Mike Rudd

Wednesday, 23 March 2005 05:49

On the shelf

Eighty percent of your revenue is generated by 20 percent of your customers. It is also true that 80 percent of your profit is generated by 20 percent of your customers. But we often fail to recognize that these are often not the same customers.

The customer that places inordinate demands on delivery, pricing, payment terms and inventory stocking requirements can cost you gross margin. The customer that places his orders on time, expects a reasonable delivery schedule and pays on time makes a good profit for you and reduces the stress on you and your employees.

As the old saying goes "You can't sell from an empty shelf." This may have some validity. But a shelf full of nonmoving or obsolete product is a profit drain. This is compounded by squandering working capital. and contributes to increased borrowing and interest expense.

Before analyzing inventory stocking requirements, reorder points and all of the other factors that go into managing your inventory, you need a game plan that reflects all facets of your business. Your business must make the transition from working in the business to working on the business.

There are several factors that must be taken into consideration.

* Identify the customers that are most profitable. These may not be your best customers. This includes identifying the minimum gross profit acceptable for your business to achieve a return on the risk of doing business.

A customer that habitually pays in 60 or more days is less profitable that the customer that pays in 30 days or fewer. A customer that constantly demands special treatment due the its inability to plan creates a cascading effect that forces adjustments in schedules. Promises can be broken, and your profitable customers can become displeased. That could send them to a different supplier that appreciates the business.

* Give your sales team incentives to produce profitable sales, not just sales. The most effective way to hold salespeople accountable is to have a program that rewards and pays a higher commission based on gross profit, and pays a lesser or no commission for sales that do not meet the company's standards.

Not doing so results in increased sales, but the company "grows" itself out of business. This same philosophy of profit-based incentives should be used for all employees. Incentives must be tied to cost areas that employees have control over -- labor hours, material costs, overtime, inventory waste and consumable supplies. This is in direct contrast to an incentive that does not reflect the direct contributions of employees.

* Develop a system for accurately tracking and managing financial information on a daily, weekly and monthly schedule. If there is a lack of truly useful information, it is impossible for the business owner to make informed decisions.

Without accurate information based on historical percentages, it is impossible to measure the impact on break-even rate, overhead application, inventory levels and pricing matrixes. Relying on gut feelings and an annual financial statement leads to misinformation and a false sense of security. Solid, accurate information is developed by analyzing critical functions, developing a financial statement to reflect these functions and implementing specific productivity goals.

In creating this matrix of information, you will be able to identify the profit holes in the business and take decisive action to correct the problems.

* Identify working capital and cash flow requirements. Most businesses start with inadequate working capital and never reach the point where they have enough capital so they can manage their daily and weekly cash flow requirements and grow the business profitably.

Identify your business needs and maintain an adequate safety net to compensate for the unexpected. Predicting and improving cash flow are functions of clearly understanding the revenue and expense cycles of the business.

Once you have a clear understanding of the all of the facets of your business -- and possess the tools to measure and react to the ever-changing business climate -- you can answer the question about whether inventory is your biggest asset or your biggest liability.

Mike Rudd is director of client services for International Profit Associates. IPA's 1,700 employees offer consulting services to businesses throughout the United States, including Alaska and Hawaii, as well as Canada. Reach Rudd at (847) 808-5590, mike.rudd@ipa-iba.com or www.ipa-iba.com.

Wednesday, 22 December 2004 10:09

Establishing small business profitability

There are several elements within a small business environment that should be analyzed and reviewed to establish potential profitability as compared to current performance.

Financial statement review

In a review, three to five years of financial statements should be analyzed and categorized. Compare the performance of each category within the chart of accounts over the financial review time period. Categories should include types of revenue, variable or direct costs, indirect overhead, general and administrative overhead, debt service and leases.

Break down each dollar amount into a percentage of revenue to determine operational variances within each line item. Review individual circumstances that contribute to variances and their impact on company profitability. Combine the best-performing percentages to establish the business's optimal financial performance.

Quantifying financial impact

The financial impact of a business owner's management practices should be reviewed.

* Accounts receivable. Lack of consistent monitoring and specific collection procedures lead to reduced cash flow, restricted access to product and increased borrowing. By reducing the accounts receivable collection cycle, a business is able to increase the amount of cash flow on an annual basis, reduce borrowing and increase profitability.

* Inventory analysis. In the case of a stocking distribution company, inventory is one of the single largest assets the company has. The management of this asset plays a significant role in the success or failure of the business. Excess inventory on hand reduces profitability due to handling costs, breakage, shrinkage, reduced cash flow and increased borrowing.

* Sales and margin mix. The gross margin mix of the individual revenue categories determines the overall margin available to the business for indirect overhead, administrative overhead and profit. If the product revenue mix is skewed toward low margin products or services, then the revenue stream will not compensate for reduced margins. Increased sales could actually lead to decreased profitability.

* Break-even pricing.Break-even is the point of revenue generation that has covered the associated variable costs and produced enough gross margin to cover the company's indirect and administrative overhead. Utilize break-even pricing to understand and create a pricing structure that allows for new product introduction and customer development, and takes into consideration the inherent competitive advantage of additional gross margin without the burden of overhead.

* Labor incentives. Increase labor productivity by developing and implementing excess profit-based incentive programs, performance job descriptions and management information systems. Average employee productivity can be increased, and the reduced overtime, reduced warranty, scrap and waste expenses and additional capacity will increase profitability.

* Reducing variable or direct costs. A business can reduce material costs by negotiating better terms or pricing, consolidating purchases, utilizing buying groups, committing to one supplier for annual purchases and reducing theft, waste and warranty work.

Benchmarking

Review the performance gaps between your business and peers within the industry. Identify gaps in profitability, productivity, costs and financial ratios. That information should be combined with the problem costs associated with the lack of appropriate and consistent systems and controls, in addition to procedures that must be embraced and implemented to achieve desired company profitability.

Each business is unique and should take into account special considerations when establishing its viability.

Mike Rudd (mike.rudd@ipa-iba.com) is director of client services for International Profit Associates. IPA's 1,700 employees offer consulting services to businesses throughout the United States, including Alaska and Hawaii, as well as Canada. Reach him at (847) 808-5590 or at www.ipa-iba.com.

Wednesday, 28 December 2005 05:01

Stand ready

A business can be struck by earthquakes, vandalism, floods, tornadoes or fire at anytime. Unfortunately, most small businesses around the country are not prepared to recover from such disasters. According to the U.S. Department of Labor Statistics, more than 40 percent of all companies that experience a disaster never reopen and more than 25 percent of the remaining companies close within two years.

Businesses that do reopen are often crippled by staff turnover, increased debt or an economic downturn. As big businesses have the resources to support backup computers, extra offices and elaborate disaster recovery plans, they tend to be the survivors when disaster strikes.

Yet small businesses are the key to economic recovery after disasters. They create two-thirds of new private sector jobs in America, employ more than half of all workers and account for more than half of the output of our economy.

Small businesses stimulate employment and diversification of the economy. Small firms produce the items that line the shelves in stores and keep intact the heritage of ingenuity and enterprise.

Disaster preparedness for small businesses

  • Back up vital information. Losing vital information such as accounts payable, accounts receivable or inventory management can be a devastating blow. The easiest and safest way to prepare for catastrophe is to back up the data stored on computer systems.

Record backups include ownership documents, account numbers, banking and financial information, insurance policies, product lists, employee databases, customer databases, supplier databases and personnel files. Back up copies should be stored off premises.

  • Safeguard equipment. Store equipment off site or elevate it above flood level, move it away from windows and doors, and protect it with covering. Protecting your equipment will save time and aggravation in the event of a disaster.

  • Know disaster resources. For example, the IRS allows business owners to amend their previous year’s taxes to claim disaster-related casualty losses if the president declares a disaster. The Small Business Administration may be able to provide low-interest loans, and your state or local Economic Development Agency may be able to help. Identify these organizations ahead of time.

  • Review your insurance. Premiums and deductibles increase for businesses in the wake of natural disasters, so you’ll need to review your property/casualty insurance carefully with your insurance agent or financial adviser, and review it annually thereafter.

The Small Business Administration suggests that business owners have three types of coverage: Property insurance to protect against losses from fire and theft, liability insurance to protect against lawsuits and business-interruption insurance to cover revenue loss. A prepackaged policy generally includes all three, and is more affordable than purchasing coverage separately.

  • Develop a specific disaster plan. Map out precisely who will do what if disaster occurs. Who will be in charge of evacuation or of making certain that important documents and data are safely secured? Designate a meeting spot outside of your business. Share the plan with your employees and keep it up to date.
  • Keep a business savings. The key to a successful disaster recovery is money. You won’t be able to wait weeks or months for insurance adjusters and settlement checks, so prepare by saving.

  • Keep strong communication. An important part of disaster recovery is to make sure that the correct information is communicated to employees, customers, media and the general public. Someone must be assigned the responsibility for deciding when it is appropriate to make public statements and for creating appropriate answers to the questions that will be asked by each of these groups.

Disaster can strike any time. It does not have to be a catastrophic event such as Hurricanes Katrina or Rita — it can be as simple as a broken waterline that destroys your company records, a fire, the loss of a key employee or any other significant disruption to your company’s operations. The key to recovery is planning. Communicate the plan to your employees so they know what is expected of them during a time of crisis. Most of all, be prepared.

Friday, 16 July 2004 09:28

Employee motivation

The focus of a productivity-based excess profit incentive system is to reward the employee based on the work performed over and above the minimum profit standards established by management, as opposed to a bonus given based on entitlement.

Every company has several obligations -- to generate enough cash flow to meet the company's daily cash requirements, produce a profit commiserate with the risk involved in the business practice, allow the owner(s) to maintain a good quality of life and assure the employees a fair wage and safe work environment.

The concept of excess-based profit incentives was developed as a mythology to assure the business maintains the profit margins required to thrive and provide employee motivation based on specific performance criteria.

There are a few key principles that need to be addressed to establish and maintain a good incentive program.

  1. Define the minimum gross profit your organization must produce to maintain its return on risk. The amount of incentive is calculated on the gross profit generated in excess of this amount. This allows the company to increase profits as the excess profit is shared with the company and employees.

  2. Incentives must be tied to cost areas that employees have control over. This could be labor hours, material costs, overtime, reworks and waste and scrap, small tools, and consumable supplies. This is in direct contrast to an incentive plan that does not take into account the individual contribution of the employees.

  3. The financial reporting system must reflect the distinct/discreet operations of the company so it will be possible to measure the performance of the employees. If a company lumps all of the direct job/production costs into one ledger account, it will be impossible to measure where either improvement or poor performance is coming from.

  4. The way to hold employees accountable is to have a program that rewards good performance and negatively impacts the incentive amount if the performance is subpar. For example, if the employees maintain a waste and scrap budget below what is established by management, the incentive paid to employees increases. If the waste and scrap budget is exceeded, the incentive is decreased.

  5. The incentive plan should reward the all employees of the company based on their specific contributions to the overall success of the company; the greater the responsibilities, the greater the reward. This includes senior management, administrative personnel, supervisors and line employees, down to the least senior positions.

  6. Rewards on a consistent basis monthly or quarterly maintain motivation but reduce the administrative burden on management. Do not fall into the year-end bonus syndrome. The bonus is generally arbitrary, is not based on performance, leads to entitlement and is often paid because the employees expect it regardless of the financial ability of the company to absorb the expense management pays because it does not want to disappoint the employees.

  7. Excess profit incentive plans force the employees to pay attention to the work at hand. They have the greatest impact on profitability and whether the management pays because they do not want to disappoint the employees.

Mike Rudd (mike.rudd@ipa-iba.com) is director of client services for International Profit Associates. IPA's 1,700 employees offer consulting services to businesses throughout the United States, including Alaska and Hawaii, as well as Canada. Reach Rudd at (847) 808-5590 or at www.ipa-iba.com.

Monday, 24 January 2005 08:51

Business methodologies

Many small to medium-sized businesses display similar unfavorable management techniques that can be threatening to the business. Here are five of these so-called "business killers" to avoid.

* Lack of strategic planning. The tendency to react to each circumstance without the advantage of a strategic plan is a downfall for any business. Without a plan, owners jump from crisis to crisis without control, teaching employees to do the same.

A strategic plan must be designed to increase the chances of success, not simply reduce the likelihood of failure. It must identify a competitive advantage by differentiation and value.

* Inaccurate financial information. If there is a lack of truly useful financial information, it is impossible for executives to manage or make solid decisions. Without accurate information, owners are unaware of the financial impact of their decisions and how those decisions impact the break-even rate, overhead application and pricing matrix. A business owner who relies on gut feeling leads with a false sense of security.

Solid financial information is developed by analyzing critical functions. Based on this information, specific productivity goals should be set, along with a reporting mechanism to monitor costs to enhance profitability.

* Insufficient liquid assets. Business owners who use U.S. Government Trust funds to cover costs put tremendous pressure on themselves to resolve financial crises. Often, this leads to making expedient short-term decisions, to the detriment of the long-term survival of the company.

Understanding the true cost of running the business is the first step in gaining control of the company's finances and, ultimately, the success of the business. Utilizing break-even for pricing and competitive advantage, understanding the impact of indirect and administrative overhead and making profit the first item of expense allow the company to generate enough cash flow to meet its needs and generate a substantial profit.

* Inability to measure employee productivity. A business owner who is not able to measure employee productivity is forced to discipline negative work habits based upon visual observations. If a company has not defined employee performance standards or has not quantified the desired results, it will have a difficult time providing incentives to employees.

The lack of a system to measure productivity leads to an inverse pyramid organizational structure, with the owner spending less time on long-term planning and more time on daily crisis situations. This structure can lead to discouragement and poor performance among the best employees.

Incentive programs and performance job descriptions allow management to motivate employees, shift responsibility to a lower position within the structure and hold employees accountable for overall performance.

* Inability to identify company costs. When no system is in place to identify costs, business owners must rely on visual observation to determine how each section of the company is managed. This can lead to a wasted budget or time, in turn leading to a decrease in billings or costing the company clients.

Business owners should identify the critical variables within the company, such as revenue, direct job cost, margin contribution, indirect costs, administrative and general overhead.

Each business is unique in its cost structure, employee and management profile and market, but owners must follow the principles of sound business management and learn to adapt these techniques to their specific industry. Each category works in conjunction with the others to provide the necessary information to make cogent decisions that are critical to the success of a company.

For business owners to realize their profit potential, they must understand that every decision has an impact on profit. If owners are diligent in the execution and follow-through of sound management techniques, they will achieve their predetermined profit.

Mike Rudd (mike.rudd@ipa-iba.com) is director of client services for International Profit Associates. IPA's 1,700 employees offer consulting services to businesses throughout the United States, including Alaska and Hawaii, as well as Canada. Reach him at (847) 808-5590 or at www.ipa-iba.com.

Friday, 20 August 2004 09:37

The 'metric' system

If you can't measure it, you can't manage it.

This age-old adage is as applicable today as it was when it was first coined. It is incumbent upon senior management to drive the revenue numbers higher every day, every week and every month, while at the same time absolutely controlling the company's expenses.

Managing your company without a clear understanding of how the financial decisions you make every day affect your company is akin to driving a NASCAR racecar while looking only in the rearview mirror.

Many years ago, there was a shift in the accounting world to tax-based accounting to keep up with the requirements of the Internal Revenue Service. This has enhanced IRS compliance but has been a disservice to managers and business owners trying to run their company by the numbers.

Measuring business success is a two-step process; the first is developing a realistic variable budget, and the second is capturing and utilizing the data to make informed decisions regarding the operation of the business.

To effectively measure the performance of a company, the owner or senior management must identify the critical variables that affect operations. This process starts with identification of the distinct revenue streams the company has or would like to develop. Historical data, coupled with competitive analysis and market trends, allows for realistic forecasting. This process also allows senior management to hold the sales function accountable for specific performance and to fine-tune marketing efforts.

The next step is to identify the variable costs -- labor, labor burden, materials, subcontractors, equipment rental, expense, scrap and warranty and applicable royalty expense, etc. -- within the operation. By carefully analyzing variable costs and measuring the results on a percentage basis, as opposed to dollar amounts, senior management is able to react and control variable costs related to revenue fluctuations. The information generated from these categories is a direct reflection of the ability of your line managers and employees to manage and control costs.

The impact of overhead is often misunderstood, and too often, the consequences are fatal to the company because management did not understand the direct relationship between overhead and gross margin.

There are two types of overhead that management must take into consideration: indirect and general/administrative overhead. Indirect overhead expenses are the costs associated with performing the functions of product production, but the costs are spread over the entire organization. Examples are product development costs, estimating expense, supervisor wages, consumable supplies, government compliance, uniforms, equipment maintenance and associated labor, auto expense and small tools and supplies.

General and administrative overhead typically accrue independent of business operations. Examples include accounting expense, depreciation, bank charges, interest expense, office rent, office payroll, owner's payroll, office supplies and professional fees.

By carefully identifying and forecasting the company's critical variables, developing a realistic budget, driving the numbers daily and measuring performance on a weekly basis, senior management can understand and control the numbers critical for company success. Mike Rudd (mike.rudd@ipa-iba.com) is director of client services for International Profit Associates. IPA's 1,700 employees offer consulting services to businesses throughout the United States, including Alaska and Hawaii, as well as in Canada. Reach Rudd at (847) 808-5590 or at www.ipa-iba.com.

Wednesday, 28 April 2004 06:44

Accelerate business profitability

Nearly everything an entrepreneurial contractor learns about the business of being a contractor comes from previous business experience.

Most contractors who start their own business do so because of their expertise and skill in the field, and generally do not have formal business training. In this business situation, critical issues such as implementing effective bidding procedures and exercising professional management become acquired skills. The following are techniques geared to addressing the issues that your last boss never taught you.

Improve bid-to-award ratios

Increasing the percentage of jobs that are awarded does not guarantee higher profit -- volume does not always equate with profit in contracting or any other field. In fact, the contractor who successfully and consistently underbids the competition without understanding the actual cost will most likely run out of working capital and seriously imperil the health of the business.

The two main components in identifying costs are direct job cost and the application of overhead. The first, direct job costs, are the estimated variable costs associated with completing the project such as labor, labor burden, materials, subcontractors and equipment rental. Those items that vary in cost correlate with the size of the project.

The second component is overhead application. Overhead can be a combination of indirect overhead such as estimating wages, supervisor wages, fuel and oil, and consumable supplies. These costs are job-related, but must be allocated over all of the company's jobs.

The other overhead component is the total fixed cost related to the operation of the business. Administration, wages, insurance, rent, utilities and owners wages are components of the fixed cost.

The overhead rate is calculated from the annualized budget. The formula is overhead expense divided by direct job cost, which gives you an overhead rate that can be applied to all of your projects. To calculate the break-even point for a given project, the overhead rate is added to the direct job cost.

This number allows the contractor to cover the estimated job cost as well as the actual overhead expense. If the project is sold for less that this number, there will be a loss associated with this project.

The remaining factor in the equation is profit. The amount of profit you add to the job is dependent on factors such as how the project fits into your existing workload, competitive environment and pay history of the client. Using break-even calculations in your bidding process will help you understand your true cost of doing business and provide a return on your risk.

Develop incentive systems to increase profits

You or your designee may sign the checks, but your employees spend all the money. The best incentive programs take that simple fact into consideration.

There are also other factors that must be taken into consideration when developing an incentive plan.

* If you do not provide an incentive program, employees will develop one on their own by cheating hours or stealing materials.

* If employees do not understand how the program works, they will not be motivated by it. It must remain simple.

* Incentives must be tied to specific cost areas that the employee has control over.

* The incentive plan must reward the group as a whole. Performance will improve each employee's work affects the bonuses as a whole. This method tends to reinforce good behavior onto themselves.

* Supervisors should be compensated at a higher rate than laborers, as they have direct responsibility for the performance of the crew, including financial accountability.

* The incentive plan must have positive and negative components. This forces the employees to focus on costs.

* The incentive payout should occur often enough to provide motivation, but not become an administrative burden.

Using these simple techniques will allow you to apply better cost controls in the field from the ground up rather than after the fact from the management team.

Learning to improve bid-to-award ratios and develop incentive systems to increase professional management skills can play a vital role in your company's success. When done correctly, these steps can substantially increase productivity and profit. Mike Rudd (mike.rudd@ipa-iba.com) is director of client services for International Profit Associates. IPA's 1,700 employees offer consulting services to businesses throughout the United States, including Alaska and Hawaii, as well as Canada. Reach Rudd at (847) 808-5590 or at www.ipa-iba.com