You are at the start of the 12Faces path to finding a solution to Poor Profits
There are several ways you can arrive at the conclusion that your profit level is unsatisfactory. Some will be via our ScoreBoard analysis. Or you may have used your power of observation and intuition to arrive at that conclusion.
The path forward in 12Faces is the same; irrespective of what got you to here.
If your profitability is falling, the easiest way to look for reasons is to compare the accounting results for a period before any deterioration and the most recent period. The simplest way to do this is to use your annual accounts for the last two years. Using a full year will help remove the effect of any seasonal issues like financial quarters with holiday periods.
You may already be familiar with parts of the following analysis pathway. To avoid duplication, we provide branches to background information that you can follow, if necessary, while we move down the fastest path to finding solutions to the problem of Unsatisfactory Profits.
There is usually a mixture of reasons for unsatisfactory profit. We have a process that;
- identifies the likely significant contributors
- suggests tests you can use to confirm that they are contributing
- helps you short-list the problem issues you want to focus on and then
- suggests actions for resolving those selected issues
These are many different accounting terms used by accountants and in different part of the world. 12Faces uses one set. If you are uncertain about matching our accounting terminology with your accounting records, see our Accounting Terminology Translator
Step 1: Identify the likely contributors to the problem
At this point, we choose between one or more of the three major contributors to Unsatisfactory Profitability;
- falling or static Revenue and/or
- increasing Operating Costs in proportion to Revenue change and/or
- Increasing Overhead Costs in proportion to Revenue change
As you work through the following steps, keep a record of anything you find that might have contributed to the Unsatisfactory Profit problem that spurred you to start this diagnosis. You will likely find several contributors with varying contributions to the issue. Later in this analysis, we will look at how to prioritise the various candidate solutions to the problem.
It is vital to have revenue coming into your business if there is to be a profit at the end of the business workflow.
If Revenue is increasing, it is a sign of problems elsewhere in the workflow so that is the first thing we study
1. Is your Revenue static or falling between time periods?
Yes: linking to Revenue Improvement strategies
No: continue to Step 1.2
1.2 Gross Margin
Gross Margin can be expressed as a percentage and calculated by the formula;
Gross Profit/Revenue *100
If it is falling, it means the costs of your operating processes are growing at a faster rate than your revenue so your business is becoming less efficient at production.
This means your Gross Profit will reduce in proportion to changes in Revenue and this will flow directly to falling Operating Profits.
Yes: Gross Margin % is falling. Read More at Gross Margin Reduction explanation
No: continue to Step 1.3
1.3 Overhead Costs
If you have reached this point, it is likely that disproportionate increases in your Overhead Costs are reducing your profit.
You can test this by looking at the Overhead Cost Ratio calculated with;
Overhead Costs/Revenue *100
If this is increasing, your overheads are increasing faster in proportion than your Revenue is.
If you a re a growing business, this weakening might be explained by investing in assets required for growth (like labour) which will take a while to become fully productive.
Yes: Overhead Cost Ratio is increasing. Read More at Overhead Cost Significance explanation
No: Continue to Step 2
Step 2: Prioritize the Problems to Solve
When your doctor tells you you have a blood pressure problem they will explain it can be caused by several things; and probably more than 1 to various degrees. The same is true of your business.
This Step helps you decide which of the various factors contributing to Unsatisfactory Profit you are going to focus on first.
To learn more about ranking potential solutions, visit How to Prioritize Changes to Improve Your Business (link)
At this point, you should have "short list" of just a few, most important, potential solutions to the root causes of your Unsatisfactory Profit.
Step 3: Research Solutions
There is a great deal of information on solutions to the particular problems that you have prioritized to solve. Any Google search will turn up many.
Unfortunately, most of these information resources discuss the problem but many fewer discuss practical, implementable, solutions.
12Faces collects the best information and training resources we can find on a particular topic and makes it available to you in easily studied formats.
To discover our solution resources for the particular issues you have identified as your priority target problems, start down the solutions stage of path to fixing Unsatisfactory Profit
Step 4: Completing the PDCA Cycle
The PDCA Cycle is a tool that Toyota developed to manage a product improvement cycle. Tools like this led to Toyota far outpacing the non-Japanese car manufactures; until they also began implementing them.
PDCA stands for Plan, Do, Check, Adapt and this link explains in more detail.
So far, you have done the Plan part of the PDCA Cycle.
The next is to Do or implement the Solutions you have found.
Then you should make the time to Check that the Solutions you have implemented are heading in the right direction.
If not; you could implement other shortlisted solutions from the first stage or consider using a different diagnostic that might indicate different solutions.
If the Solutions have worked, the final step is to Adapt how your business operates so that the healthy practices you have found to work get fully integrated with how your company does business so the team does not slip back into bad practices. This will require some combination of change to work practices and to the culture of the business towards such changes. You can read more on how to achieve this by working your way down the relevant paths on Change Management in our set of Solutions.
Once your changes are integrated, you are ready to move onto the the next stage of your business improvement process.
We encourage you to continue to carry out the same PDCA cycles again and again in order to improve your business en-route to your goal of Sustainable Business Success.