Profit maximization is an important goal for all businesses. Understanding accounting profit, operating profit margin, and other profitability ratios is also necessary; along with calculating cash flow.
Successful small business owners focus on maximizing profit as the key strategy in business.
And that's how it should be (after startup financing or operating capital is raised); most of the time and, at least, for the longer term.
But profit maximization is not the only strategy that business owners need to focus on.
For the short term and the near term, particularly in today's financial and business climate, business owners also need to focus on calculating cash flow, using cash flow charts to track inputs and outputs, and optimizing your cash flows.
Analyzing financial statements is usually only number one on your reading list when you're focused on profit maximization.
But make sure that you also read the statement of cash flow for your business regularly and focus on working capital management. Ensure that you (if you do the books yourself), or your accountant, focus on improving your cash flow as a primary financial strategy for your business.
If you invoice your clients (rather than cash and carry in various forms), then you must do your invoicing daily (at minimum). Ensure that the day the product is shipped or service is delivered, is the day the invoice is produced. In a worst case scenario, invoice the next day.
If your work is spread out over time, progress bill. For example, a graphic designer I work with will progress bill jobs that are longer than one week and/or are worth more than $1000. She bills one third before she starts the project (and she doesn't start work until she receives that first payment), the second invoice (for a third) is submitted midway through the project, and the last third is invoiced upon completion. She makes her terms very clear from the start, both in person and on her invoices. By using this method, you can receive a more consistent cash flow.
Consider offering discounted payment terms; 2% discount if paid in 10 days, Net 30 days. I have mixed feelings and mixed results with this tip. Some customers are just going to take that discount regardless of whether they pay within 10 days.
If you have a customer that is consistently late paying, you need to consider whether or not you can afford to do business with them; you may need to 'fire' that customer. But before you get to that stage, start tracking your receivables very closely. See who pays on time, who pays inconsistently, and who pays late (consistently). Be proactive and contact the inconsistent and late payers before the invoice becomes overdue, and then steadily keep the pressure on.
Yes, this takes time (consider the advantages of outsourcing if you don't have time or people to do this important task) but the pay-off is in improved cash flow and ultimately, improved profit maximization.
A variation on tracking and working with inconsistent and later payers, is to ensure that new customers are closely screened. Don't take them on as customers if their credit reports (use credit reporting agencies; these usually cost money but are worth it for large size orders) show late payments. Contact others in your industry (try your industry association, they may provide you with contacts) and do reference checks on potential new customers. Make sure you have a clear and concise credit policy and have all new customers apply for credit with you.
Also be aware of your market environment and economy. If the economy is very slow, good payers may become slow payers. If you are tracking your receivables closely and if you develop good relationships with your customers' accounting people (the accounts payable department), you will be able to see a slow- down coming and be able to manage your cash and work on profit maximization.
Reduce inventory to reduce your investment and reduce cash costs and cash outflows. But do not reduce inventory to the level that it will hurt sales.
I've worked with clients who have been able to develop terms with suppliers (the supplier holds your inventory on their floor, or they give you extended payment terms (60 days or 90 days) to lower the cash drain that inventory can cost. I've also worked with clients who were able to streamline the supply chain and improve their inventory turn cycles so they had to carry less on their floor, and therefore invest less in inventory.
Ensure that your sales plan is current and accurately reflects the market conditions and your business capabilities. The sales plan will 'feed' your cash flow projection, and will be built with profit maximization in mind.
Look at your business debt. Can you consolidate loans (think credit cards, equipment loans, line of credit, and more)? Can you negotiate better rates? I've worked with a client who participated in industry ratio studies. The studies showed that his business was a profit leader in his industry; he shared that with his banker and received a percentage point off the lending rate.
It is always better to ask for money when you don't need it (I know this sounds wrong, but it's true; banks are concerned if you need money in a hurry, but if you have money in your account and the cash flow looks positive then they are often happy to lend you money. Negotiate a business line of credit (to be used when you need it) during the good times, not when the business has gone flat.
If money is really tight, and you have a good explainable reason (such as you're entering your busy Christmas season and are building inventory higher than usual), check with your lenders to see if they will let you re-negotiate your term (say from 3 years to 5 years). On that note, if you have cars on business leases, see if you can re-finance them for another year or two, rather than turn the lease in and inevitably the new car(s) come in at a higher price.
Managing and calculating cash flow means looking for ways to reduce cash outflow, while increasing cash inflow. While the statement of cash flow is usually part of the monthly analyzing financial statements process, if cash is tight maintain a daily cash flow chart or projection spreadsheet (easy to do online). When you manage your money that tightly, you will spend less and look for ways to increase income more (and focus on profit maximization).
Don't pay your payables early. If your supplier's terms are net 30 days, pay your bill in 30 days. Even if you have the cash to pay, don't pay; keep the money in an interest account until you have to pay the bill. Set up for electronic invoice payments- then you can pay on the last day due.
If cash is very tight, contact your suppliers and see if you can work out terms with them but hold to those terms. If you say you are going to pay 25% of the bill every week or every two weeks, you must do so. And as soon as the cash problem is reduced, get back to paying on time.
Consider consolidating suppliers for a better price and/or better payment terms. I worked with one client who used more than 30 transportation companies for his cross-country business.
By developing programs with eight companies, he was able to save significant dollars, get better service and he negotiated extended payment terms. Profit maximization can be accomplished one step at a time.
If cash is impossibly tight, consider asking your best customers to pay early. Give them a discount if necessary. This is hard to do, and you want to be careful NOT to scare your customers into looking for another supplier, but if times are tough you need to do what you can to save your business.
Also consider what assets you can sell: under-utilized assets, inventory reductions or sell-offs, or whatever can make you some quick money.
Understanding how to maximize profit includes analyzing profitability ratios such as accounting profit margin, net profit margin, operating profit margin, and gross profit margin.
Profit maximization is a primary goal for any business, but analyzing financial statements and using the statement of cash flow to ensure that your business thrives and survives is also a key strategy in business growth.
Find effective Startup Financing Strategies.
Your Business Financial Plan needs to be a key element of your overall Strategic plan.
Getting financing for starting up your new business is a challenge.
But just as challenging is ensuring that you have enough financing to operate your business.
Most businesses do not have a steady flow of cash incoming (or outgoing); it comes in 'fits and starts' no matter how much we try to plan for consistency in cash flow.
You need to ensure that you forecast your cash flow needs realistically and that you are on top of your accounts receivable; do not let your customers use you as their bank (by extending long payment terms), especially during the start up years of your business when every dollar is important to your success.
Make sure that you are clear in setting up new customer accounts: tell your customers what you need and expect in terms of payment (for example, cash on delivery (COD), 15 days from date of invoice, a deposit on order and balance on delivery, etc.).
However, also make sure that your invoice terms are competitive for your industry; check out what your competitors offer and make sure that your terms are competitive. For example, if you want payment in a shorter time frame than your competitor offer an incentive for that earlier payment: perhaps a discount of the next order, or a rebate, or a gift.
Merchant 'advances': from companies that lend money on credit card cash flow rather than collateral;
Accounts receivables or trade financing: from 'factoring' companies that buy and assume the ownership for the invoice from a customer;
Raise money through preferred shares (non voting) or common shares (voting) in your limited company;
Subordinate financing: typically a higher interest (because it is higher risk) loan based on cash-flow and receivables, rather than on assets.
For each of these alternatives, talk to your accountant and your banker: even if the banker isn't loaning you the money, they can provide valuable input and advice.