Are you in control?
Unfortunately, strategic planning ranks low on many business owners ‘to do’ list.
There are several issues that virtually all small and medium-size businesses have in common when struggling to achieve their predetermined profit. Although each business is unique in its cost structure, employees, management profile and market, they all must follow the principles of sound business management in order to reach their goals.
Unfortunately, strategic planning ranks low on many business owners to do list. Those same owners tend to react to each circumstance without the advantage of a well thought out plan to benchmark their decisions. They fail to define the company vision, and are more comfortable working ” in” the business as opposed to looking outward and working “on” the business to define and identify the critical variables that drive profitability.
In addition to the lack of strategic planning, there tends to be very little sales planning. The sales staff is generally told to make sales and turn in orders. There are no specific performance criteria established, such as how many calls are required to achieve an acceptable sales rate. There is very little thought given to their accounts and the profitability of each, nor is the commission and pay structure designed to reward the top performers and motivate the underperformers.
Owners, without strategic plans, tend to react to daily circumstances. They make expedient decisions that cause them to jump from crisis to crisis, with a lack of control, and teach their employees to do the same. Ultimately, employees are rewarded for their ability to manage a crisis as opposed to their ability to plan ahead.
As well, most business owners do not generate or receive useful information to manage and make decisions. Many are completely unaware of the financial impact of their decisions on the company and how those decisions impact their breakeven rate, overhead application and pricing matrix. They don’t have the tools to understand or consider the effect that overhead has on the company’s profitability. They don’t analyze their costs from period to period based on percentages, thus failing to analyze trends versus unique circumstances and are unable to take corrective action to rectify the variations. Invariably, many rely on their ability to manage their businesses on “gut feeling.” This leads to a false sense of security and surprise when found unable to service debt, make payroll, pay taxes or make a living wage.
Businesses should implement systems in order to allow them the ability to measure the productivity of employees. Unless this is accomplished, it is difficult to differentiate the good employees from the non-performers. Consequently, discipline should not be random or based on visual observations. Job performance standards should be defined for employees with the quantified results achieved through their efforts. Any incentives that may be employed are therefore employee determined. If a bonus system is put in place, it should be related to specific performance criteria and profitability. A business organizational structure should not be an inverse pyramid with the owner at the bottom, spending the day putting out fires. When there is little or no position function analysis, job duties are spread out between the employees with little regard for the position requirements. This tends to leave the best employees discouraged and with a suffered performance. They may even leave to find employment elsewhere. The unproductive employees’ standards become the norm while quality and productivity suffer to the detriment of the company.
When there are no systems in place to identify specific production costs, business owners typically rely on a visual observation and “feel” for what is going on in the production departments. This leads to unchecked waste, warranty-expense increases, inability to finish a job on time or within budget. Invariably, this results in customers pulling their business. In turn, product prices are lowered in an effort to make up for the lost business further reducing profitability.
Develop a strategic plan! One of the crucial factors in developing a strategic plan is that it must be designed to increase the chances of success, not simply reduce the likelihood of failure. The strategic plan must identify a competitive advantage by differentiation and value. A strategic plan dictates the direction of the company and the development of the following areas:
Organizational structure: A functional organizational structure is developed based on three basic categories that are common to all businesses. The first is sales–without revenue the company will fail. Second is operations–in order to be successful you have to perform what you promised when you promised it. Third is administration–companies must have the ability to track the key variables within the company and measure the success or failure of the activities, plans and people.
Performance job descriptions: The American with Disabilities Act compliant job description takes into consideration the specific physical requirements of the job, as well as the educational and experience requirements. The duties and responsibilities are clearly spelled out so that the employees know what tasks are expected of them. The critical components of the job description are the performance standards the employee is expected to meet on a daily, weekly, monthly and annual basis. These standards and expectations must be clearly defined so management can hold the employees accountable for their actions. Employees should agree with the job descriptions and sign a statement that says they understand the requirements and can perform the job as defined.
Excess profit incentive plans: The concept of excess profit based incentives is based on the philosophy that employees should share in the profit of the company which is over and above the predetermined amount of profit the owner has established as mandatory. This is critical in motivating employees to do their best at all times. The incentives must be based on specific measurable criteria and must be shared among all the company’s employees. The contribution the employee receives is based on the effect the employee has on the profit, the incentive must have positive and negative components and the impact positive or negative cannot be the result of a one-time windfall or disaster. Incentives must be paid often enough to motivate, but not so often that it becomes a burden on administration or taken for granted as entitlement by the employee.
Production Controls and Job Costing: The ability to monitor and control production is critical to the success of a business and is required in order to achieve the potential profitability of the company. These systems are developed by analyzing the critical functions in the production process. Once the processes are identified, specific productivity goals are established and a reporting mechanism is put in place to monitor the production and costs. Information is available to management within a time frame to allow for changes in the process to enhance profitability and inversely put changes in place to avoid additional cost and subsequent erosion of profit.
Finance and Accounting: A financial reporting system is based on the strategic plan and the identification of the critical variables. The first step is the development of a P & L Chart of Accounts. These account categories identify the following:
Revenue: Not all sales are created equal, some products or services are more profitable than others. This is the result of competitive pressure, purchasing leverage, supplier requirements and so forth. These should be taken into consideration as separate revenue categories are tracked and specific goals are set to assure a balanced revenue stream.
Direct job cost: Direct costs vary. As revenue increases, these costs increase proportionally. These costs can include labor, labor burden, subcontracting, equipment rental, energy and fuel, materials, warranty expense, commissions and royalty expenses.
Margin contribution: The difference between revenue and direct cost is margin contribution, which is also known as gross profit. This is the amount of money a business has to pay the rest of the company’s expenses.
Overhead: Overhead expenses are related to the execution of the activity, but are not allocated to the variable cost of the company. They include supervisor wages, sales salaries, small tools, supplies, fuel, oil, transportation, training expense, shipping and equipment expenses and much more.
General and administrative expense: The G & A expenses are the overhead categories that continue regardless of revenue. These include accounting, professional fees, rent, utilities, depreciation, interest expense, owner’s wages and administrative wages, and associated burden.
In order to realize profit potential, you must understand that nothing stands alone within the business and every decision has an impact on profit. Decisions must be made in tandem to provide the information to make cogent decisions and the tools to both measure and manage the critical functions of the company. Although each business is unique, you must follow the principles of sound business management and learn to utilize the aforementioned management techniques. If you are diligent in the execution and completion of these techniques, you will achieve the predetermined profit.