Profit Planning: How To Increase Your Business Profit

Source: Small Business Management

Introduction  

Profit planning, increasing your business profit, is simply the development of your operating plan for the coming period. Your plan is summarized in the form of an income statement that serves as your sales and profit objective and your budget for cost.

How Is It Used?

Advantages of Profit Planning

Profit planning offers many advantages to your business. The modest investment in time required to develop and implement the plan will pay liberal dividends later. Among the benefits that your business can enjoy from profit planning are the following:

• Performance evaluation. The profit plan provides a continuing standard against which sales performance and cost control can quickly be evaluated.
• Awareness of responsibilities. With the profit plan, personnel are readily aware of their responsibilities for meeting sales objectives, controlling costs, and the like.
• Cost consciousness. Since cost excesses can quickly be identified and planned, expenditures can be compared with budgets even before they are incurred, cost consciousness is increased, reducing unnecessary costs and overspending.
• Disciplined approach to problem-solving. The profit plan permits early detection of potential problems so that their nature and extent are known. With this information, alternate corrective actions can be more easily and accurately evaluated.
• Thinking about the future. Too often, small businesses neglect to plan ahead: thinking about where they are today, where they will be next year, or the year after. As a result, opportunities are overlooked and crises occur that could have been avoided. Development of the profit plan requires thinking about the future so that many problems can be avoided before they arise.
• Financial planning. The profit plan serves as a basis for financial planning. With the information developed from the profit plan, you can anticipate the need for increased investment in receivables, inventory, or facilities as well as any need for additional capital.
• Confidence of lenders and investors. A realistic profit plan, supported by a description of specific steps proposed to achieve sales and profit objectives, will inspire the confidence of potential lenders and investors. This confidence will not only influence their judgment of you as a business manager, but also the prospects of your business' success and its worthiness for a loan or an investment.

Limitations of Profit Planning

Profit plans are based upon estimates. Inevitably, many con?ditions you expected when the plan was prepared will change. Crystal balls are often cloudy. The further down the road one attempts to forecast, the cloudier they become. In a year, any number of factors can change, many of them beyond the con?trol of the company. Customers' economic fortunes may decline, suppliers' prices may increase, or suppliers' inability to deliver may disrupt your plan.

The profit plan requires the support of all responsible par?ties. Sales quotas must be agreed upon with those responsible for meeting them. Expense budgets must be agreed upon with the people who must live with them. Without mutual agreement on objectives and budgets, they will quickly be ignored and serve no useful purpose.

Finally, profit plans must be changed from time to time to meet changing conditions. There is no point in trying to operate a business according to a plan that is no longer realistic because conditions have changed.

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Advantages vs. Disadvantages

Despite the limitations of profit planning, the advantages far outweigh the disadvantages. A realistic plan, established yearly and reevaluated as changing conditions require will provide performance guidelines that will help you control every aspect of your business with a minimum of analysis and digging for financial facts.

Guide Objectives

In this guide, you will learn how to do the following:

• Develop a forecast for sales and gross profit, considering all of the various internal and external factors that are relevant to the forecast.
• Develop budgets for operating expenses to quickly detect excessive expenses so that corrective action can be taken and purchasing commitments held within budgetary limits.
• Estimate net profit so that you can determine whether or not the projected return on your investment is satisfactory. You will also be able to determine how much cash will be generated from operations either for reinvestment in the business or to compensate owners for their investment.

Forecasting Sales And Gross Profit  

Development of your profit plan should usually begin with a forecast of your expected sales and gross profit for the coming year. The sales and gross profit must be considered together since they are so closely interrelated. Gross profit percentages are determined by pricing policy, which also affects expected sales volume. A decision to increase the expected gross profit percentage will usually tend to decrease expected sales, while reducing the expected gross profit per?centage should increase sales.

A second major reason for beginning the profit plan with a sales forecast is that the volume of expected sales often determines a number of other factors such as the following:

• Expected changes in variable expenses, those expenses that tend to change in direct proportion to changes in sales. These could include expenses such as sales commissions or delivery costs.
• The impact of the added sales volume on the various fixed costs of operating your business. These costs, by definition, do not tend to vary in direct proportion to changes in sales volume. However, substantial increases in sales over an extended period can force an increase in many fixed expenses. For example, a sales increase realized through the addition of many new accounts could affect bookkeeping and credit costs.
• The ability of present resources such as storage space, display area, delivery capability, or supervisory personnel to accommodate the added volume.
• The need for funds to invest in increased inventory or accounts receivable to accommodate sales increases.
• Cash generated from operations to meet current operating needs as well as expansion requirements, debt repayments, and owners' compensation.

Realism

A realistic sales forecast must rely on careful analysis of market potential and the ability of your business to capture its share of this potential. The forecast should not be based upon "what you would like to do" or "what you hope to do." It must be "what you can do" and "what you will do."

Any forecast of a sales increase must be supported by realistic expectations for stronger market demand and specific marketing steps that will be taken to capture a share of this market.

The key to successful forecasting is realism. You only fool yourself if you reject reality in forecasting. Such fore?casts serve neither as a realistic planning basis nor as a reliable means of performance evaluation.

Your forecast can be the basis for important decisions such as decisions to add personnel, lease additional facilities, or increase promotional costs. If these decisions are based upon unrealistic sales expectations, any money expended on them will be wasted.
Forecasts are often presented to lenders or potential investors to guide them in their decisions. If they lack confidence in your forecast, they will certainly be reluctant to commit their funds to your business.

Every forecast should be supported by carefully considered, specific action plans. It is inadequate to forecast a sales increase of 20% or 30% without plans for specific actions to achieve the increase. These actions could include the intro?duction of new products, opening of new branches, market expansion, commitments from new customers, increased require?ments from existing customers, additional salesmen, or an intensified promotional effort to attract new customers.

Analyzing Current Sales and Gross Profit

Your sales and gross profit forecast begins with analysis of current performance. Sales are usually divided into various categories. Each category is examined individually to deter?mine expected sales for the coming year.

Selecting Sales Categories

The selection of categories will depend upon the nature of your business. For example, a food broker selling to a large number of relatively small accounts might be interested pri?marily in analyzing sales by product. The owner of a single retail store might choose to analyze sales by selling depart?ment, while the owner of a retail chain would probably be interested in analyzing sales by outlet. An insurance broker with several agents might categorize sales by agent. An individual wholesaler might consider sales by sales territory.

Factors Affecting Sales

After categories have been selected and current sales divided among them, the various factors which can affect sales in each category must be considered. These factors could be either internal or external. Internal factors are those that you can influence. External factors are those that affect the market served by your business, but are generally beyond your control.

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Internal Factors

The following are typical internal factors that could influence your sales forecast:

• Promotional plans
• Expansion plans
• Capacity restrictions
• New product introductions
• Product cancellations
• Sales force changes
• Pricing policy
• Profit expectations
• Market expansion to new customers or territories

External Factors

Among the external factors that must be considered are the following:

• Business trends
• Government policies
• Inflation
• Changes in population characteristics
• Economic fortunes of customers
• Changes in buying habits
• Competitive pressures

Analyzing Gross Profit Percentages

It is often useful to begin a sales forecast with an examina?tion of your current gross profit percentage (markup percentage or gross profit percentage). The gross profit percentage is usually the best indicator of pricing policy which can have significant impact on sales volume. To some extent, the gross profit percentage will also reflect the buying economies of your business. However, the range over which costs of pur?chased goods will vary is not ordinarily as wide as the possible range of prices you may seek for your products.

Three Bases of Comparison

Examination of current gross profit percentages can indicate the need for pricing policy revisions to meet competition or closer attention to purchasing costs in order to provide extra gross profit without increasing prices.

The evaluation of gross profit percentages requires comparison of current performance with three bases:

• Objectives originally set for the current year, if available
• Other businesses in the same industry
• Results of prior years

Comparison with objectives permits you to determine how well you have done compared with your original expectations. Assuming that these objectives were realistic, this is often the best single performance indicator. Deviations from objectives can quickly be identified and explored in detail to determine the cause of the deviation.

Comparison with industry averages permits identification of areas where the experience of similar businesses indicates room for improvement in your own.

Unfortunately, businesses are often too quick to dismiss the applicability of industry averages to their own operation, claiming that "Our circumstances are different." Such an attitude is self-defeating. It prevents you from taking advantage of the experience of others to improve your own sales and profit. A far more productive attitude is to say, "If everybody else can realize a gross profit of x percent, then we should be able to." Until specific circumstances are identified that make it impossible for your business to be consistent with industry averages, every attempt should be made to bring performance in line with the experience of others.

Comparison of current operations with performance in prior periods permits detection of trends so that progress, or the lack of it, can be identified. It also permits evaluation in light of those specific considerations that may be unique to your business. For example, if your gross profit as a per?centage of sales is low compared with the industry, analysis of your historic performance may reveal the cause of this apparent deficiency such as reliance upon a major customer where severe competition restricts the available gross profit percentage.

Evaluating Gross Profit Percentages

Refer to the table below, which is an analysis of gross profit percentages realized by Western Appliances in the year XXX2. Percentages are shown for cost of sales, gross profit, total expenses, and profit before taxes as follows:

• XXX2 actual
• XXX1 actual
• Industry average
• XXX2 objective

Each basis of comparison provides a different viewpoint of the company's operations.

WESTERN APPLIANCES, INC. Profit Percentage Analysis

             XXX2 actual   XXX1 actual Industry average   XXX2 Objective
Sales             100.0%        100.0%           100.0%           100.0%
Cost of Sales      80.0%         80.5%            81.8%            80.7%
                  ______         ______          ______           ______
Gross Profit       20.0%         19.5%            18.2%            19.3%
Total Expenses     17.9%         18.6%            14.7%            17.2%
                  ______        ______           ______           ______
Profit Before Taxes 2.1%          0.9%             3.5%             2.1%

Conflicts

Sometimes financial analysis can lead to conflicting conclu?sions derived from identical facts. Comparing Western Appliances' 20.0% gross profit with the 18.2% industry average could raise questions. If Western Appliances were more com?petitive in its pricing, could it capture a larger market share? A reasonable answer to this question would depend upon thorough knowledge of their operations and the experience of their sales personnel in dealing with specific customers. Perhaps their pricing is fully competitive in their area or local retailers are willing to pay slightly more because of the superior services they offer. If this is the case, price cutting might only trim profit margins with no realistic hope of additional sales volume to offset the effects of the price reduction.

On the other hand, if their gross profit percentage is below that of the industry, a number of other questions would be raised, such as the following:

• Are they purchasing at prices that are too high to provide an adequate gross profit?
• Is their pricing structure so low that adequate gross profit margins cannot be attained?
• Are salesmen too quick to cut prices?
• Is their marketing effort too heavily concentrated in those product lines that offer a relatively low gross profit percentage?
• Is their marketing effort directed toward those high-volume accounts that are so highly competitive that gross profit must be trimmed to an unrealistically low level?

Analysis of Sales Performance

The table shown below, analyzes the XXX2 sales of Western Appliances by account. Actual sales, gross profit, and the gross profit percentage are shown individually for major accounts and as a group for smaller accounts. These are reported on the bottom line and represent 50 small retailers served by Western Appliances.

WESTERN APPLIANCES, INC.
Sales Forecast, xxx3

                               XXX2 Actual                     XXX3 Forecast
Account                Sales    Gross Profit     %          Sales    Gross Profit      %
Giant Discount     $ 300,000         $45,000    15.0     $323,500         $45,300   14.0
Appliance Mart       150,000          27,000    18.0      174,000          31,300   18.0
TV Center            120,000          21,600    18.0      159,000          23,900   15.0
Whitney Brothers      80,000          15,200    19.0      100,000          20,000   20.0
Packer Electronics    70,000          14,000    20.0       40,400           8,100   20.0
Consumers Outlet      40,000           7,200    18.0       50,000           9,000   18.0
Other (50stores)     440,000         110,000    25.0      553,100         142,400   25.7
                  __________        ________   _____   __________        ________  _____
Total             $1,200,000        $240,000    20.0   $1,400,000        $280,000   20.0

 Let us consider Appliance Mart, one of the major accounts shown.

In XXX2, Western Appliances' sales to Appliance Mart were $150,000. These sales generated gross profit of $27,000, or 18.% of sales.

In XXX3, Western Appliances expects a general price increase of 5% with no change in the discount structure available to them from their suppliers.

Appliance Mart's business in XXX3 is expected to be affected only by general economic conditions such as the 5% price in?crease and an expected 10% industry growth in consumer demand for electrical appliances.

Appliance Mart operates a chain of discount stores in an economi?cally stable suburban area. For XXX3, they have no plans to add or eliminate any stores. There are no changes expected in Western Appliances' relationship with them that would materially affect sales.

Therefore, the only factors affecting the sales forecast for Appliance Mart would be the planned 5% price increase and the general 10% increase in demand. Sales to Appliance Mart in XXX3 could then be forecast as follows:

XXX2 Sales                   $150,000
+ 5% Price Increase             7,500
                              _______
= Subtotal                     157,50
+ 10% Demand Increase          15,750
                              _______
= Total                      $173,250

This amount, $173,250, has been rounded to $174,000 and entered in the XXX3 sales forecast column.

Since there is no planned change in Western Appliances' dis?count structure from its suppliers, nor is there any indication that competition for Appliance Mart's business will be any more or less severe, Western Appliances probably should assume that gross profit as a percentage of these sales will remain at 18.0%, the XXX2 level. The gross profit expected on these sales could then be calculated as follows:

$174,000 x 0.180 = $31,320

This amount has been rounded to $31,300 and entered in the gross profit forecast column.

Subdividing Sales Categories

It is often useful to subdivide sales into more detailed classifications in order to develop a more precise forecast such as potential sales to a single customer. As an example, refer to the table below, Western Appliances' sales summary by product line to Giant Discount, its major customer in XXX2. Sales, gross profit, and the gross profit percentage are shown by product line so that each line may be considered separately to determine a realistic forecast for XXX3.

WESTERN APPLIANCES, INC.
Customer Sales Analysis - Giant Discount

                                 XXX2 Actual                     XXX3 Forecast
Product line             Sales   Gross profit    %         Sales   Gross profit       %
Television            $160,000        $16,000   10.0    $184,800        $18,500      10.0%
Automotive radios       20,000          6,000   30.0          --             --         --
Table radios            30,000          6,000   20.0      34,700          6,900       20.0
Stereo                  40,000          7,000   18.0      46,200          8,300       18.0
Small appliances        50,000         10,000   20.0      57,800         11,600       20.0
                        ______         ______  _____     _______        _______     ______
Total                 $300,000        $45,000  15.0%    $323,500        $45,300       14.0

Development of the XXX3 forecast will assume that Giant Dis?count's various stores are located in areas that are represen?tative of the general economy and therefore will reflect the industry's expected sales growth of 10%; the price increase of 5% will have no significant effect on Giant Discount's sales; and competition among appliance wholesalers for Giant Dis?count's business will prevent Western Appliances from increas?ing its gross profit percentage in any product line.

The first product line on the table above, television sales, could then be forecast as follows:

XXX2 Sales              $160,000
+ 5% Price Increase        8,000
                         _______
= Subtotal              $168,000
+ 10% Demand Increase     16,800
                        ________
= Total                 $184,800

Assuming that the gross profit percentage of 10.0% on television sales is maintained in XXX3, the forecast for gross profit can then be calculated as follows:

$184,800 x 0.100 = $18,480, rounded to $18,500

Giant Discount plans to discontinue its sales of automotive radios in XXX3. Therefore, sales, gross profit, and the gross profit percentage for all are shown as zero on the table above.

Sales, gross profit, and gross profit percentages have all been determined for the remaining product lines and shown on the XXX3 forecast on the table above. You will note that the gross profit as a percentage of total sales in the XXX3 forecast, 14.0%, is well below the XXX2 experience of 15.0% even though the gross profit on each product line remains the same. This is due to the elimination of the highly profitable automotive radio line which produced a 30% gross profit but is being discontinued from Giant Discount's stores. In fact, the net effect of this discontinuation is that Western Appliances will realize addi?tional gross profit of less than $1,000 on sales to Giant Discount despite a sales increase of almost $24,000. This important fact probably would not have been revealed if sales to Giant Discount had not been subdivided into individual product lines for analysis.

This negligible increase in gross profit will probably be more than offset by normal cost increases in various expense accounts required to handle Giant Discount's business in XXX3, At this point, the owners of Western Appliances would be well advised to take a hard look at their pricing strategy to see if more favorable prices can be realized in any product line without any significant sales loss so that the gross profit earned from this, its largest account, can be improved.

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Developing Expense Budgets  

After a realistic forecast has been developed for sales and gross profit, expenses for the coming year must be estimated in order to establish expense budgets and to determine ex?pected operating profit.

Comparisons

As with the forecast of sales and gross profit, expense estimating begins with a review of the current year's per?formance based upon comparison with the following indicators:

• Performance in prior periods
• Industry averages
• Objectives established for the current year

For purposes of comparison, it is often useful to express each expense as a percentage of total sales.

Comparing Variable Expenses

The use of percentages as a basis of comparison and forecast?ing is particularly applicable when analyzing variable expenses. Variable expenses are those that tend to change as a result of changes in sales volume. For example, if salesmen's commissions are based upon a percentage of sales, the total dollar amount of commissions earned would increase as sales increase. If sales in a month were 20% higher than expected, commissions paid would also increase 20% as a direct result of the higher sales volume.

Comparing Fixed Expenses

On the other hand, fixed expenses are not directly affected by short-term variations in sales volume. Therefore, a 20% increase in the dollar amount of any fixed expense such as salaries or rent would normally be considered unacceptable even if sales for the period increased by 20%. When com?paring fixed expense levels with objectives or from one period to another, it is more realistic to make comparisons in absolute dollars rather than in percentages.

A business has sales and rent expense in January, February, and March as follows: Rent expense

Month              Sales         $     % Sales
January         $100,000     1,000        1.00
February          80,000     1,000        1.25
March            125,000     1,000        0.80

As a percentage of sales, rent expense was high in February and low in March. However, this does not indicate that con?trol of this expense was more or less effective in either month. It simply reflects the changes in sales volume. In all three cases, the actual rent expense was 1,000.

Long-Range Considerations

Despite the shortcomings of using percentages to evaluate fixed expense control within the business from month to month, they can be useful when making long-term comparisons or com?parisons with industry averages. These averages normally express expenses as percentages of sales, regardless of whether they are fixed or variable.

For example, assume that a business found that its rent expense as a percentage of sales was 2% compared with an industry average of 1%. This differential would have to be offset by better than average performance in gross profit or other expense classifications if the business expects to realize net profit equal to its industry average. Perhaps the reason for the high percentage is due to an exorbitant rental expense, or it may be caused by inadequate sales. In either case, certain questions must be answered. These could include the following:

• Are we renting more space than we need?
• Is our space too expensive for our requirements?
• Could a less elaborate facility be located that would be adequate for our needs?
• Would a less costly location be sufficient?
• Is our space utilization inefficient?
• Will expected sales increases be handled without renting additional space? Will this bring our rent expense per?centage in line with the industry?
• Can the terms of our lease be re-negotiated?

Similarly, when comparing long-term performance with prior periods, the use of fixed expense percentages can be helpful. For example, if you found that warehouse salaries jumped from 2% of sales to 4%, a number of important questions would be raised. These could include the following:

• Are we now using too many warehouse personnel?
• Are warehouse personnel less efficient?
• Has ineffectiveness crept into the warehouse layout or operating procedure?
• Are warehouse workers overpaid?
• Is warehouse supervision inadequate?

Identifying Excessive Expenses

At Western Appliances, no objectives were available for XXX2 performance. Therefore, excessive expenses can be identified only by comparison with XXX1 results, and, in some cases, with industry averages.

Industry Average Comparisons

Comparisons with industry averages are not available in all of Western Appliances' expense accounts. However, this can be determined by examining those accounts on the company's income statement that can be combined for comparison with industry averages. For example, the industry averages show that office salaries for the industry were 4.9% of sales. Examining the operating expense accounts at Western Appliances, the accounts that would appear to fall into this classification are the following:

• Salary - Office Manager 1.4%
• Salaries - Clerical 1.0%
• Salaries - Warehouse 1.8%

The total of these expenses, 4.2% of sales, compares favorably with the industry average of 4.9%.

Comparison with Previous Periods

The information permits comparison of all expenses in XXX2 with XXX1 results.

The only variable expense at Western Appliances in XXX2 is salesmen's commissions. These represented 2.0% of sales in both XXX1 and XXX2. Therefore, they would not appear to be excessive.

In the fixed expense accounts, sharp increases could be noted in the following accounts and would warrant review and pos?sible corrective action.

Account                      XXX2            XXX1
Salary - Owner            $24,000         $20,000
Salaries - Warehouse       22,000          18,000
Salaries - Clerical        12,000          10,000
Employee Benefits           8,000           6,000
Utilities                   4,000           3,000
Telephone                   4,000           2,000
Supplies                    2,000           1,000
Travel and Entertainment   13,000          10,000

Comparing Western Appliances' XXX2 fixed expenses with its experience in XXX1, significant increases are noted in almost every account. Some of these increases should be regarded with more concern than others and therefore given prompt attention. Reasons for the increases and possible corrective action must be determined.

Some increases were probably unavoidable, having been dictated by contract, legal requirements, or price increases beyond the company's control. Others could probably be reduced with closer control. For example, travel and entertainment expense jumped from $10,000 to $13,000, an increase of $3,000. This sharp increase should indicate that a closer look at all travel and entertainment expenditures is in order to determine whether or not all were necessary. Could some have been avoided by restricting salesmen's expense accounts? Could more economical means of travel have been used? Could the company eliminate unnecessary trips that resulted in costs far beyond any real value to the business?

Supplies expense doubled from $1,000 to $2,000 although the volume of business increased by only about 10%. This sales increase would not seem to indicate a need for such a sharp increase in supplies usage. Such an expense could be con?trolled by closer attention to purchasing procedures and supplies issued to employees, use of less expensive supplies where possible, and so on.

Determining Expense Budgets

Budgets for each expense must be established, considering both external and internal factors, as in sales forecasting.

From the standpoint of expense budgeting, the following would be considered internal factors:

• Corrective actions planned to bring excessive expenses in line.
• Policy changes such as new commission plans.
• Commitments such as equipment purchases, leases on new facilities, or professional service contracts.
• Planned salary increases.
• Planned changes in benefit programs.
• Additional personnel.
• Promotional plans.
• External factors could include the following:
• Inflation and its effect on price increases from suppliers.
• Tax rate increases including payroll taxes, local property taxes, inventory taxes, and so on.
• Utility rate increases.

Additionally, the interrelated effects of expense increases must be considered. For example, payroll increases will increase payroll taxes and, possibly, employee benefits. Rent on larger facilities can also involve additional utilities expense.

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Initial Forecast

The table below shows Western Appliances' initial forecast for XXX3 operating expenses.

The owner's salary will be increased from $24,000 to $26,000.

The office manager's salary will be increased from $17,000 to $18,000.

Salesmen's salaries will remain unchanged.

The expected sales increase will cause salesmen's commissions, 2% of sales, to increase from $24,000 to $28,000.

Warehouse salaries will be increased about 5% from $22,000 to $23,000.

Clerical salaries will be increased about 17% from $12,000 to $14,000.

Payroll taxes, approximately 8% of total compensation, will increase to $10,000 as a result of the compensation increases

Employee benefits expense is expected to increase from the present $8,000 to $9,000. This increase is dictated by increased premium costs for employees' health insurance.

Rent expense will increase from $9,000 to $10,000 due to a tax escalator clause in the lease agreement and a proposed municipal tax increase.

Utilities expense is expected to remain unchanged at $4,000.

Telephone expense is expected to be reduced from $4,000 to $3,000 because of tighter controls introduced by management in response to the sharp increase in XXX2.

New controls on supplies should hold this expense at $2,000 despite price increases.

To increase sales, the advertising and promotion budget will be increased from $13,000 to $15,000, a 20% increase.

Through tighter control, the owner expects to restrict travel and entertainment expense to the XXX2 level of $13,000 despite the general increase in travel-related costs.

Freight expense will increase from $16,000 to $18,000 reflecting the increased sales volume and higher freight tariffs.

Professional fees are expected to remain at $5,000.

Depreciation expense will increase from $6,000 to $8,000 due to the addition of new receiving equipment being purchased at a cost of $10,000 and depreciated over 5 years.

Total operating expenses will increase from $200,000 to $218,000. Profit before interest and taxes will be $62,000, an increase from $40,000 in XXX2.

WESTERN APPLIANCES, INC.
Sales And Expense Forecast
January 1 To December 31, XXX3

                                                                                       Revised
                             XXX2        XXX2         XXX1      XXX1     Industry         XXX3
                           Actual   (% sales)       Actual  (% sales)    (% Sales)     Forecast
Sales                  $1,200,000      100.0%   $1,080,000     100.0%      100.00%    1,400,000
Cost of Sales             960,000       80.0%      880,000      81.5         81.8     1,120,000
                         ________     _______      _______    _______      _______    _________ 
 
Gross Profit             $240,000       20.0%     $200,000      18.5%        18.2%      280,000
  
Operating Expenses:
Salary-Owner             $ 24,000        2.0%     $ 20,000       1.9%         1.7        26,000
Salary-Office Manager      17,000        1.4        16,000       1.5                     18,000
Salaries-Salesmen          12,000        1.0        11,000       1.0                     12,000
Commissions-Salesmen       24,000        2.0        22,000       2.0                     28,000
Salaries-Warehouse         22,000        1.8        18,000       1.7                     23,000
Salaries-Clerical          12,000        1.0        10,000       0.9                     14,000
Payroll Taxes               9,000        0.8         8,000       0.7                     10,000
Employee Benefits           8,000        0.7         6,000       0.6                      9,000
Rent                        9,000        0.8         9,000       0.8          0.7        10,000
Utilities                   4,000        0.3         3,000       0.3                      4,000
Telephone                   4,000        0.3         2,000       0.2                      3,000
Supplies                    2,000        0.2         1,000       0.1                      2,000
Advertising and Promotion  13,000        1.1        12,000       1.1                     15,000
Travel and Entertainment   13,000        1.1        10,000       0.9                     13,000 
Freight                    16,000        1.3        16,000       1.5                     18,000
Professional Fees           5,000        0.4         4,000       0.4                      5,000
Depreciation                6,000        0.5         5,000       0.5           0.5        8,000
                         ________      _____        _______   ______       _______      _______
Total Operating Expenses  200,000       16.7%     $173,000      16.0%                  $218,000
Profit Before 
    Interest and Taxes    $40,000        3.3%      $27,000       2.6%                   $62,000
Interest                   15,000        1.3        12,000       1.1                     17,000
                         ________     _______      _______    ______        _______      _______
Profit Before Income Taxes 25,000        2.1%      $15,000       1.4%          2.5%       45,000

Income Taxes                6,000        0.5         4,000       0.4                      15,000   
                         ________     _______      _______    _______        _______     _______
Net Profit                $19,000        1.6%      $11,000       1.1%                    $30,000

Reevaluating the Plan

Once an initial plan has been established, it is often useful to review it in order to identify areas of further improvement.

In the example of Western Appliances, the expected profit before income taxes, 3.2% of sales ($46,000 : $1,400,000), is well above the industry average of 2.5% and no extensive reevaluation appears needed.

Summary  

Too often, the owners of small businesses rely upon their eyes and ears to tell them whether or not the performance of their business is up to par. Unfortunately, our eyes and ears often betray us. The sales representative with the glib tongue and quick wit may appear to be your star performer while the facts, actual sales and profit, may show that someone else is doing a far better job. The secretary who constantly appears busy may be far less efficient than another who works in a more organized fashion with fewer errors and less need for duplicate effort.

There are also many aspects of a business that our eyes and ears cannot always sense. Changes in the market, shifts in customers' economic fortunes, and gradual but seemingly irreversible increases in costs can develop into crises unless they are detected at an early stage and effective action is taken promptly.

Performance Evaluation

The establishment of a profit plan permits you to evaluate performance in your business based upon facts, not upon random observations. Certainly, there is no substitute for the "gut feel" of the small business owner in making these important decisions that affect the prosperity of the business. However, the effectiveness of the owner's gut feel, when combined with facts, can dramatically increase the accuracy of management decisions.

Profit Plan

With a well-considered profit plan, out-of-line conditions can be detected at the earliest possible date. Corrective action can be taken promptly, eliminating the erosive effect of continuing losses as well as the need to react in a time of crisis. The profit plan also permits the owner to agree upon specific responsibilities with all employees who are in a position to influence sales or costs. Their performance can be evaluated and any deficiencies brought to their at?tention so that they can participate in the development of corrective action plans. As a further plus, the disciplined thinking about the future will permit you to foresee many problems before they occur and assist you in anticipating opportunities in your market that will permit you to build your business for greater sales and profit.

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