An essential first step to improving profitability is to step back from the day-to-day business and analyse the activities and financial accounts from a third party perspective.
Small business owners are frequently totally involved in every business activity on a day-to-day basis. Such close, hands-on involvement has major advantages, although not taking time out to focus on the factors affecting business profitability, both as a whole and in detail, can result in the profit performance being lower than is achievable.
Review
Accurate and up-to-date accounting records are a pre-requisite to the options available since the accounting records place a value on the trading history.
If financial records are not up-to-date, the first step would be to update the financial accounts by either manually recording the transactions or using accounting software to produce the financial accounts. For small businesses this is often a problem as accounts are often left until the last minute and produced for tax purposes. Simple bookkeeping spreadsheets are adequate for many small businesses while medium sized businesses may adopt more sophisticated accounting software packages.
Strengths and weaknesses
List the strengths and weaknesses of the business examining each activity from sales and purchasing, running costs, employees and financial control.
Particular areas to consider are:
- Past and present sales turnover sub-divided into product areas;
- Sales volume; and
- Selling price.
Costs need to be analysed by type and separated into:
- Direct purchasing costs;
- Operating expenses; and
- Fixed overhead costs, such as rent and premises costs.
Use the financial accounts to place values on the different business activity areas. This list should be as detailed and extensive as possible, as it is through this listing that plans of action will be developed and emerge as a business plan.
Assets and liabilities
The business assets and liabilities is another important area. List the main businesses fixed assets and the relevance and importance to the business. Working capital being the difference between the liquid assets and liquid liabilities.
Liquid assets include:
- Cash;
- Bank account balances;
- Stock; and
- Debtors.
Liquid liabilities include:
- Creditors;
- Bank overdrafts;
- Loans; and
- Credit agreements.
Having analysed the activity and financial areas of the small business and listed the strengths and weaknesses, the real work can begin to examine and review each area to determine how each of the historical financial figures, produced from the accounts to accompany the review, can be changed to form part of the future financial business plan.
Planning
A serious business plan for the future is the ultimate target to carrying out this exercise. A business plan might be produced in the form of a financial accounting budget, against which the planned action can be monitored to achieve the target objectives.
Sales
- Review sales turnover by determining both the sales volume of existing products, associated products and new product areas that might be introduced.
- Examine selling prices and the relationship with major clients and how additional important clients can be added.
- From the analysis, produce a sales plan to improve the sales volume preferably targeted at those products and product groups which will produce the highest gross margins.
Sales channels are important, and while several sales channels will already exist, they may not have been fully exploited in the past. Examine the strengths and weaknesses of each existing sales channel and other potential sales channels.
Other areas to consider are:
- The selling price, and whether selected price increases can be achieved; and
- The effect that more competitive pricing might have to increasing volume.
A review of existing customers may identify areas where increased sales can be achieved, rather than increasing sales volume to lower value clients.
Cost management
Cost management is obviously an important area.
- Examine the supplier base and whether better or cheaper suppliers are available, including shopping outside the existing geographical area or importing products. The majority of small and large businesses can always drive purchasing costs lower.
- The cost management review should include going through each cost component and determining if maximum use is being made of the services those costs are providing to the business. Are premises being fully utilised, could storage be improved, are the best heating and power options being exploited?
Staff
Businesses that employ staff have a whole raft of areas to consider. Motivation and cost management are important, as staffing is usually a highly significant cost base. Areas which may indicate improved productivity levels are:
- Directing staff resources to the most profitable areas; and
- Reducing waste through idle time.
Alternate staffing options might be considered, particularly if volumes are variable. Permanent staff levels are a fixed cost, while employing temporary staff or outsourcing services become variable costs and can be used effectively to reduce overall costs.
Financing costs
Financing costs should be considered and the finance policy generally reviewed. Paying high market rates using credit cards is a poor cost option, and any small business funding operations in this way should consider producing a business plan to obtain cheaper funding.
If working capital is a problem and holding back growth and opportunities, then alternative financing of assets, such as leasing and hire purchase agreements, may be useful if the funds released can be used more effectively. External financing costs real money in interest payments and should be viewed against the additional profit that can be generated through improved liquidity and cash flow to boost the working capital.
Forecast and revision
Following a full review, the management action to be taken should be listed and evaluated financially. Produce a financial budget forecast of the business plan supported by statements of actions to be taken to improve profitability. On a regular basis, review the progress and its effect on profitability, which may require adjustments as time passes to exploit new opportunities or revise existing plans.