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Profit and Loss Statement Article

Maximizing Profits in Your Business – Profit & Loss Fundamentals, Analysis and Strategy

This Article will show the business owner how to understand and analyze an Income and Expense Statement; perform a Maximum Profit Analysis; plan for Profits; and apply Profit Maximization Principles. Having a good Business Plan in place to successfully run your business is key but implementation of that Plan is necessary to reap its benefits. One aspect of implementing your Business Plan into your Company’s Operations is through good Income Statement Analysis, Planning and Application. As your Strategic Plan tracks and implements your Profitable Operations, it is important to understand what your Income Statement is telling you, how to realistically project your future profit potential and how to effectively maximize Company Profits.

I. Income Statement Fundamentals

Note: We use a Manufacturing Company as the example.

A. Major Components of an Income Statement:

1. Sales and Revenue

2. Cost of Goods Sold/ Cost of Sales (COGS)

a. Material

b. Direct Labor

c. Manufacturing or Factory Overhead

3. Operating or Gross Margin (GM)

4. Expenses

a. Engineering

b. Marketing

c. General & Administrative (G & A)

5. Pre-Tax Profit

B. Revenue / Sales:

1. Breakdown of all Products & Services and the resulting Revenue for each category.

2. Last Line should be the overall average: Units sold times the Average Unit Price.

C. Cost of Goods Sold/ Cost of Sales:

1. Cost of providing a product or service for sale.

2. In a manufacturing Company it comprises of:

a. Material: Raw material and parts required to build a unit. A significant part of each Revenue Dollar, i.e. 40% of each sales dollar on new equipment and 15% for spare parts.

b. Direct Labor: Labor cost in manufacturing a product. Typically, 7 cents of each Revenue Dollar for new equipment and 1.5 cents for spare parts.

Note: Material & Direct Labor costs are Variable, varying directly to the quantity produced.

c. Manufacturing or Factory Overhead: Costs which don’t contribute directly to the production but necessary to build a product. For example, Employees of the Purchasing Department, Material & Production Control Planners, Clerks, Quality Assurance Inspectors, Manufacturing Department Personnel, etc.

Note: Overhead is a Fixed Expense, not fluctuating appreciably with output.

D. Operating Margin: Sales minus Cost of Goods Sold

E. Expenses:

1. Engineering

2. Marketing: Usually the highest expense.

3. General & Administrative: Usually the smallest expense.

F. Pre-Tax Profit: Operating (Gross) Margin minus Expenses.

II. Maximizing Profit Analysis

A. Market Analysis & Marketing Plan:

1. Must have an accurate Analysis to determine what the Market is willing to pay.

2. Understand clearly your Competitor’s pricing and develop a successful Pricing Strategy for your Marketing Plan.

3. Price War Considerations:

a. Pricing below your Competitor’s pricing may go too far and set off a Price War.

b. Competitors respond by reducing prices below market values to recapture market share lost.

c. Customers can become accustomed to the lower fair-value price, making it hard to return to pre-war pricing. Gross Margins of a profitable 50% can quickly erode to the breakeven point, typically about 30%.

d. An Accurate Market Analysis and an Effectively implemented Marketing Plan understands both the Customers and Competitors responses to certain price levels.

B. After Market Sales: Spare Parts

1. Most profitable product line: 70% Gross Margin (GM), representing about 12% of Sales Revenue.

2. Cost of Goods (COGS) on Spare Parts is normally about 30 cents of each Sales Dollar when operating with a 70% Gross Margin.

a. COGS on new equipment represent about 60 cents of each Sales Dollar and a resulting 40% GM.

3. Key: Keep a high ratio of spare parts to new equipment for Maximum Profits.

a. Package Spare Parts when you sell New Equipment with a GM range of 70-95% on the various parts, discounting the New Equipment.

C. Cost of Materials:

1. Although Materials (all the parts, components and sub-assemblies of a product) is a cost that is fixed on a per unit basis, it can be manipulated for maximum profit potential.

a. Material for a manufacturing company typically represents about 38 cents of each sales dollar for new equipment and about 1.5 cents per sales dollar for spare parts, for a total average of about 39.5 cents per sales dollar.

2. Value Engineering: Designing and re-designing products for the lowest cost without performance compromises.

a. Each part and sub-assembly is analyzed to determine if comparable function can be achieved at lower costs by utilizing different materials, components, manufacturing processes or lower cost vendors.

i. An example would be adjusting a component’s tolerance from 5% to 10%, provided the design analysis finds the substitution acceptable.

ii. Simply cleaning a part during the machining or assembly steps can lower costs.

b. Examine production procedures to reduce waste and spoilage.

3. Raw Material Management: Strongly contingent on good Market Planning & Forecasting. If the forecast is too optimistic, then too much material is purchased, which unnecessarily raises inventory costs. If the forecast is too conservative or too low, then too little material is procured, which can result in late product delivery, customer dissatisfaction and lost sales, which in turn causes an increase in effective material costs.

This article is an excerpt of a Chapter from our Business Success Guide. For the rest of the Chapter, please visit:  The Business Success Guide

The remaining major sections of the book’s Chapter have been left below as an outline so you can get an idea of what else is contained in this Chapter of the Business Success Guide.


4. Inventory Management:

5. Good Relationship with Suppliers:

D. Direct Labor Cost Savings Strategies

E. Manufacturing Overhead Cost Savings

F. Cost of Goods Sold (COGS)

G. Gross Margin (GM)

H. Pre-Tax Profit:

I. After-Tax Profits:

J. Summation of Components:

III. Profit Planning

A. Profit Relationships and Components:

B. Plan for Profit:

IV. Applying Profit Principles to Real Life Situations

A. Overview:

B. Successful Company:

C. Mediocre Company:

D. Company Failure:

E. What can be Learned?