Improving Operating expenses

The second of the 5-chapter Science of Business Wealth financial performance evaluation is profitability growth.

Practitioners of our Business Health Assessment mention “I can show the results but how can I help the improvement process”. This diagnostic evaluation process is aimed at helping you through that journey.

Remember you goal is to identify where improvement or opportunity lies. The business owner will know how to take your analysis and make it actionable.

Profitability growth is measured by the increase in profit per revenue $ from one period to the other.

The core components of profit performance is:

  • The performance of gross profit from the previous period to the current period.
  • The way operating costs have behaved from the previous period to the current period.

Profitability is considered in relation to revenue growth.

The question is “has profitability improved irrespective of whether revenue has grown or declined”

Profitability growth is a good indicator of how scalable the business is.

This part of the diagnostic series deals with operating cost performance.

Tool kit

  1. Segment the operating costs into Fixed and variable costs
  2. Horizontal analysis
  3. Vertical analysis

Fixed and variable costs segmentation

Review the operating costs within the detailed income statement line items.

Identify

  • The variable costs components
  • Fixed costs components
  • Depreciation and amortization
  • Interest charges on monies borrowed.

Variable costs include those operating expenses that vary or change directly in response to revenue changes. Examples of these costs would be commissions paid, freight, contract labor, and certain types of promotional costs like “pay for click”

exp1.png

The relationship of the variable and fixed operating expenses is displayed in the profitability window within your scorecard

exp2.png

Consider

  • Which of the fixed or variable costs component is increasing / decreasing in relation to the changes in revenue growth %.
  • Where fixed costs are declining as a proportion of revenue this could be an indicator of improved scalability.
  • Where fixed costs are increasing, identify the specific costs that relate to the increase.

Vertical analysis

The comparison of each income statement element to revenue

In the example below it shows the benefit of the cost improvement through revenue growth has been diluted with the declining gross profit margins.

exp3.png

Horizontal analysis

Displaying the growth within the income statement components

exp4.png

The above example shows how strategy impacts financial performance. Discounting or the derivative thereof delivered a 20% growth or a $2.4M of additional revenue.

This revenue creates an additional $55k in profit. A lot of work for very little in return.

Identifying and reducing operating cost

We deploy 3 tools

  1. Eliminate redundant and duplication activities
  2. Reduce low value-added work
  3. Deploy technology

Eliminate redundant and duplication activities

This involves the review of your process. Redundant activates are usually caused by

  • Each person does things their way (no consistent defined way of doing things)
  • Duplicate tasks are performed by another person (because it’s always done that way)
  • Do things that are not used.

Reduce low value-added work

These are activities that do little or no value to the customer

Deploy technology

Identify where technology / software applications can make process or work more efficient.

Improving Gross Profit
Strategic growth rate – the new standard or is it

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Wednesday, 12 December 2018

Mick Holly & Andre Gien

Wealth Scientists

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