Finding Purpose – Profit Equation (Part 2)
If you read Part 1 of this blog series, you now know what a profit equation is. In Part 2, we’ll focus on the purpose or the equation and what you can do with it. Before we continue, be sure to read Part 1 to be fully up to speed.
At a high level, the purpose of the profit equation is to increase your profits. As you get into the different parts of the equation you will see how adjusting each cost category impacts your profits.
Better Marketing & Selling
Your profit equation gets you to review your marketing and selling in conjunction with revenue. You cannot assess the effectiveness of your marketing and selling simply on how much you spend on them. The actual revenue generated is the direct return on the investment. As you collect and review more marketing and selling investment data, you’ll marketing and selling will be generate more sales.
The sales cycle of your product or service will help determine how frequently you should review your marketing and selling investments. If your sales cycle is less than a month, then a monthly review will make sense. If your sales cycle is longer, the marketing and selling costs should be reviewed at a frequency to match that. You need to give your marketing and selling investment enough time to prove that it works.
Control Direct and Admin Costs
After revenue, the direct and administration costs are the largest part of the profit equation. However, many businesses overlook controlling costs because investing resources in growing sales seems to offer a better return on investment. A small business could have over 50 individual vendors that they have bought from in the last 12 months. Those expenses are then detailed on a standard income statement in 15 different cost types. Frankly, controlling costs can be daunting.
Your profit equation helps you monitor costs quickly and effectively, allowing you to be as proactive in controlling costs as you are in generating revenue. The 15 different expense types are grouped into two cost categories and are managed in real-time, and not just at the end of the year. It turns cost control from an accounting year-end activity into an ongoing operations activity.
Clear Profit Strategy
Creating a profit strategy can be complicated. Many businesses hesitate to, for example, offer a different product or expand into a new location, because they don’t know if that will increase profits. Business owners can get overwhelmed by the many considerations needed in making strategic decisions. At times, when a decision is finally made, it’s not the best one because the business owner was too focused on the wrong details.
Using your profit equation to analyze your financial information helps you make better strategic decisions for your company. Simplified and clear cost categories break down the choices and help highlight the most important variables in your decisions. Your strategy and next steps will be driven by correct variables based on your business data.
Your profit equation also gets you to look at your strategy continually as it creates a feedback loop. With rapidly changing technology and constantly evolving customer appetites, static strategic planning no longer cuts it. Your equation helps you compare your results to your strategy frequently, and highlights where your plan is deviating from market demands.
Ultimately, your profit equation is the collective results of your business’s performance. More importantly, it is the bridge to get your business from where it is now to where you want it to be.
Need tailored advice on how to build a system to easily create your profit equation? Or how to benefit most from implementing your profit equation? Contact us and we’ll walk you through it.
*Be sure to check out our previous blog here to learn how to find more clarity in analyzing your financial information