need to understand major variations and trends compared to our forecast. Why are we consistently below or above our forecast? What are the reasons behind the variations? Has the market moved? Is there some disruptive force happening in our markets? Are we being outperformed by our competition? These questions should be understood as a part of establishing a business development plan. Understanding our current markets and trends is a good first step in any business development effort. Where are your current customers coming from? How do they find you? What research and decision process do they use to ultimately purchase from your company? Who are our best customers? How can we find more of them? Why are they buying from us instead of our competition? Are our customers loyal to our brand? How long or how many times do our customers buy from us? What is the percentage of ‘new’ and ‘repeat’ customers, and are they both increasing month over month?

These are essential questions that you need to answer for your business. Historical sales data, the customer journey, your unique selling proposition, competitive analysis, market segmentation analysis, and customer profiling are some of the tools that can be used to assess your current revenues and strategize how to grow them.  

Once we understand our current customer base and have done some market evaluation, it is time to determine what products, services, or group of customers we want to address with our marketing messages. Through customer profiling, the customer journey, and other tools mentioned above, we begin to understand who our customers are, what process and medium they use to make purchasing decisions and differentiate our offering from our competition. This is known as ‘market messaging. ’What messages do we want to convey to our potential customers or a specific group of customers? How can we encourage or entice our customers to purchase our product or service? Traditional marketing strategies include Product, Positioning, Pricing, and Promotion. 

Our marketing messaging should address the benefits of using our products or services, how our offering is ‘better’ than the alternatives, and what we are willing to do to get you to buy our product or service over other alternatives. Not so obvious, our Pricing sends a message of what we believe is our ‘value proposition’ to the customers. Do we want to be the ‘lowest price,’ the best ‘value’ or seen as a premium over the average alternatives? All these together form our market messaging. This is the foundation of any marketing program is to determine our ‘messaging’ before we decide what is the best medium to communicate the message.  

If our customers are social media savvy, we might choose to use that media. If they require a lot of technical information, we may have a knowledgeable sales force to interact with potential customers. Our online presence is often a place with we need to make sure our website is consistent with our messaging and allows potential customers to find us, learn about our offering, and quickly and conveniently purchase our products or services. Once we have defined our markets, understand our customers and their buying habits, know which customers we are going after with our marketing, have our message clearly articulated, and chosen the appropriate method to reach them, then we can begin to implement these things that can impact our revenues.

A sales forecast without a plan is just a dream.

Simply ‘increasing sales by 10%’ is NOT a forecast or a plan. Basing the future on the past is rife with opportunities for failure to meet the forecast. The economy changes, the market changes, and the end-users change. 

For some of us, the weather is a big factor. Who of us has figured out how to control that? Unless you are in a very mature market with very predictable growth, which is unlikely, the basis for your sales forecast needs to be based on something more than just past sales. Sales history can be a place to start, as it can often reflect the seasonality of your business and general growth trends. However, a good business plan includes actions that are intended to increase sales as a result. This may be a new marketing campaign, an additional salesperson, opening a new market, or launching new products. Each of these should be evaluated and tracked as to ‘how’ they impact sales. What actions do we plan to take that will positively affect our sales? A good sales revenue forecast starts with historical sales data and predicts the impact of the actions we plan to take, taking into consideration the anticipated changes in the economy and markets. It is important to mention that to know how your plans are progressing, you need to define a means to measure or track the results of your actions from the very beginning. As it becomes clearer which of your revenue growth strategies produce the most increases, you can ‘double down’ your marketing investments. This may involve increasing your investment in one strategy or perhaps moving the investments from underperforming strategies.

Once you have determined the markets you want to focus your growth, define your target market messaging strategy, prepared your desired sales forecast, it is time to evaluate how you close the sales. What channels do you use to obtain your forecast sales revenues? Are your customers the end-users or are they other businesses? (B2C & B2B) Do you focus on direct selling, where customers buy directly from you? Do you establish ‘manufacturer’s representatives’ who market and sell your product or services for a piece of the action? Do you use distributors or wholesalers to get your products or services to the end-users? Do you have a physical presence in one or more locations to offer your products or services? How do you structure your pricing, commissions, and promotions to best leverage your sales channels? The days of traveling salesmen are being replaced with many online and virtual alternatives. You should not get stuck in how you have always done it, or what worked last year. 

Look for new and creative ways to sell your products. Does your industry have an association? Are there local or online ‘networking’ opportunities for you to offer your products or services? Each of these have their place and should be evaluated as a part of a good business development plan.

So, now that you have some tools to use in growing your revenue, you can start to communicate your plans, actions, and performance goals. This is what the result of a good Business Development Plan is intended to do. A good business plan has actionable strategies and plans, targeted market segments, and measurements to track progress towards sales revenue goals. You don’t have to be on the sidelines just watching your sales revenues. You can now do something to impact them. No matter what business you are in or what you are trying to achieve, taking planned steps towards your goals, making them visible, and measuring your progress is an absolute life-changer.

Cash flow is basically what describes what comes in and comes out of a business treasury, such as income from sales and/or bill payments. Its’ importance lies in the fact that it allows us to quickly know the liquidity of a business, giving us key information that helps us make better decisions.

However, as business expands, it will need more money to keep it growing. As your income increases, so will your costs, and the profits from your first sales are likely not enough to finance this initial growth spur. Getting your brand known and reaching sales volume takes an average of 6 months, so you’ll need to have capital before you start to see sales revenue. In this first stage of growth, it is essential to have an orderly and methodical control of your cash flow.

A 2017 Fifth/Third Bank survey of 505 employees in private organizations with less than $ 10 million in revenue found that 32% of business owners consider lack of funds to be one of the main obstacles to growth. 

This means that if a business is growing, but cash flow is not managed effectively, the venture may not operate, much less prosper and be successful over time.

3 Ways To Improve Liquidity & Generate Higher Profits

Thinking about how you can improve cash flow while growing a business is one of the biggest concerns for departing business owners and managers. The good news is that even though a business can grow rapidly, it can improve its cash flow. Traditionally obtaining financing is the main alternative for many entrepreneurs. Today it is possible to obtain capital through new investors, request lines of credit, crowdfunding or use accounts receivable factoring. However, there are other ways to improve the cash flow in a business, including some approaches that may seem unconventional.

Have a conversation with your clients/customers

Although using factoring is an excellent alternative to obtaining immediate financing, there is another option that few managers and entrepreneurs take into account: talk honestly with your customers.

It sounds logical and straightforward, but many business owners and leaders fail to see the advantage. If they owe you money, you will have problems with your cash flow, and therefore, you probably also owe money to your suppliers or have unpaid bills. Typically, in new businesses, doubling revenue also doubles costs, but the time to handle the workload stays the same. The situation becomes worse when customers go beyond the payment terms of 30, 60, and 90 days. To reverse this and improve your cash flow, a practical option is to talk to the suppliers or whoever money is owed to see the possibility of paying them when they pay you. This is an example that communication is essential when maintaining solid relationships with suppliers.

Adjust prices

As time goes by and there are continued liquidity problems, it is likely that the prices for products or services are not set correctly, or profit margins are too low. For example, if you are spending a lot on salaries, rent, advertising or infrastructure but have little to no profit left over, you should evaluate if the price you are charging is correct.

Profitability has a direct relationship to liquidity; if your prices are not set to the desired profitability and the numbers to calculate that are not clear or accurate, then liquidity problems will persist. Many times, business leaders fail to review pricing regularly to include profit margin goals and how to cover costs like overhead. Some companies go for years before they adjust pricing or even raise pricing. Understanding the market and building the value proposition is vital to have the confidence to raise pricing. Most entrepreneurs worry that a price increase will result in losing existing customers or market share. However, the price increase must be well thought out and accompanied by strategic objectives. For example, if prices are eventually increased, you may accompany it with a marketing campaign that can offer a royalty program to existing customers, so they do not receive the news so abruptly. In the current environment and economic situation, we are in, raising prices is probably expected by the market.

Determine the problem:

It might be that the problem is not really in what comes in and goes out of the business treasury, but it may be in other external factors such as not accurately forecasting how the market is expected to change in the coming months, or even taking a long time to finalize contracts with new clients or lead times are too long from receiving/producing to invoicing, for example. Producing and measuring cash flow reports regularly is another good practice. If it is done continuously, it will allow, for example, visibility on possible negative balances concentrated on a certain day of the week. In this way, you will have better understanding of the movements and fluctuations of cash, so it will be easier to find a solution in the coming periods and forecast cash needs. It is also advisable to review the operational cash flow cycle at least once a month, updating the values and assumptions each time is produced.

Lastly, when recording income, list separately as line item on the cash flow or cash management platform, checks and promises of payment, since it is money that does not yet physically exist, it is preferable to list separately since it is not a certainty that you may be collecting it. The best practice in these cases is to include a calculation of expected future income.

Cash flow is one of the best tools in any investment project. However, when your business grows, keeping your finances in order can be complex. The information that cash flow provides, from even the basic aspects that each business must consider to less traditional ones, as mentioned above, are essential metrics to make future strategic decisions that lead to healthy business growth.

In startup and established businesses, the need to maintain a consistent revenue flow is constant pressure on management. In responding to the demands of management, sales efforts for any shortfall are easily blamed on pricing. Claims of too high or non-competitive pricing do occur. They are less frequent than claimed and are an easy scapegoat for failing to win a sale.

For the long-term health and profitability of the business, when presented with the option, always price high. 

When you do, you can decide to use the additional revenue to increase profits or increase marketing efforts.

The hesitation and failure to understand the critical importance of pursuing the opportunity to use price to increase revenues is a common problem among large and small companies.

Pricing Strategy Errors

Error One

It is a common and easy excuse to believe sales are being lost because the price is too high when the real problem is the product, service, or company is inferior to the competition. If a product or service fails to meet buyer expectations, the amount of buyer’s risk from failure is greater than the bid price for assurances of superior delivery and performance.

In most cases, price sensitivity is a myth. A business that delivers poor quality or inferior service has a short life span in the market. Every business has or should have a unique selling proposition that differentiates them from the competition. Discounted pricing cheapens the value of the company’s unique selling proposition.

Error Two

Fear is a strong motivational factor in the sales process. The fear of not making a sale, lack of confidence in product and service, and fear of not making payroll and pay bills are prime reasons products and services are undervalued. In the case of the less seasoned salesman, unemployment from failure to sell is a constant companion. Lowering price is a perceived path of least resistance to winning sales. However, underpricing results in lost revenue and creates an impression that the company is struggling or inexperienced when a good, feature-rich product or service is being offered cheap compared to the competition.

Charging true worth enhances the buyer and market’s perception of the company while increasing revenues and profitability.

Error Three

In avoidance of pricing challenges during the sales process, another path of less resistance is for the sales contracts to be written with vague specifications pushing the confrontation with the client over expensive changes and add-ons without proper reimbursement to a later date. It is not uncommon in less structured companies for anxiety over missing the sale to keep prices low and driving vagueness in delivery specifications.  

Specificity in product and service combined with clear communication of charges for changes promotes strong client relationships by avoiding unnecessary confrontations and protects revenue and profits.

Pricing Strategy

It is a fact that price drives perceived quality. Mercedes, BMW, and other “Quality Brands” have successfully executed the strategy for years. To be viewed as the best and superior to competitors, price higher. Pricing below that of a competitor promotes an inferior perception; pricing the same promotes a perception of no difference in product/service with competitors.

To protect against the erosion of revenues, price all new products and services above existing products and services whenever possible. Failure to do so erodes profitability and destroys sales morale with lower commissions.

A low pricing strategy weakens your market position and lowers buyer’s perception of your products and services. Price reductions allow competitors to raise doubts with potential buyers about your product/service quality, your market position, and business viability.

Competing by lowering the price is a characteristic of modest business expectations and short-term goals/objectives. A viable market position, consistent revenue, profitability, and strong market perception are reinforced by a higher pricing practice.

Difficult times often require rethinking a company’s products and markets to maintain or grow revenue. These last months have certainly been a time for owners to review their business model and product strategy. Many markets have shifted or disappeared entirely. Products that worked yesterday may be obsolete tomorrow. 

Merely being the best or lowest cost of producing a product that the market moves away from will not help grow revenue. Therefore, businesses must seek to maintain and increase their product revenues by applying several product and market strategies.

In the 1950s, Igor Ansoff1 came up with a new market strategy matrix based on two factors: Product and Market. Simply put, you can improve or change the product or go after new markets, or both. A simple illustration of Ansoff’s Product / Market Matrix is shown here. Each strategy carries a varying amount of risk, based on how many changes and how much the change.

According to Ansoff’s matrix, a company can choose to take several alternatives with increasing risk but potentially increasing returns. The matrix allows a company strategist to evaluate the options for growing sales revenue. 

The first and least risky approach is to obtain deeper market penetration with existing products within existing markets. Higher market share can be achieved through increasing awareness, price reductions, and sales incentives. Another approach is to evaluate selling an existing product into a ‘new market.’ 

New markets can be new geographic markets or find alternative uses for the product in markets other than the primary market. Think of the traditional marketing of baking soda as an odor absorbent in refrigerators. 

Finding alternative or subsequent uses for a product can sometimes out-perform the original market the product was intended for. Deep insight into how existing customers are using a product can often identify these potential market expansions.

When considering new ‘products,’ one must be careful to do appropriate due diligence on the market and the competition before making large product development investments. The easiest way to develop a ‘new product’ is to significantly change or improve an existing product in such a way as to out-perform the other competitors in the current market. This product enhancement often has limited duration if the competition can also add features or match performance without violating patents or proprietary designs. Another twist on this approach involves redesigning a product to reduce its material or labor cost significantly. While it may not increase sales volume or revenue, this approach can benefit a company through higher gross margins and net profits.  

Lastly, developing a new product based on company strengths and capabilities can allow the company to continue to grow and expand. What core competencies does the company possess? How can these core competences be leveraged into new products? 

What market intelligence do you have that would give insight into the opportunities? Product Development can be a significant investment; however, it can also reap growth and potentially extend a company’s life. Disciplined product development starts with accurate market information on what the product needs to do, who would potentially be the customer and end-user, any alternatives that might exist, or development.  

Once it is determined that a potential market exists, key product characteristics and features should be defined. Many market research firms provide information on potential market growth. 

However, this market information can sometimes be misleading or inaccurate. A prudent next step is to validate the market. This can be done in several ways. One popular method is to define a ‘Minimum Viable Product,’ or MVP, and find a way to ‘test’ the market. This could be a conceptual product brochure, a virtual product that potential customers can interact with, or an actual physical prototype. This step is often overlooked in many product development efforts. This step’s importance is to make sure that 1) the market exists and 2) that your product concept meets the market need. Before companies spend large amounts of money developing a product that no one wants, they must test the market.  

If there is some validated market need, these early MVPs can refine the essential product features. In Eric Ries’ book The Lean Startup2, he states that successful product development companies master the ‘design-measure-learn’ feedback loop. 

This concept is a repetitive process of building or designing something, measuring how it operates (in the market, for instance), and learning from the feedback to modify the design and go back through the process. This product development method ensures that the right product is developed to meet the real market need. The converse of this approach is to spend large amounts of time and money and design the perfect product that no one will buy. Many an entrepreneur has fallen into this trap.

By far, the riskiest approach is to develop a new product for a new market. In this case, little data exists on the potential market or what a product might do to capture it. History is full of recent product / new market successes such as online auctions, secure web payments, and handheld digital music devices. These new product developments are not for the faint of heart and often require significant research and development resources that most small and medium businesses don’t have. However, innovative companies create these new products launched into new markets every day. The wisdom here is to know what it will take and balance it against the potential return.

These are a few of the options for revenue growth through product development and launching products into markets. The most important take-away is to evaluate the product and market strategy before going down a path. Know the risks and potential returns. Evaluate what makes your company what it is. What are you good at? What do you see lacking in the market? New product development can be an exciting and invigorating process if done correctly. 

It can ensure the longevity and success of a company, or it can bankrupt it. Know yourself, know your markets and make a conscious decision to pursue the strategy that suits your unique situation. Dream big and good luck!

Cogent Analytics exists to help small and medium-sized privately held business reach their goals. This is accomplished through establishing partnerships to build, implement, train and evaluate systems, processes, people, and organizations that create value for owners. We achieve this through coming alongside companies to provide Profit Engineering, Organizational Engineering, Process Engineering, and wealth creation for its owners. 

With the new year just underway, everyone is talking about New Years Resolutions, and every business owner has the same one: Earn More Profit than last year. Business owners often look at a new year as a new beginning; with a new year comes new goals and a unique opportunity to earn more profit than the previous year. Ideally, a business owner will have started this process in the 4th quarter; however, if they haven’t, it is not too late yet to prepare for the rest of the year. You must start by developing goals based on your objectives for the year. For starters, what objectives, often called KPIs (Key Performance Indicators), should you even measure? This will vary from business to business and industry to industry, but some of the most basic KPIs include:

• Sales
• Number of active clients
• Profit
• Productivity
• Employee turnover %
• Quality of product
• Customer satisfaction
• Customer retention

Once your KPIs have been identified, setting realistic time frames and frequency to monitor results is critical. While it’s great to have yearly goals, don’t forget to set some smaller period goals, such as monthly or quarterly as well. Remember, the longer the time allowed to achieve the goal, the less urgency is likely displayed toward meeting it by staff. Set up regular meetings, discussions, and report outs with your teams so that goals and results may be analyzed and updated with key team members regularly.

So, how do you get started? You can begin by following this six-step plan to prepare, plan, and present a meaningful roadmap for earning more profit in the new year.

1. Perform an in-depth analysis on what you accomplished this year with your stated KPIs and metrics. Compile and distribute year to date reports to understand where you succeeded and fell short. Don’t just post a scoreboard of wins and losses. It’s imperative to know the reasons why you achieved what you did. For example, ask yourself and the team:
   • Did you predict the market trends accurately for the year? Did you course correct as conditions changed throughout the year?
   • Were the targets set too high or too low? Were they adjusted up or down during the year as trends were analyzed?
   • Did you have the right people in the right places to be successful?
2. Have in-depth conversations with your teams about what went right during the previous year and what you could have done better. This will help keep you from repeating the same mistakes in 2020 or abandoning successful practices from 2019 which is a sure recipe for disaster and missing out on making more profit. Business owners must understand where they have been to know where they are going.
3. Set company-wide goals and targets for the upcoming year. Collaborate with the leadership team to create high-level company goals for the forthcoming year.
4. Each department in the company creates their goals from the company goals. Each department should understand what the company is committed to achieving in the new year so that they can create their goals and tactics to support the overall company goals.
5. Ensure all your goals are S.M.A.R.T. S.M.A.R.T is an acronym for five essential elements of goal setting: specific, measurable, achievable, relevant, and time-based. Stay away from vague goals that have no way to determine if the objective was truly met. Once you do this, your S.M.A.R.T. goal of earning more profit in 2020 will be easier to attain.
6. Present your goals to the entire company in a clear, concise, and inspirational way. Your full company must buy-in to the plan and work toward the results every day. Spend a lot of time in this “buy-in” phase. You can hold department meetings, schedule one on one conversations with key employees, even present the entire plan again. A team is only as good as their belief in the mission.

Remember, the goal of any KPI or goal is to create sales and more profit for the business. As part of the goal-setting process, understand how much additional revenue each initiative will bring in comparison to the overall sales and profit goal. This exercise will help determine if the tactics you plan support the global goals. For example, if you have KPIs that call for 12 additional projects to be sold in 2020 vs. 2019, tie that back to how many sales dollars each job will create and do a full analysis to understand how much profit each job will bring. If the 12 projects don’t create the sales and profit goals, you must change either the goal or the tactic (i.e., # of projects) so that the two align.

One of the more essential parts of earning more profit is finding the “sweet spot” for goals that are challenging enough to stretch the business but not so challenging that they are entirely unattainable. Remember, one of the criteria of a S.M.A.R.T. goal is that it’s achievable. It may take a bit of trial and error to get to goals that challenge the staff, but it’s worth the effort. Make sure to include key team members (not just management) in this process. Getting the team’s buy-in during this process is a crucial component to success.

By the way, it’s okay if every goal isn’t met at the end of the year. Some people use the term “stretch” goal for targets that are achievable but just outside the comfort zone of what people think they can achieve. By creating these stretch goals, you have a much broader avenue to manage for success. The best-case scenario will come when the team is suggesting even higher goals than you thought were possible. You may need to talk them off the ledge a little bit and move them back to an attainable goal, but the enthusiasm and buy-in from the team that created the higher goals is a critical element of success and earning more profit.

As with any plan, much of the success is found in the execution. The critical thing to remember as we begin the new year is that you must set goals and benchmarks for your business to earn more profit in 2020 than in the previous year. Once your plan is in place, work it very day. Throughout the year, goals and objectives will likely change but, don’t worry; that’s all part of the plan.

At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:

Cash flow planning is one of management’s most important, ongoing duties. In a simple comparison, Cash Flow is like checking your bank statement for money going in and money going out every month.

The budgeting of incoming and outgoing cash results in the following benefits:

• It gives management an early warning of future difficulties with cash availability.
• It shows management when a surplus of funds will be available for things other than operating use.
• It provides a plan for payments to creditors that are balanced with receipts.
• It indicates the need to step up collections activity if accounts receivable payments are lagging.
• It demonstrates to lenders that management is informed as to the financial requirements and has planned to meet the company’s obligations.

The basic philosophy of a cash flow system is that things don’t just happen in a business, they can be influenced and controlled. If a business embraces this philosophy, then a system of planning when bills can be collected and paid can be devised and utilized to take guesswork, or perceived Providence, out of the equation.

In other words, checks don’t just show up in the mail, and a company doesn’t just happen not to be able to meet payroll this week. Conditions can be somewhat foreseen, and planned responses can be had. Of course, cash flow projection/management must be used in conjunction with a proper collection policy and procedure.

The theory behind a cash management system is that the due dates of Accounts Receivables and Accounts Payable can be listed and planned-out in advance, the payment history of customers can be tracked and planned in advance, and due to this tracking, the company can prognosticate with a reasonable degree of certainty when it will have money coming in.

Therefore, it can determine ahead of actually doing it when it can pay bills, when it can buy equipment or inventory or computers or anything. It will thus not write checks without knowing ahead of time that the cash flow will support all expenditures when they are made, and, in extreme circumstances, if the cash flow will not support expenditures in the future. It will be able to see that well ahead of time, and then take the corrective action of concentrating on sales before the company gets to that bridge.

At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information: