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Profit driver management: when you review all the factors involved in creating and selling a product, you plan a better operation. Make sure you're seeing the whole picture.



Business leaders are compelled to intensify in·ten·si·fy  
v. in·ten·si·fied, in·ten·si·fy·ing, in·ten·si·fies

v.tr.
1. To make intense or more intense:
 their efforts to reach profitability targets by ever increasing market pressure. Identifying new opportunities to bolster This article is about the pillow called a bolster. For other meanings of the word "bolster", see bolster (disambiguation).

A bolster (etymology: Middle English, derived from Old English, and before that the Germanic word bulgstraz
 financial results is critical in this process. Guesstimating profits is no longer acceptable--profit management has to be precise, and organizations need a way of identifying their profit drivers.

Managing real growth entails reducing costs while boosting sales volume, rather than managing sales growth and cost reduction independently. The focus has to be on understanding how profit drivers affect profits--in other words, understanding how businesses make profits.

But defining profit drivers can be a challenge. Below, we explain what they are and how they interact to generate profits for a business.

The four profit drivers

Businesses of all types are subject to production and distribution capacity limits for each of their product families. These limitations affect the flow of products the company is capable of producing and selling. The primary profit factor is therefore the organization's capacity to produce and sell each product family. That's what generates the sales dollars.

However, a product family is a production and not a sales-related concept. A company's capacity is therefore measured according to according to
prep.
1. As stated or indicated by; on the authority of: according to historians.

2. In keeping with: according to instructions.

3.
 the similarity Similarity is some degree of symmetry in either analogy and resemblance between two or more concepts or objects. The notion of similarity rests either on exact or approximate repetitions of patterns in the compared items.  in production processes or paths for the different product families. The potential of each of these production paths is what determines a company's capacity.

For instance, figure 1 shows the manufacturing speeds of five product families in one plant. From this, it would appear that D is the weakest product line.

Manufacturing speed is only one consideration, however. The second is average selling price The average sales price of goods or commodities. Especially used in the retail sector and technology distribution.  per product family. This gives a snapshot (1) A saved copy of memory including the contents of all memory bytes, hardware registers and status indicators. It is periodically taken in order to restore the system in the event of failure.

(2) A saved copy of a file before it is updated.
 of the market from the company's perspective. Identifying the average selling price per product family helps determine the company's actual revenues per production stream.

The third consideration is average material costs (per product family), which are incurred directly through the production of the products. They would include all materials used to create a product.

Figure 2 illustrates these last two considerations per product family, as well as the resulting unit contributions. According to these criteria, to maximize profits, the company should promote the sale of D-A-E-B-C, in that order. The combination of these two profit drivers measures the organization's capacity to interact with its markets through the sale of its products and the purchase of raw materials, but doesn't does·n't  

Contraction of does not.
 take into consideration its capacity to manufacture the products.

Figure 3 shows the effect of manufacturing speed on unit contributions. Combining unit contributions with manufacturing speed leads to another criterion--dollars per hour, as described by the theory of constraints Theory of Constraints (TOC) is an overall management philosophy that aims to continually achieve more of the goal of a system. If that system is a for-profit business, then the goal is to make more money, both now and in future. . The order in which the organization should prioritize pri·or·i·tize  
v. pri·or·i·tized, pri·or·i·tiz·ing, pri·or·i·tiz·es Usage Problem

v.tr.
To arrange or deal with in order of importance.

v.intr.
 product sales therefore becomes E-A-B-C-D. Surprisingly, the D product family, which initially appeared to be the most profitable, falls into last place on the list.

The fourth profit driver is operating expenses Operating expenses

The amount paid for asset maintenance or the cost of doing business, excluding depreciation. Earnings are distributed after operating expenses are deducted.
, which involves assessing all the costs a company incurs independent of its production activities--specifically, the sum of direct labour costs, indirect labour costs and overhead expenses (production, sales, etc.).

Some might maintain that direct labour costs are proportional proportional

values expressed as a proportion of the total number of values in a series.


proportional dwarf
the patient is a miniature without disproportionate reductions or enlargements of body parts.
 to the company's level of activity. However, although direct labour costs may vary, they tend to stay fairly stable. Today's increasingly automated au·to·mate  
v. au·to·mat·ed, au·to·mat·ing, au·to·mates

v.tr.
1. To convert to automatic operation: automate a factory.

2.
 companies don't don't  

1. Contraction of do not.

2. Nonstandard Contraction of does not.

n.
A statement of what should not be done: a list of the dos and don'ts.
 want to lose their knowledge base, which continues to require significant investments in training. Moreover, the proportion of direct labour in the operating expenses equation has been on the decline, since it has been optimized in recent years. An evaluation of daily operating expenses clearly indicates that operating expenses are relatively stable and are independent of the company's production activities.

The operating costs operating costs nplgastos mpl operacionales  in our example amount to about $28,000 per day, or $7 million per annum Per annum

Yearly.
 over the past three years.

A clearer picture

The four profit drivers above interact and represent a partial explanation of what profit is. As described by the theory of constraints, the dollar per hour component is used to classify clas·si·fy  
tr.v. clas·si·fied, clas·si·fy·ing, clas·si·fies
1. To arrange or organize according to class or category.

2. To designate (a document, for example) as confidential, secret, or top secret.
 product families according to the company's capacity to absorb its operating expenses. It's it's  

1. Contraction of it is.

2. Contraction of it has. See Usage Note at its.


it's it is or it has
it's be ~have
 therefore possible to determine which product family contributes the most to the absorption of operating expenses. The company can then use this information combined with market demand to identify sales strategies consistent with its strengths and market demand.

There are, however, three other profit drivers that have an equally significant impact on a company's profits. They are work in progress (WIP WIP Work In Progress
WIP Work in Process
WIP World Internet Project
WIP Women in Prison (movie genre)
WIP World Institute of Pain
WIP Wash-In-Place
WIP Women in Publishing
WIP Work In Place
WIP Wireless Internet Protocol
) change, other revenues and amortization.

WIP change represents the variation in the work in progress and finished goods inventory from one period to the next, a variation that can serve to either over-estimate or under-estimate a company's profits. When the value of WIP change increases, profits are over-estimated by the same amount, and vice-versa. This is a significant issue because it can conceal conceal,
v to hide; secrete; withhold from the knowledge of others.
 the profitability of an operation if, for example, the value of the inventories decreases.

Other revenues aren't aren't  

Contraction of are not. See Usage Note at ain't.


aren't are not
aren't be
 directly related to product sales, but represent a source of revenues in addition to sales. These revenues contribute to the absorption of operating expenses without being classified in terms of dollars per hour. They include the sale of spare parts Spare parts, also referred to as Service Parts is a term used to indicate extra parts available and in proximity to the mechanical item, such as a automobile, boat, engine, for which they might be used.

Spare parts are also called “spares.
, service fees and similar items.

Amortization is the final driver--one that can conceal a company's true cash flow performance. It's therefore essential to identify its impact on profits.

Figure 4 shows the results of a simulation that reconciles net profit before income taxes and cash flow with the profit drivers. This exercise details financial performance and explains the source of company profits. And various scenarios may be simulated to determine how a company interacts with its markets to generate profits. The simulation provides answers to the following questions:

* What is the net profit based on a real or estimated sales mix sales mix

See product mix.
?

* How can available production capacity be used to maximize net profits?

* What is the best strategy (low selling price--high volume versus high selling price--low sales volume) for each product to maximize its contribution to profits?

* What should the company's strategic plan be to ensure the best fit between the company and its markets?

* How should the efforts made by the company's various sectors (sales, marketing, production) be oriented o·ri·ent  
n.
1. Orient The countries of Asia, especially of eastern Asia.

2.
a. The luster characteristic of a pearl of high quality.

b. A pearl having exceptional luster.

3.
?

Profit management is clearly not a random process, but the result of specific actions on the company's profit drivers. When they are tightly managed within clearly specified boundaries, a company's decision makers are more likely to meet the profitability targets set by investors.
Figure 1 - Manufacturing speed

Families  Manufacturing speeds (flow)

   A           2000 units / hour

   B           2700 units / hour

   C           2700 units / hour

   D           420 units / hour

   E          3 000 units / hour

Figure 2 - Price and cost considerations

Families  Selling price  Material cost  Unitary contribution

   D          $2.75          $0.95             $1.80

   A          $1.99          $0.45             $1.54

   E          $2.35          $0.75             $1.60

   B          $1.50          $0.59             $0.91

   C          $1.65          $0.85             $0.80

Figure 3 - Speed and unit contributions

Families  Selling  Material    Unitary     Manufacturing     Hourly
           price     cost    Contribution      speed      contribution
             $        $           $         Units / hr      $ / hour

   E       $2.35    $0.75       $1.60          3 000         4 800

   A       $1.99    $0.45       $1.54          2 000         3 080

   B       $1.50    $0.59       $0.91          2 700         2 457

   C       $1.65    $0.85       $0.80          2 700         2 160

   D       $2.75    $0.95       $1.80           420           756

Figure 4 - Considering three additional profit drivers

SIMULATION                         Family E     Family A    Family B

Sales (units)                      1 500 000    1 250 000   500 000

% Utilization A-B-C-D                           5 400 000   5 400 000

% Utilization A                                 4 000 000

% Utilization D

% Utilization E                    6 000 000

Sales ($)                          3 525 000    2 487 500   750 000

MTL costs                          (1 125 000)  (562 500)   (295 000)

Contribution (spread)              2 400 000    1 925 000   455 000

$ / hour                           4 800 $/hr   4 158 $/hr  2 457 $/hr

Sub-contract costs                 0            (75 000)    0

Other revenues                     100 000      0           175 000

TOTAL CONTRIBUTIONS                2 500 000    1 850 000   630 000

Op. expenses (28 000 * 250 jours)

Profit << Cash flow >>

<< WIP Change >>

Profit after << WIP >>

Amortization

Accounting Profit

SIMULATION                         Family C     Family D   TOTAL

Sales (units)                      1 750 000    200 000

% Utilization A-B-C-D              5 400 000    5 400 000  68.5%

% Utilization A                                            31.2%

% Utilization D                                 840 000    23.8%

% Utilization E                                            25.0%

Sales ($)                          2 887 500    550 000    10 200 000

MTL costs                          (1 487 500)  (190 000)  (3 660 000)

Contribution (spread)              1 400 000    360 000    6 540 000

$ / hour                           2 160 $/hr   756 $/hr

Sub-contract costs                 (55 000)     0          (130 000)

Other revenues                     35 000       0          310 000

TOTAL CONTRIBUTIONS                1 380 000    360 000    6 720 000

Op. expenses (28 000 * 250 jours)                          7 000 000

Profit << Cash flow >>                                     (280 000)

<< WIP Change >>                                           675 000

Profit after << WIP >>                                     395 000

Amortization                                               150 000

Accounting Profit                                          245 000

Available production capacity to promote high $ / hour families
Non profitable operation while the accounting profit shows a different
result


Jean-Francois Fontaine, P.Eng., M.A.Sc., (fontainejf@sympatico.ca) is with Creative Cognitive Consulting Promoting Optimization optimization

Field of applied mathematics whose principles and methods are used to solve quantitative problems in disciplines including physics, biology, engineering, and economics.
 (C3PO C3PO Star Wars protocol droid model
C3PO Custom Third Party Object
) Inc.
COPYRIGHT 2004 Society of Management Accountants of Canada
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2004 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Business Strategies
Author:Fontaine, Jean-Francois
Publication:CMA Management
Geographic Code:1CANA
Date:May 1, 2004
Words:1483
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