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p In this article I will help the business owner to understand the basic principle of the Income and Expense Statement (Profit and Loss Statement), and how to effectively analyze it to maximize company profits. It is important to have a a href=http://www.businessconsultingabc.com/Writing_An_Effective_Business_Plan.htmlBusiness Plan/a to run a successful business and part of that business planning process is good Income Statement analysis, planning and application. As you roll out your a href=http://www.businessconsultingabc.com/Strategic_Plan_For_Business_Success.htmlStrategic Plan/a to track and implement your profitable business success strategies, it is crucial to understand what that Profit and Loss Statement is telling you. It is also important to effectively and realistically project your future profit expectation and maximize those profits./p
pstrongI. Income Statement Fundamentals/strong/p
pLetrsquo;s first understand what is in an Income Statement and what the various components of it represent.nbsp;/p
pstrongemNote:/em/strongem nbsp;I am using a Manufacturing Company as an example this article./em/p
pstrongem–Major Components of an Income Statement/em/strong/p
ul
liSales and Revenue/li
liCost of Goods Sold / Cost of Sales (COGS)
ul
liMaterial/li
liDirect Labor/li
liManufacturing or Factory Overhead/li
/ul
/li
liOperating or Gross Margin (GM)/li
liExpenses
ul
liEngineering/li
liMarketing/li
liGeneral and Administrative (G amp; A)/li
/ul
/li
liPre-Tax Profit/li
/ul
pstrongem–Revenue / Sales/em/strong/p
ul
liBreakdown of all Products and Services and the resulting Revenue for each class./li
liLast Line should be the overall average:nbsp; Units sold times the Average Unit Price./li
/ul
pstrongem–Cost of Goods Sold / Cost of Sales/em/strong/p
ul
liCost of providing a product or service for sale./li
liIn a manufacturing Company it comprises of:/li
listrongemMaterial:/em/strongnbsp; Raw material and parts required to build a unit.nbsp; A significant part of each Revenue Dollar, i.e.nbsp; 40% of each sales dollar on new equipment and 15% for spare parts./li
listrongemDirect Labor:/em/strongstrong /strongnbsp;Labor cost in manufacturing a product.nbsp; Typically, 7 cents of each Revenue Dollar for new equipment and 1.5 cents for spare parts./li
listrongemManufacturing or Factory Overhead:/em/strongnbsp; Costs which donrsquo;t contribute directly to the production but necessary to build a product.nbsp; For example, Employees of the Purchasing Department, Material and Production Control Planners, Clerks, Quality Assurance Inspectors, Manufacturing Department personnel department, etc./li
/ul
pstrongemNote:/em/strong emMaterial and Direct Labor costs are varying, varying directly to the quantity produced./em emOverhead is a Fixed Expense, not fluctuating appreciably with output./em/p
pstrongem–Operating Margin:/em/strongnbsp; Sales minus Cost of Goods Sold/p
pstrongem–Expenses/em/strong/p
ul
listrongemEngineering/em/strong/li
listrongemMarketing:/em/strongnbsp; commonly the highest expense./li
listrongemGeneral amp; Administrative:/em/strongnbsp; Usually the least expense./li
/ul
pstrongemPre-Tax Profit:/em/strongnbsp; Operating (Gross) Margin minus Expenses/p
pstrongII. Maximizing Profit Analysis/strong/p
pstrongem–Market Analysis and Marketing Plan/em/strong/p
ul
liMust have an accurate Analysis to determine what the Market is willing to pay./li
liUnderstand clearly your Competitorrsquo;s pricing and develop a successful Pricing Strategy for your a href=http://www.businessconsultingabc.com/Developing_and_Writing_A_Winning_Marketing_Plan.html target=_blankMarketing Plan/a./li
listrongemPrice War Considerations/em/strong
ul
liPricing below your Competitorrsquo;s pricing may go too far and set off a Price War./li
liCompetitors respond by reducing prices below market economic values to recapture market share lost./li
liclients can become accustomed to the lower fair-value price, making it hard to return to pre-war pricing.nbsp; Gross Margins of a profitable 50% can quickly erode to the breakeven point, typically about 30%./li
liAn Accurate Market Analysis and an effectively implemented Marketing Plan understands both the Customers and Competitors responses to certain price levels./li
/ul
/li
/ul
pstrongem–After Market Sales:nbsp; Spare Parts/em/strong/p
ul
liMost profitable product line:nbsp; 70% Gross Margin (GM), representing about 12% of Sales Revenue.nbsp; /li
liCost of Goods (COGS) on Spare Parts is normally about 30 cents of each Sales Dollar when operating with a 70% Gross Margin./li
liCOGS on new equipment represent about 60 cents of each Sales Dollar and a resulting 40% GM.
ul
listrongKey:/strongnbsp; Keep a high ratio of spare parts to new equipment for Maximum Profits./li
liPackage Spare Parts when you sell New Equipment with a GM range of 70-95% on the various parts, discounting the New Equipment./li
/ul
/li
/ul
pstrongem–Cost of Materials:/em/strong/p
ul
liAlthough Materials (all the parts, components and sub-assemblies of a product) is a cost that is fixed on a per unit basis, it can be manipulated for maximum profit potential./li
liMaterial for a manufacturing company typically represents about 38 cents of each sales dollar for new equipment and about 1.5 cents per sales dollar for spare parts, for a total average of about 39.5 cents per sales dollar.
ul
listrongemValue Engineering:/em/strongnbsp; design and re-designing products for the lowest cost without performance compromises./li
liEach part and sub-assembly is analyzed to determine if comparable utilisation can be achieved at lower costs by utilizing different materials, components, manufacturing processes or lower cost vendors.
ul
liAn example would be adjusting a componentrsquo;s tolerance from 5% to 10%, provided the design analysis finds the substitution acceptable./li
liSimply cleaning a part during the machining or assembly steps can lower costs./li
liExamine production procedures to scale down waste and spoilage. /li
/ul
/li
/ul
/li
listrongemRaw Material Management:/em/strongnbsp; Strongly dependant on(p) on good Market Planning amp; foretelling.nbsp; If the forecast is too optimistic, then too much material is purchased, which unnecessarily raises inventory costs.nbsp; If the forecast is too conservative or too low, then too little material is procured, which can result in late product delivery, customer dissatisfaction and lost sales, which in turn causes an increase in effective material costs./li
listrongemInventory Management: /em/strongMinimize costs through volume purchase agreements with suppliers.
ul
liContract with a supplier to buy a maximum number of parts over a fixed period, normally 1-2 years./li
liThe buyer stipulates minimal and maximum monthly quantity limits in its purchase order, which allows the buyer to adjust inventory levels within the set range and to known production requirements at the time./li
liAgain this system only works well when the Marketing Forecast is accurate within reasonable levels./li
liThis also helps suppliers as they can optimally adjust their inventory and labor levels, which enables them to pass savings on to the buyer as discounts./li
liemBill-Back Clause Protections/em for the supplier:nbsp; Protects the supplier if the Buyer doesnrsquo;t meet the minimum purchase level and/ or puts a premium or extra discount on purchases exceeding the maximum agreed level./li
liUse an structured Computer Software Program, customized to your Company which tracks, manages, budgets and forecasts your Raw Material and Inventory needs.nbsp; This system needs to be carefully integrated with your Marketing Department./li
listrongemGood Relationship with Suppliers/em/strongem:/em Suppliers experiencing low capacity offer better discounts./li
liSuppliers can suggest different methods, processes, materials or manufacturing tolerances to help you save money./li
liPay your bills early or on time to take in Supplier incentive discounts.nbsp; Late payments will result in higher cots being levied in the future./li
liHave excellent communication lines established with your Suppliers which can be very helpful when you hit a downturn in sales and find meeting obligations difficult./li
liDevelop a Supplier Business Plan./li
/ul
/li
/ul
pstrongem–Direct Labor Cost Savings Strategies/em/strong/p
ul
liDirect Labor on average for a manufacturing company should cost about 9 cents of each sales dollar; of this cost, new equipment is 7 cents and spare parts is 2 cents./li
liKeep personnel turnover low, which reduces training costs./li
liSkilled, trained labor can accomplish the same task at a lower cost, with fewer errors, along with, better efficiency amp; productivity./li
liProactive emEmployee Incentives/em is much more effective than trying to retain employees through fear tactics./li
liProvide good working conditions and donrsquo;t overwork your experienced employees.nbsp; Use temporary or flex workers for short-term production gear ups and upturns.
ul
liLocate production facilities in less expensive parts of the region which offer tax incentives and lower labor costs for highly skilled laborers./li
/ul
/li
/ul
pstrongem–Manufacturing Overhead Cost Savings/em/strong/p
ul
liThe key in this area is Management Control.nbsp; Overhead typically accounts for about 14 cents per sales dollar./li
liGood Control Mechanisms executed from the outset can keep costs in check without Budget cut./li
liOverhead Cost Management is divided into three areas:/li
liFacilities, Communications amp; Data Management/li
liIndirect Labor/li
liOperating Expenses /li
listrongemFacilities:/em/strongnbsp; Immediate space requirements should have expansion options which meet your Companyrsquo;s emStrategic Plan Goals/em.
ul
liEnsure your Facility is designed to minimize utility costs and located in an area which has reasonable utility rates. /li
/ul
/li
liemCommunications:/emnbsp; Bundle your communication needs into a package for maximum cost minimization, better company integration and superior operating results.
ul
liBundle your communications with a Company that offers excellent customer service as that keeps expensive down-time to a minimum./li
li
pBundle a maintenance contract with your Communications package to minimize long-term costs./p
/li
/ul
/li
listrongemData Management:/em/strongnbsp; Utilize a Consulting Firm to customize a Data Management system to your Companyrsquo;s products and operations.nbsp; This should be carefully linked to the Marketing and Strategic Planning Departments, while also fully integrated into the Companyrsquo;s procurement, inventory, sales and operations areas./li
listrongemIndirect Labor:/em/strongstrong /strongnbsp;Typically the second largest expense of operations departments in manufacturing companies.nbsp; This is an area where maximum Control can be utilized.
ul
liWeigh the costs of trained labor verses inexpensive labor and determine a cost effective, yet rich mix of the two./li
liUtilize rigorous employment level management.nbsp; Indiscriminate hiring and firing has detrimental long-term effects./li
li
pFoster strong Employee communications, mutual trust and relations, which ensures efficiencies and lower overall labor costs./p
/li
/ul
/li
listrongemOperating Expenses:/em/strongstrong /strongnbsp;The least expensive operational category for a manufacturing concern.
ul
liThe key here is avoiding waste./li
liSatisfied employees, who understand how waste negatively impacts their pay and benefits through lower productivity and higher per unit costs, will reciprocate in adhering to Waste Management Procedures./li
/ul
/li
/ul
pstrongem–Cost of Goods Sold (COGS)/em/strong/p
ul
liUnderstand that COGS is the sum of Materials, Labor and Overhead.nbsp; COGS can amount up to 61% of each sales dollar, so just 1% saved here can make a significant impact on Pre-Tax Profits./li
/ul
pstrongem–Gross Margin (GM)/em/strong/p
ul
liThe difference between Sales and COGS.nbsp; For a Manufacturing Company, a good target goal is 50% GM, as break-even is often in the 25-30% range.nbsp; While 50% GM can be a difficult goal, ensure you have at least a 10% cushion between GM and Break-Even to ensure profitable operations during slow periods or unpredictable circumstances./li
liHow do you strongemMaximize GM/em/strong?
ul
liEffectively managing your Companyrsquo;s Engineering Costs and Gamp;A expenses./li
liRealistic and integrated Market Planning./li
liAny costs minimized in Engineering, Marketing and Gamp;A adds significantly and directly to Pre-Tax Profits./li
/ul
/li
listrongemManage Engineering Costs/em/strong
ul
liConsider Engineering as an Investment and should be integrated closely with your Companyrsquo;s Strategic Plan.nbsp; The most expensive cost at first, stabilizing to @ 9 cents per sales dollar./li
liAccurate strongemStatement of Work/em:/strongnbsp; Engineering director divides each project/ product into components of skill, time, skill hours, labor requirements, labor costs, benefits costs, supply costs, material costs and so forth./li
liYou cannot manage costs until they are broken down, identified and quantified./li
liEngineering Cost Management should be closely aligned with the Strategic Planning Departmentrsquo;s Budgeting Process and Controls in order to fully maximize cost reductions in this area./li
/ul
/li
listrongemMarketing Expenses:/em/strongnbsp; Generally the highest of the three Expense Categories for Manufacturing Companies.nbsp; 10 cents per sales dollar is typical for a stabilized Manufacturing Company.
ul
listrongemAreas to Analyze/em/strongstrong:/strongnbsp; Salaries and commissions of sales people; manufacturing reps commissions; product managers salaries; service and administrative personnel salaries; advertising and travel costs; communication costs; supply costs./li
liUnderstand how Bonuses and Incentives can significantly increase the productivity value of your Marketing Expense bottom line./li
/ul
/li
listrongemGeneral and nbsp;Administrative Expenses (Gamp;A):/em/strongnbsp; Typically the least expensive expense category for a manufacturing company.nbsp; 7 cents of each sales dollar is a good goal. /li
li
ul
listrongemComponents Include:/em/strongnbsp; CEO, Executives, Finance, Accounting, Personnel and Support Staff./li
liPrimary expense item in this category are salaries, so Competitive Salary Structures should be monitored regularly to ensure the 7% goal is maintained./li
/ul
/li
listrongemTotal Expenses:/em/strongnbsp; For a manufacturing company, total Expenses normally account for 25 cents of each sales dollar.nbsp; The remainder is Pre-Tax Profit, which should typically be in the 15% range or 15 cents per sales dollar./li
/ul
pstrongem–Pre-Tax Profit:/em/strongnbsp; Pre-Tax Profits can only be effectively maximized through a step by step Analysis of a Companyrsquo;s Income Statement, ensuring it is closely aligned with the Marketing Analysis, Marketing Plan and Strategic Planning.nbsp; The resulting strategy will significantly minimize Expenses, which has a direct effect on Pre-Tax Profits.nbsp; This should be a comprehensive, cumulative approach in order to achieve maximum profitableness./p
pstrongem–After-Tax Profits:/em/strongnbsp; In a 30% tax bracket, after-tax profit is 10.5% or 10.5 cents per sales dollar./p
ul
liHigher or lower resulting tax brackets can significantly affect After-Tax Profits, so utilizing an Accounting and Tax Firm specializing in your business is highly important./li
liAverage after-tax profit for Manufacturing Companies runs about 5%./li
liAfter-Tax Profits are vital to a Companyrsquo;s Growth and Investment, resulting in more Retained Earnings and higher Cash Flows and needed when opportunities arise in the market./li
liCash Accumulation allows for better leverage and terms when negotiating funding to expand and grow your Company./li
/ul
pstrongem–Summation of Components:/em/strongnbsp; The Profit and Loss analysis shows how a companyrsquo;s sales dollars are distributed and how to effectively minimize those pesky costs to increase the profits of the company. Critical to this analysis is determining how each of the Income Statementrsquo;s componentrsquo;s percentage of cost contribute to the sum total of costs and relating profits. Adjusting each component has an exponential effect on company Profits and Profitability. strongemYou can only maximize Profits by understanding and managing its components and parts./em/strong/p
pstrongAbout this Article Author/strong/p
p Frank Goley is a business plan consultant, business consultant, and business turnaround consultant for ABC Business Consulting, and he has been helping companies to succeed for many years. He is an expert in developing business plans, marketing plans, funding plans, strategic plans, turnaround plans, web marketing strategies,nbsp;and project specific business plans. Frank is also a business coach and a web development, web marketing and web seo consultant. Frank is author of the business plan book, strongemThe Comprehensive Business Plan Workbook ndash; A Step by Step Guide to Effective Business Planning/em/strong, and he has over 50 published articles on business success strategies. He also writes the Business Success Strategies Blog./p