Contributed Column

Josh Patrick

Profit Strategies 

by Josh Patrick, Stage 2 Planning Partners

A yardstick for growth

Many business owners are interested in increasing profit, but may not understand how to get started. Their first difficulty may be the challenge of measuring accurately what they do now. Before there can be any improvement, there must be a good baseline of measurements in the business — measurements that can have a real impact on the business.

Identifying key metrics can help

Most businesses have a profit-and-loss statement of some sort. This basic financial statement tells owners whether they are making or losing money for the tax man, but it doesn’t tell them if they are making or losing money for themselves. 

A key metric is a numeric measurement that can track the profitability of your business. It might be something from your profit-and-loss statement, balance sheet or cash-flow statement. More often than not, it will be a number you gather outside your normal accounting functions.

To develop good key metrics, you need to start with what drives your business. Most business owners have a good intuitive sense of this. For a business that requires significant capital investment, return on assets is key. The business owner would want to develop subsidiary metrics that would drive higher return on assets, then focus on using that investment, whether it’s heavy earthmoving equipment or a fast-food facility. 

In contrast, for a business that has mostly variable costs — say a distribution business — the focus would more likely be on gross profit. Sales go up, and costs go up, more or less at the same rate. So this owner might be more apt to focus on generating profitable volume. In either example, there would likely be a set of five to 10 key metrics that support the owner’s goals for the business. 

Where to start?

The first step is deciding which measurement will have the largest impact for the least amount of effort. For example, ranking your customers from most profitable to least profitable is always a useful activity. 

It’s easy to find out which account produces the most sales. The problem is that the accounts producing the most in sales are not always the ones that produce the most profit. In fact, many times, the accounts that produce the most in sales can actually cost your company money.

For evaluating customer profitability, first figure out which customers made the most money for your company. Then build a demographic profile of what that customer looks like. This means to find the attributes that all your best customers have in common. Then build a marketing program that attracts more of these customers.

You also now have a profile of the customers who cost you money, and you can figure out ways to make sure you don’t let your sales department sell to this type of customer. With the proper information, you have the tools for your employees to improve the focus on your key measurements. 

Key measurements to look for

We’ve found the following metrics are most useful when it comes to improving company performance:

• Return on assets

• Return on equity

• Gross profit

• Profitability per customer

• Net free cash flow

• Average inventory turns per year

The metrics you choose will depend on the largest opportunity your business has. Installing a key metric program is often an early step that companies take when they are changing their focus from tactics to strategic activities. 

We know that when a company focuses on tactics, it often focuses on the wrong things. When the focus moves to strategic activities, key measurements must be established and management focus will automatically move toward measuring the things in the business that can have the greatest return.

Getting to a different outcome starts with identifying and taking action on your company’s best key metrics. •

Josh Patrick, Founding Principal of Stage 2 Planning Partners in South Burlington, specializes in working with closely held businesses. 

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