Business growth can have many positive effects on the overall profitability of a company. Economy of scale, which is an economic term but can be applied to business growth, can be realized through extending the productivity of the workers. One hundred percent utilization of time and equipment allows businesses to spread the cost for better return on investment. Controls and management can be developed to provide better transparency of the business. And the overall increase in revenue should yield higher profit.
The negative effects are just as significant and, if not managed, can render a company less profitable, or even go out of business. One example of this was my own business that I purchased out of college. We purchased the company, a solid 20 year old retail audio/music chain with 3 stores. During the 1st year of business, it appeared that everything was moving along as expected. Cash flow was good because we were living off the injected capital received from the banks and sales so each store seemed to be holding their own. However, all at once the economy took a nose dive. Interest rates went to 21% (we had a loan that was tied to 2% over prime), sales plummeted 50% due to economic recession and union strikes in our area, and unemployment was the highest ever among blue collar workers which were our customers. The decisions we made, or did not make, next proved to be the eventual failure and fire sale of the company.
Our first bad decision was not consolidating our resources. Having 3 stores meant having 3 of everything. Much of our working capital was tied up in inventory to keep up the image that we had all the "right" stuff. In human capital, we needed 3 of every position. Since we needed at least one person for all the positions, we could not reduce our overhead by reducing full time equivalents, even when the sales did not support even 1 full time employee for that position. The physical plant and all the cost related to keeping the stores open and running had to be maintained. We should had consolidated our resources to our best store. Then, we could have rode out the storm, by reducing cost, overhead, and inventory by over 65%.
The second bad decision was not putting the proper controls in place for inventory quantities, accounts receivable, and expenses. We had those functions on computer but never really looked at reports to help us analyze our problems. If we had, we would have quickly recognized from inventory the items that needed to be fire sold, to get cash, and the items we needed to invest in to generate profit. Looking at turns, we could have pin pointed the items that were needed and be able to managed ordering and stock levels using those metrics. With times being tough for everyone, our receivables got well out of hand and our collection process left much to be desired. Add bad account write off increases of over 50%, the strain on cash flow was significant. Finally, expenses were out of control, because there was no control. Managers, who were part owners, would take money from the registers to buy lunch and various other sundries. Three stores 9 managers that amount was significant.
The last bad decision was not recognizing a change in our business customers and their buying habits. Eight track tapes were on the way out and cassettes where coming in fast. Since we had both music and audio, we waited too long to replace the 8 track inventories with cassettes and got caught holding a bunch of 8 track inventory that would not sell. This was mainly due to our managing partner being blind to the future and felt that 8 track was there to stay. Boy was he wrong.
Business Cycles are inevitable and seem to come more frequent as the years go by. When business cycles are in a downturn, a management style and technology structured around MBSM will provide daily reporting of key profitability indicators to guide you through the restructuring of your business during a down cycle. You will be able to analyze and focus on the key areas of your business that will lead you through the cycle, and help you monitor your cost to limit your loss exposure. If I had this in place back then, I probably would be in the audio business today!
Expanding a business can come in many shapes and sizes, too. It might be related to market acceptance of your product, growing the territory from which you attract business, economic stimulation which increases your customers' needs for your products, acquisition of a competitor, or expanding your product line into new markets. Whatever the reason, there are some fundamental key profit indicators (KPI)'s that will help you monitor daily the impact the growth has on your bottom line. Here are some of the indicators:
Every business should work through a process to determine the capacity of each task in the organization. How many invoices can a person process in a day, how many jobs can a person handle, and so on. Analyzing your organization by task will give you a better grasp of capacity by position and it is an easy metric to obtain. Ask each employee to record and assign time to their daily tasks over a period of a month. From that information several KPI's can be gleaned. Daily task time will show you how long it takes to handle routine functions. Daily time lines will show you how that employee/position manages his/her time. If you have multiple folks doing the same task, you can compare productivity. Taking a birds eye view of the daily work of a department can help you resolve issues related to the distribution of work. After you complete this process you will have good capacity metric both from a departmental and personnel level. Processes then can be monitored through management and technology to insure that the capacity you desire for that position is being achieved by the individuals who are doing the work.
Now, when you project your growth, you now can analyses the impact on the cost of process (tasks) to determine if another FTE is required, re-assignment of tasks, or investment in technology is needed to increase the efficiency of performing the tasks. If your growth is to dig a longer ditch, then investment in a backhoe might be more efficient that hiring people and purchasing shovels. Also, when you know your company capacity, as business cycles through the year, you will better be able to manage your resource needs in order to achieve a higher return on resource investment.
At this point, it probably would be fitting to discuss resources. It is easy to see how you can create a capacity KPI for a piece of equipment, or an hourly producer. You determine the maximum usage of those resources per week, then divide that by the cost of the resource, including burdens. It is a bid harder with support resources. Those are the resources you need that are not tied to a revenue source. However, those resources are the hidden profit killers in your KPI and most companies do a poor job in managing that number.
One example would be in a construction company you might have a capacity KPI centered around a project manager (How much revenue can he manage at one time). You need to consider ALL the resources that will support his work and account for those costs as either burden or direct additions. If a PM has a project assistant that he shares with another PM, then 1/2 of her/his cost should be associated to his capacity KPI. Also, if he is using technology, like Procore or Omnidek, those costs should be figure in as well.
One company that I have consulted with was not figuring their truck rental or their technology requirement correctly in their capacity KPI cost, so they were missing about $15 per productivity hour in their indicator. The managers were surprised at the end of the month that their weekly profitability reports, which did not include the overhead of the trucks and technology, did not match the financial statements and their bonuses where less.
I have seen over the years of working with companies that were growing the impact technology made on the efficiency of tasks performed by individuals. Accounts payable processors were able to process three (3X) times the number of invoices per day, credit card/expense processors reduce their processing time by over 70%, project managers could increase their managed project budgets by 100%. These increases in capacity allowed the growing companies to increase their revenue while keeping their overhead cost relative neutral.
Another example from above. Remember we had three folks for every position. Each store had its ordering and inventory people. If we had evaluated capacity of the task, we would have noticed that this task only took several hours per week per store. If we would have consolidated that position to 1 person, not only would we reduce FTE (full time equivalents) for that task, we would have centralized the process and eliminated all the issues related to the ordering and inventory management silos between the stores. The cost and cash issues would have be abated and better management of inventory quantities and stock movement would have be achieved.
This is the most important metric that needs to be evaluated when looking to expand. It starts with investment, works through timing of revenue and cost, then ends with profitability. When a company begins to talk about expansion analysis on the investment is critical and spans not only money, but time, and resources. The investment in expansion can come from several places, cash flow from existing operations, bank loans or equity capital. These sources requires detailed analysis to insure that cash flow is not depleted or your equity investment covers all the cost.
Most growth comes organically and the effects on cash are dynamic to the management of daily operational tasks centered on sources and uses of cash. Looking at the investment side, increases in cost of inventory, employees, expenses, and operational processes must be evaluated to insure that the uses of cash do not outpace the sources of cash. Technology can play an important role by increasing capacity of your workforce (see above), providing report analytics to management daily, and automating process to achieve paperless efficiencies. Further, management and technology together, can streamline and control the sources of cash generally associated with billing and collections. Making sure that every bill that is sent will pass the customers inspection, and that collection is proactively monitored so that due dates are dependable metrics that can be monitored in cash flow reports.
Deploying technology and management into a growing operation can make a huge impact on profitability. As a company grows there are two impacts on profitability that need to be addressed. First, is the aspect of maintenance. If a company is growing in the same line of business with the same profit margin, it would make sense that the increase of revenue should come with and equal increase in profit based on the existing margin. There might be some increases due to economy of scale, however, growth and profit margin should at least be equal. The second is burden. What is it going to take in cost to increase your business. This is where utilizing the management and technology tools outlined in this book will help you increase your revenue while flat-lining your cost of burden and overhead.
Production is another important indicator that should be monitored. A good MBSM strategy would include in the daily dashboards production indicators. When these numbers are paired with cost and revenue dollars, then you add capacity projections, a manager can see his gross profitability on a daily basis. Moreover, with today's technology, collecting and validating that information is can be readily achieved either by using the existing ERP solution, investing in a BI tools that creates dashboards, or invest in a "smart" form solution, like Omnidek, that can be configured to achieve this task.
It is probably important to note that measuring production might not always be tied to daily revenue, but overall profitability. That is where "smart" estimating is utilized to break down a project by capacity and cashflow to provide the daily progress picture towards the overall profitability of the project. One of the biggest profit killers is getting off schedule in a project. Using production indicators can help you adjust resources, add shifts, or change schedules to "catch up" a job.
One final note, while management plays an important role in flat lining burden and overhead cost, technology is the key. Today, many of the processes (task) performed by individuals in the company can be automated either through existing ERP systems or specialized apps. This automation will increase the efficiency of the user which reduces cost. Those cost generally and equally effect profit. It is interesting that many companies don't manage burden cost properly and fail to see its effects on the bottom line. A good burden strategy should provide the KPI necessary to calculate the growth/profit equation.