Profit First: How to Transform Your Business (Part 2)

Profit First: How to Transform Your Business Part 2

You may recall in part 1 we looked at human behavioural concepts and why many businesses grow and grow and yet the bottom line doesn’t improve as the business consumes more and more resource. We looked at the concept of Parkinson’s Law and the triggers in behaviour that occur when supply is scant, namely: –

  • First you become frugal
  • Secondly you become extremely innovative

We also looked at the new way of considering the accounting formula for your business to give you the Profit First formula of: –

            Sales – Profit = Expenses

You can find the full article on the following link.

In this article we are going to look at assessing the health of your business by urging you to run a Profit First Instant Assessment on it – below is the Profit Assessment Table. You will need your last profit and loss account of the business to complete the details: –

  ACTUAL TAP PF£ VARIANCE FIX
Top line revenue A1        
Material and Subs A2        
Real Revenue A3 100% C3    
Profit A4 B4 C4 D4 E4
Owners Drawings A5 B5 C5 D5 E5
Tax A6 B6 C6 D6 E6
Operating Expenses A7 B7 C7 D7 E7

To complete the table, here is an outline of what is needed: –

A1 – Enter your top line revenue for the last full 12 months – this will be referred to in your accounts as turnover or takings or sales etc.

A2 – If you are a manufacturer, retailer or more than 25% of your sales are derived from the resale of stock, put the cost of materials for the past 12 months in this cell.

If sub-contractors deliver the majority of your services, put the cost of the subcontractors for the past 12 months in this cell. Please note this should only include sub-contractors and not payroll staff.

If you are a service company and the majority of your services are provided by employees, don’t include these in cell A2.

If your material and sub-contractors costs are less than 25% of your top line sales, do not include them in cell A2 – as they will be accounted for as operating expenses.

Don’t overthink this at this stage!

A3 – Subtract the materials and subcontractor costs from top line revenue. The idea is to get a feel for the “real revenue” of the business. This is the real money your company makes and its important to understand this. For example, a construction company with sales of £6m but materials and subcontractors of £4m is really a £2m business!

A4 – Now you have your real revenue number, let’s start with Profit First. Take your annual profit for the last 12 months – this will be your profit before tax, owners pay and drawings / dividends.

A5 – In the ‘Owners drawings‘ cell, enter the amount you paid yourself (and any other owners of the business) by way of salary, dividend and any other drawings you had.

A6 – In the ‘tax’ cell, enter the tax the business has paid on your behalf. For a company, this will be the company tax plus any of the owners’ tax that the company may have paid for them. For a sole trader this will be the tax paid in the last 12 months.

A7 – ‘Operating expenses’: – add up all the business expenses paid in the last 12 months. This will be everything except your Profit, Owners drawings and tax and any materials and subcontractors you may have already included in cell A3 above.

The idea of this initial assessment is to gather a broad understanding of your numbers, so it doesn’t have to be 100% accurate!  However, in the table above, operating expenses plus tax plus owners pay should equal real revenue. 

B4 – B7

These are Target Allocation Percentages (TAP’s) and are based on research of how fiscally healthy companies perform so act as a “target” to strive towards. They are not to be considered as perfect but are a good starting point to act as a target as you go through the Profit First process.

Below is a grid of TAPs you can use in your business.

  A B C D E
Real revenue range £0 – £250k £251k – £500k £501k – £1m £1m – £5m £5m – £10m
Profit 5% 10% 15% 10% 15%
Owners drawings 50% 35% 20% 10% 55%
Tax 15% 15% 15% 15% 15%
Operating expenses 30% 40% 50% 60% 60%

C3 – C7

These cells can now be completed by multiplying the number in column A by the percentage in column B. For example, C4 is A4 x B4 and so on.

D4 – D7

This is the difference between column A and column C – for example A4 minus C4 = D4. This is likely to be a negative number for Profit, Owners Pay and Tax and a positive number for Operating expenses – but don’t’ worry about that at this stage as this is just a measure of the “gap” between where you are now and the target you can strive to get to, although it is usually an eye-opener for many business owners!!

E4 – E7

This final column is the action / Fix column and only needs the words on each row.. increase or decrease. If the number in column E is negative write “increase” (as this is a category we need to improve) ; if the number in column E is positive write “decrease” (as this is a category we need to spend less on)

Below is an example of a completed Instant Profit Assessment

  ACTUAL TAP PF £ VARIANCE FIX
Top line
revenue
£1,233,000        
Material
and Subs
£0        
Real
revenue
£1,233,000 100% £1,233,000    
Profit £95,000 10% £129,000 (£118,000) Increase
Owners
drawings
£190,000 10% £123,000 £67.000 Decrease
Tax £95,000 15% £184,950 (£89,950) Increase
Operating
expenses
£943,000 65% £801,450 £141,550 Decrease

Looking at the above, it is clear where attention needs to be focused. Profit should be higher, ‘Owners pay‘ is too high and not sustainable at this level; ‘Tax‘ needs to increase to ensure there is cash allocated to pay all the taxes; ‘Operating expenses’ are too high and need to be looked at carefully to see where savings can be made.

In the next part we will look at how you go about making the Profit First allocations to start to move towards the Target allocations as well as starting to look into more detail behind the methodology, so be sure to revisit in due course.

In the meantime, if you would like our help to take you through your own Initial assessment and to set an action plan to improve the health of your business, please do not hesitate to contact us.

Article by
Paul Dell

020 3146 1606
Partner

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