Answer:
Concept of Profit Planning:
A lack of accurate cost estimation and analysis results in profits of unknown quantity and often loss. Some companies who are profitable still fail because profits are not necessarily in the form of cash, such as accounts receivable, and focusing just on net income can be a mistake unless contingent variables are considered. It is vital that a company sets and monitors certain benchmarks in its strategic planning from which performance can be measured and tracked.
The relationship between components related with profit shows that profit is excess of revenue overexpenses [Net Income (Profit) = Revenue (Income) minus Expenses (Costs)] and revenue comes in the form of cash and accounts receivable and there are two types of expenses i.e. fixed and variable. The fixed expenses includes periodical expenses regardless of operational effect and include items such as rent, insurance and depreciation etc. whereas variable expenses vary according to the level of operations and includes items such as product labor and material, sales promotion and cost of delivery etc. The expressions of profitability indicate a certain relationship between revenue and expenses. A decline in profit margin should be the catalyst to search for a cause, such as an increase in expenses; discounting or pricing errors caused a decline in per unit sales revenue; or a change in business operations.
Planning for profit required to consider important fundamental aspects such as developing an understanding that liquidity provides maximum flexibility; income statement needs to be viewed in relation to the balance sheet and the cash flow statement; and managed, under control growth leads to planned growth.
Profit Planning Process/Steps:
Abrief explanation of profit planning process is given below.
- Determine the Goal of Profit: The target value for profit should be based on the realistic and planned results of Entrepreneur Company’s strategic plan.
- Determine Planned Sales Volume Required for Achieving the Profit Goal: Planned sales volume to achieve profit goal can be determined by utilizing operating and sales budget forecasts. This is because these forecasts influence decisions on materials purchasing, production schedules, financial resource acquisition, plant and equipment procurement, personnel enumeration, along with employment and inventory planning. Such forecasts should be derived from well developed, realistic determinations of market conditions, market trends, industry trends, competitive analysis, competitive edge, market segmentation, promotion strategies, pricing strategies, distribution, inflation and so forth.
- Estimation of Expenses for the Planned Sales Volume: Entrepreneur should make the use of previous years’ figures if it is an existing company. For start-ups, analyze similar companies in the industry and tap published research to come up with realistic estimates of Expenses. Entrepreneur should make adjustment in expense projections based on, change in economic conditions; ratio of expenses to sales level change; production methods improvements and efficiencies; reasonable salary levels; materials to produce products; and labor to produce products. Once he arrived at cost of goods entrepreneur needs to compare it to the industry average for accuracy.
- Profit Estimation: Entrepreneur should subtract the expected expenses from estimated / projected sales income and arrive at projected profit.
- Compare Estimated Profit with Profit Goal: If there is a wide discrepancy between estimated profits and profit goal continue with the following steps.
- Determine Alternatives to Improve Profits: Entrepreneur should identify the alternatives to improve profits and such alternatives may be in the form of Changes in Planned Sales Income; Increasing Sales Promotion; Improve Product Quality; Improve Access to Product’s Availability; identify Alternative Product Uses; Analyze Unit Pricing Strategy to determine Best Pricing Policy for defined Target Markets; improve Service; work for improving Product Reliability; establish more Integrity in Sales Process; Better Updating / Upgrading Strategies; improve After Sales Strategy. An alternative should also be considered for reducing planned expenses planned expenses and such alternatives may be in the form of identifying better control systems for product development; minimizing losses; increased productivity of people & machines; product re-design, re-branding, re-packaging, product improvements; reduce unit costs; add other products in the mix to offset costs; use idle capacity and assets innovatively; make certain parts internally if more efficient than purchasing from vendors; sets specific cost reduction plans for each quarter for each department; subcontract certain work and outsource and so on.
- Determine How Expenses Vary With Sales Volume Changes: Entrepreneur should Experiment with expense levels in selling fewer or more units against planned sales, and develop his/her understanding of the relationship of fixed and variable expenses to find the optimal mix of products and the unit sales of those products. Entrepreneur should be aware that limited changes in sales volume could be preferred as high sales volumes are costly and expend a lot of effort and low sales volumes results in extra costs due to idle capacity, lack of volume discounts, underutilized highly trained and expensive labor force, and so on. Entrepreneur should also consider changing conditions such as economic shifts, inflation, deflation, customer shifts, competitive products, market shifts and other factors causing changes in unit costs.
- Understand How Profits Vary With Sales Volume Changes: Entrepreneur should Use different Sales Volumes to determine the resulting Break Even Point and the Profitability.
- Analyze Profit Alternatives: Entrepreneur should analyze profit alternatives by using the information generated in Steps 6, 7 and 8 and take in to consideration profit increasing alternatives, such as Sales Price Changes; Change Advertising / Promotion Strategy; Reduce Variable Costs; Increase/ Decrease Quality of Products; Find the right mix of Products; Eliminate Low-Margin Products; Bundle High Margin Spare Parts with New Equipment and so on.
- Finalize and Implement the Strategic Plan: Entrepreneur should Measure the effectiveness of Strategic Plan’s implementation over time to keep track of company’s resulting Return and Profit Margin. Entrepreneur should also try to Implement Tax Savings Strategies to retain more Earnings for future Opportunities and Expansion.
