A profit map, the core analytical tool of profitability management, displays the profitability and cost structure of every product in every customer in the company. Profit maps show exactly where profit is flowing and where it is lost.
A profit map is not especially difficult to develop, but it is completely different from the information developed for financial reporting. Many finance managers make the mistake of starting with their existing financial information and trying to allocate it into sectors of the business or product families. Instead, the essence of profit mapping is to create and analyze a database comprised of the net profitability of every invoice/order line. An experienced manager and analyst can develop a profit map in a month or two.
The process of developing an “income statement” for every order line is relatively straightforward. Your sales file shows the customer, product, revenue and cost of goods sold. Between each line’s gross margin and net margin is a set of sales costs, operations costs and overhead costs. For the sales and operations costs, simply develop tables of costs for each cost element. For example, you can identify whether an account is served by a sales rep, by telesales or simply by your website and assign an appropriate cost for each. Similarly, you can tell by the account location and product type the approximate cost of delivery. Overheads require more judgment.
The value of a profit map is that it quickly highlights your company’s islands of profit and sea of red ink. It also enables you to identify exactly which cost elements are most important in determining profit or loss for specific products in specific accounts. (I call these “profit levers.”) You can translate this picture into an extremely focused “to-do” list for your company’s sales reps. It also provides a powerful basis for aligning the incentives of all of your company’s managers with those of the top management team.
Here’s a critical tip: work at “70 percent accuracy.” Developing a profit map is like writing a paper. Start with a rough profit map using estimates and rules of thumb and then sharpen your pencil only where it will affect a decision. At the end of the process, your company’s operating managers only need to know what one or two things they have to change in each account, what the likely impact will be and how this will improve their compensation.
Here are a set of questions that profit mapping will enable you to answer.
- Where are we making money?
- Within these profitable customers, how much of their business is unprofitable?
- Is this business safe from competitive encroachment?
- What are we doing to lock in and grow this business (our “sweet spot”)?
- How can we focus our resources on obtaining more of this business?
- What are we doing to increase these customers’ own profitability?
- Which customers are marginally profitable?
- Within these customers, what specific changes would make the biggest improvement?
- Who should make the change?
- How can we set up an ongoing, scalable organizational process that transforms the marginal business into profitability?
- What is the likely gain vs. additional effort?
Source: “3 Steps to Turbo Charge Profits”
Original Publication: Business Finance
Subjects: Accounting, Finance, Management, Operations