9 Little-Known Factors That Could Affect Your Profitability

Are You Achieving Your Profitability Targets?

Learn What To Focus On

In order to achieve high profitability, companies must focus on pain points that are costing them money.  Some of the causes of low profitability are caused by:

 

1. Inaccurate Cost Data: Limited availability of accurate costing information prior to any negotiation process results in the inability of account executives to drive cost to serve down and win rates up.
   
   
2. Non-Current Data: Lack of accurate and timely profitability information results in the inability to grow profits at the same rate as revenue growth.  This is why it pays to be able to read a company's financial statements, and to be able to judge a company's financial health, yours and your clients.
   
   
3. Poorly Informed Decision Making: Inaccurate costing information results in erroneous decisions being made that diminish profits.
   
   
4. Limited Analytics Capabilities: Performing root cause analysis and implementing relevant solutions is limited due to lack of ad hoc reporting and analysis capabilities.
   
   
5. Inflexible Models: The organization's ability to rapidly assess the impact of changes on internal and external factors limited due to lack of flexibility in the (profitability) modeling environment.
   
   
6. Ineffective Strategy:  The ability to determine which product and customers to focus on inhibiting growth due to lack of clear strategy and visibility.
   
   
7. Uninformed Discounting Decisions: Suffering from lower gross profit margins because pricing and discounting doesn't reflect underlying costs.  
   
   
8. Continuous Improvement: Experiencing declining profit margins or low profit margins compared with peers due to an inability to implement and monitor continuous improvement efforts.
   
   
9. Non-Value Activities: Limited ability to design and implement measures geared at eliminating wasteful spending because no systematic way of identifying non-value adding activities is available.

Impact on the Balance Sheet

The balance sheet is a financial statement that provides a snapshot of a company's financial position at a specific point in time. It shows the company's assets, liabilities, and shareholders' equity. The nine items listed above can have a significant impact on the balance sheet.

 

• Inaccurate cost data and non-current data can affect the accuracy of the values reported for assets and liabilities. 
  
  
• Poorly informed decision making and ineffective strategy can lead to misallocation of resources, which can impact the values reported for assets and shareholders' equity.
  
  
• Limited analytics capabilities and inflexible models can hinder the ability to accurately assess and report the financial position. 
  
  
• Uninformed discounting decisions and non-value activities can affect the values reported for assets and profit margins. 
  
  
• Continuous improvement efforts can influence the values reported for assets and profit margins as well.

 

Therefore, addressing these profit robbing problems is crucial for maintaining a healthy balance sheet and achieving high profitability.

 

Improve Your Income Statement

 

The income statement is a financial statement that shows a company's revenues, expenses, and net income over a specific period of time.  These are an indication of how your business operations are performing. It provides a summary of a company's financial performance and is closely related to the balance sheet. The issues identified above can have a significant impact on the income statement.

 

Here are some actions you can take to improve each of these issues:

 

• Inaccurate Cost Data: Invest in accurate costing information systems and ensure that account executives have access to this data before any negotiation process.
• Non-Current Data: Implement systems and processes to ensure that profitability information is accurate and timely, allowing for better decision-making and profit growth.
• Poorly Informed Decision Making: Improve costing information accuracy and provide training to decision-makers on how to interpret and use this information effectively.
• Limited Analytics Capabilities: Invest in ad hoc reporting and analysis capabilities to perform root cause analysis and identify relevant solutions for improving profitability.
• Inflexible Models: Enhance flexibility in the profitability modeling environment to assess the impact of changes on internal and external factors more rapidly.
• Ineffective Strategy: Develop a clear strategy and visibility on which products and customers to focus on, aligning them with growth objectives.
• Uninformed Discounting Decisions: Ensure that pricing and discounting decisions reflect underlying costs by regularly reviewing and updating cost data.
• Continuous Improvement: Implement and monitor continuous improvement efforts to enhance profit margins and compare with industry peers.
• Non-Value Activities: Design and implement measures to identify and eliminate wasteful spending by regularly reviewing processes and identifying non-value adding activities.

By addressing these issues and taking these actions, you can improve your income statement, maintain a healthy balance sheet, and achieve high profitability.

 

Improve Your Cash Flow

 

A cash flow statement is a financial statement that shows the inflows and outflows of cash within a company during a specific period of time. It provides insights into the company's ability to generate cash and its cash management practices. The cash flow statement is closely related to both the income statement and the balance sheet.

 

The cash flow statement complements the income statement by providing additional information about the sources and uses of cash, beyond just revenues and expenses. It helps to explain the difference between net income and net cash provided by operating activities. It also helps to evaluate the company's ability to generate cash from its core operations.

 

Similarly, the cash flow statement complements the balance sheet by providing information about the changes in the company's cash and cash equivalents. It helps to explain the difference between the beginning and ending cash balances on the balance sheet. It also provides insights into the company's investing and financing activities, such as the purchase or sale of assets and the issuance or repayment of debt.

 

Several items can impact a company's cash flow, including:

 

1. Accounts receivable: Delayed collection of receivables can result in a decrease in cash flow. Improving the accounts receivable turnover ratio and implementing effective credit control measures can help to speed up cash collection.  Implementing better Dunning Letter Procedures using SAP FICO can also help improve your AR performance.
2. Inventory management: Holding excess inventory ties up cash. Implementing efficient inventory management practices, such as just-in-time inventory systems, can help to reduce inventory levels and improve cash flow.
3. Accounts payable: Delaying payments to suppliers can increase cash flow in the short term. However, it is important to maintain good relationships with suppliers and ensure timely payments to avoid any negative consequences.
4. Capital expenditures: Large investments in fixed assets can have a significant impact on cash flow. Prioritizing and planning capital expenditures can help to manage cash flow more effectively.
5. Debt management: Servicing debt obligations, such as interest payments and principal repayments, can impact cash flow. Negotiating favorable terms with lenders and refinancing debt at lower interest rates can help to improve cash flow.
6. Operating expenses: Controlling and reducing operating expenses can free up cash. Implementing cost-saving measures, such as optimizing energy usage or renegotiating contracts with suppliers, can contribute to improved cash flow.
7. Sales and revenue growth: Increasing sales and revenue can positively impact cash flow. Implementing effective marketing and sales strategies, expanding into new markets, and improving customer retention can help to boost cash flow.

 

To improve cash flow, companies can take several actions:

 

• Implementing effective cash flow management practices, such as regular cash flow forecasting and monitoring.
• Maintaining a healthy working capital position by optimizing the management of receivables, payables, and inventory.
• Negotiating favorable terms with suppliers to extend payment terms and improve cash flow.
• Seeking additional sources of financing, such as loans or equity investments, to increase cash flow.
• Implementing cost-saving measures and improving operational efficiency to reduce expenses and increase cash flow.
• Increasing sales and revenue through effective marketing and sales strategies.

By addressing these items and taking appropriate actions, companies can improve their cash flow, which is essential for maintaining financial stability and achieving long-term profitability.

 

Key Financial Terms and Concepts You Need to Understand

Profitability ratios are financial metrics that are used to assess a company's ability to generate profits. These common profitability ratios provide insights into the company's profitability and can help investors and stakeholders evaluate its financial performance.

Profitability ratios are essential financial metrics that businesses use to assess their ability to generate profits. These ratios provide valuable insights into a company's profitability and play a crucial role in helping investors and stakeholders evaluate its financial performance.

 

In order to identify the factors affecting a business's profit, it is important to know and understand the following terms:

 

Net Profit Margin

 

One important profitability ratio is the net profit margin ratio, which measures the percentage of revenue that is left after deducting all expenses, including taxes. A high net profit margin ratio indicates that the company is able to generate a significant profit from its operations.

 

Operating Profit Margin

 

Another profitability ratio is the operating profit margin ratio, which measures the percentage of revenue that is left after deducting only the operating expenses. This ratio focuses on the company's ability to generate profit from its core business activities.

 

Total Revenue

 

Total revenue refers to the total amount of money that a company earns from its operations. It is a key component of the income statement and is used to calculate various financial ratios, including the profitability ratios.

 

Profitability Index

 

The profitability index is a financial metric that is used to assess the profitability of an investment or project. It is calculated by dividing the present value of future cash flows by the initial investment. A profitability index greater than 1 indicates that the investment is expected to generate a positive return.

 

Business Profitability

 

Business profitability refers to the ability of a business to generate profits over a period of time. It is a key measure of financial success and is influenced by various factors, including revenue, expenses, and the overall economic environment. A profitable business is one that is able to consistently generate profits and achieve a positive return on investment.

 

Strategic Decision Making

 

Strategic decisions are decisions that are made by a company's management team to set the direction and goals of the business. These decisions can have a significant impact on the company's profitability and financial performance. For example, a company may make strategic decisions to enter new markets, launch new products, or invest in research and development. These decisions can affect the company's revenue, expenses, and profitability ratios.

 

All of the terms mentioned above are interrelated and can affect each other. For example, the profitability ratios are calculated using the financial data from the income statement, including the total revenue and net profit margin ratio. Changes in the total revenue can directly impact the profitability ratios, as higher revenue can lead to higher profit margins. Similarly, strategic decisions can influence the total revenue and profitability of a business. For instance, a company's decision to enter a new market can result in increased revenue and profitability if successful.

 

In summary, profitability ratios, financial ratios, total revenue, net profit margin ratio, profitability index, operating profit margin ratio, business profitability, profitable business, and strategic decisions are all important concepts in assessing a company's financial performance and profitability. These terms are interconnected and can impact each other, highlighting the importance of accurately analyzing and understanding these metrics for effective decision-making and achieving long-term profitability.

 

Design Your Business For Maximum Profitability

Of course, there may be many other causes of low profitability, but these are typically some of the ones we see with the greatest impact.  Our SAP BW Consulting team can help you design and implement solutions to address each and every one of these profit robbing problems.

 

 

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