You Have Got To Have A Plan
Owners always say they have a financial and operating plan, but few do. Most of these are on the back of an envelope or gathering dust in the bottom drawer, never to see the light of day again. Some owners say they have one in their head, but it only serves to clutter their brains. Most of these plans are never reviewed or modified, and changes are rarely implemented.
Stop Fibbing That You Have One
If you don't have a strong and evolving plan for profits, don't bother to come to work, because you will fail. Running your business month-tomonth, week-to-week, and day-to-day, you'll always be playing catch-up to meet expenses. But if you choose to live by our creed that "profits are the ONLY thing," then a disciplined plan is the only way you are going to get there. You should be focused about where you stand on your plan every hour that you're working and implement the required changes without mercy.
Most companies estimate sales, then go department by department to figure out the cost of those sales before arriving at the bottom number: the profit. Profit comes last. It is on the bottom of the income statement, effectively making it last on the list of priorities. And that is an unacceptable way of running your business if you care about making real money.
Owners who pretend to have a real plan use this kind of "residual budgeting," usually resulting in no profits, or worse, losses. They are budgeting operations on hope and failing to adjust accordingly when they fail to meet their projections or the market tanks. Failing to react immediately when budgets get out of line leads to disaster.
Even the most detailed and active operating plans should be tossed out in favor of what we call a Profits First plan. Most companies prepare a budget operating plan by estimating sales levels, usually too optimistically. They then determine what costs they think they need to achieve their profit goal at year end. Their profits become the leftovers of their sales and operating expenses. We refer to this tendency as a residual profit plan, and I've rarely seen one where the sales are realistic estimates. They are dreams and wind up falling apart at the seams, imperiling both profits and continued financing from the bank.
Small business owners must be fanatical about living by a Profits First plan. This operating plan depends on an owner's commitment to be in the top quartile of their industry. Average in the bottom quartile doesn't work for me, and shouldn't work for you.
If You're Not Trying to Be the Best You Can Be, Pack It In!
Owners rarely make enough changes to keep the bottom-line profits intact. They avoid the issue, allowing apathy to get in the way of fiscal discipline. Instead of making the necessary cuts as sales deteriorate, they tell themselves they'll make it up in the next quarter. This adds up to disaster.
The conventional, residual budget plan permits these lax cost controls. If we take a specialty manufacturing company with $8 million in expected sales, for example, the owner overestimates sales for the upcoming quarter or year and determines his or her best guess at expenses. The owner then comes up with a profit of $500,000. But that figure is purely abstract and almost never realized. As sales deteriorate, especially in a recessionary market, profits and cash flow rapidly disappear.
15 Cents for You, 85 Cents for the Business
Taking this same company, we would use our Profits First plan and reduce the sales to $7 million. Assuming the industry top quartile of a 15 percent profit rate, the company's operating profit should be $1.05 million. Our operating plan puts those anticipated Profits First, leaving the expense budget at $5.95 million. Ownership must then make sure all expense levels are planned and controlled to the expense budget of $5.95 million. All expenses, from sales commissions to general and administrative expenses, even rent, cannot exceed that expense budget of $5.95 million. Simply put, the company has to run on $5.95 million and expenses must be cut if they are too high going into the new year.
By doing this, by making sure your expenses going into the new year do not exceed that amount, your operating profit will be in the industry upper quartile at $1.05 million, and that's after you pay yourself a realistic salary of $175,000 to $250,000. You are taking your profit first and making sure 15 cents on every dollar goes to the house first, rather than to operating expenses. An extreme would be to take 15 cents of every dollar that you collect and put it in a separate bank account, to be used only for capital investment or other non-operating costs.
Our Profits First approach is the only concrete way you can ensure and measure performance among your departments and individual employees. Set a clear profit target, stick to a prescribed budget, and teach management how to hold everyone accountable, both operationally and financially. Each department head, and each individual within that department, needs to be given a timeline for completion of tasks, which must be performed successfully and within budget. Everyone, from the top down, must be held to a minimum and measurable standard of performance that supports this business plan. And if you don't viciously control costs according to this plan, you'll slide into razor-thin profit margins-or losses.
No room for muddy math here. With a Profits First plan in place, management has no excuse for failure, because the financial and operational goals of your business are all laid out by the numbers at the beginning of the year. Your employees have clear marching orders, which you can refer back to again and again.
In a bad year, this is a lifesaver. Let's assume that your marketing and sales costs under this plan were originally $700,000, but sales have dipped 10 percent below your budget. You then have to adjust your future sales costs to meet the new reality of lower sales so the percentage of sales costs against your new cost figure ($5,525,000) stays the same. This Profits First plan automatically forces a reduction in your sales costs and other operating expenses. By doing so, your 15 percent profit figure is maintained regardless of the sales drop. But if you don't execute the cost cuts in your sales budget and other factors, you will not meet the profit expectation in your plan.
Join us for a roundup of the top stories on InformationWeek.com for the week of December 14, 2014. Be here for the show and for the incredible Friday Afternoon Conversation that runs beside the program.