By Anton Herbst, managing director of A.C.T.
With last month’s installment of this column explaining what it takes to build an effective customer value proposition, we’re moving onto building a successful profit model and the steps towards thoroughly understanding the interplay between revenues, costs, profit margin and resource velocity.
Tackling and understanding each of these areas is relatively simple – figuring out how they impact different aspects of your business is far more difficult though.
To recap, revenue is quite simply your company’s income, i.e. the volume of stock you are selling multiplied by the price you’re selling that stock at.
Cost is the sum of all expenses your company incurs in order to sell its stock to customers.
Profit is the differential between these two – and profit margin is the percentage differential between revenues and costs.
Resource velocity – the most confusing term of the four – is how fast we need to turn over inventory, fixed assets, debtors and other assets – and overall, how well we need to utilise resources – to support our expected volume and achieve our anticipated profits
Sounds simple? Well, it’s a little more complex considering the economic downturn or recession we find ourselves in.
The Rand’s strengthening has been a challenge, since it’s meant that the price we are able to command for our products has slipped. At the same time, the natural slowdown in the market means demand for our products is tailing off.
Consequently, costs are coming under enormous pressure.
The only way to make healthy profits in this economy is to either increase margins or increase our resource velocity.
Increasing margins is counterintuitive in market conditions such as these – the tendency is towards selling higher volumes and this often calls for margins to be cut.
So, with margins under pressure, companies need to increase the velocity of resources. In a nutshell, companies’ cash to cash cycle has to speed up.
Building a sound profit model therefore revolves directly around finding the sweet spot between the profit margin your business is achieving and its ability to speed up its cash to cash cycle.
It is important to focus on both of these areas, since a company charging 10% profit margin on its stock, with a resource velocity that sees it turning cash into stock and back into cash again six times a year, makes the same return as a company with half the profit margin (5%), but the ability to turn cash into stock and back into cash again 12 times a year.
Personally, with the market as tight as what it is, I believe the key lies in maintaining margins at a reasonable limit and exercising excellent financial discipline.
There’s quite frankly far less room to move today when it comes to margins, after all, you need to remain competitive. There is however a ton more a company can do when it comes to managing its cash flow (cash to cash cycle) more effectively.
It’s no easy task, but after all we’re in a downturn – hard work is called for. I can personally testify to the fact that it can be achieved.
It can be done, but it takes focus, discipline and bravery. Good Luck.