Published by : Jean-Francois Fontaine, B.Ing. M.Sc.A.
Over my 30+ years of experiences, I’ve seen profit not matching the expectations of leaders. Profits go both ways - sometimes they are below expectations, and sometimes above. You know every detail of the company's the bank account and the cost of everything, so do you ever wonder why your management process can't better predict results?
Finance people say “it is because of the product mix.” But how can you not forecast accurate profit results, if you have all the required data? Nothing should be left to guesswork.
Maybe the financial statement process is not appropriate to predict the future - it's an accurate description of the past!
In fact, predicting profit relies more on the perspective you take to project results. What if you decided to look at your company as a “MONEY MAKING MACHINE,” rather than as a “GROSS MARGIN MACHINE” that generates profit?
That perspective could change the way you make decisions when managing your business. In fact, it could make a massive difference between making and losing money.
The most important thing to examine is the different revenue streams that feed your money-making machine.
Let’s define what those are.
Both the path your material (or service) takes to get to the market, and the end-user that acquires it make up your revenue stream.
The Revenue Streams deliver the profits not the gross margin of your products!
Based on the market served and its users, there is a multitude of revenue streams that bring revenue to the company.
The market for the same product with the same cost dictates its selling price. In other words, its price will change depending on the market the products are sold in. Thus, it is reasonable that the negotiated price changes from one market to the other.
Now, let's consider the costs that must be assumed whether we sell or not a product:
The cost of materials is directly linked to the sale. If the sale happens, the material is spent to “manufacture” the end-product. It is the same for all real direct cost such as representative’s commission, the freight charges, sub-contractors, or any other activities that must take place because the sales occurred.
A generally accepted hypothesis at every company I've worked with is to that the cost of production labour varies based on the sale activities.
Nothing could be further from the truth!
In the 19th century where people were paid based on parts produced, which made sense then. But today the workforce is scarce and costly to replace, so companies tend to keep it stable to minimize costs.
Therefore, your product cost system does not reflect today's situation.
So how could you be sure you meet our profit goals?
If you recognize that the cost of labour is not dependant on the sale, it means your pricing strategy is wrong!
When you take that into account, the revenue streams generate contributions (sales revenue minus the real variable cost).
Contributions are the foundation of profit!
It becomes a matter of selling revenue streams that have the potential of generating the highest contributions. The analysis goes from "the product makes the profit" to the acknowledging that contributions are the driver of the business profits.
Contributions from the revenue streams, not product profit dictate pricing decision.
The management of companies must be updated for the 21st century where the change of paces is accelerating. The ones who make those changes first will have a competitive advantage over the others that have not yet acknowledged the shift.
Profit prediction matter is a vast subject and could not be entirely discussed here and will be the subject of other articles, but there is the critical thing to remember:
Revenue streams are the foundation of profit, not the product profit.
Revenue streams are based on internal capacities and markets served. The market dictates the selling price and every revenue stream does not contribute to the profit the same way.
Sorting your revenue stream by potential will prioritize the sales efforts to maximize profits.