As Iowa State University reminds us, “profitability is the primary goal of all business ventures.”
Business leadership is often responsible for measuring current, past, and future profitability. But what is profitability? Profitability is the difference between the amount you sold a product or service for, and what it cost you to buy or create it.
The importance? “Organizations that are more efficient will realize more profit as a percentage of its expenses than a less-efficient organization, which must spend more to generate the same profit.”
To illustrate the importance of profitability as well as its pitfalls (if not carefully monitored), we’re sharing a client case study. Let’s dive in.
Let’s first set the scene. Our client was a printing company located in North Central Illinois with sales of $19,200,000 and a second-generation owner.
Product pricing is often based on an understanding of the cost of goods sold (COGS).
The problem arises when the actual costs are different from the estimates used. This CFO Simplified client watched profitability slowly disappear—until they incurred a $125,000 loss. Understanding the cause was the first step to returning to profitability.
To identify where the losses were occurring, job estimates were first compared to the final production costs. Manufacturing variances were caused by a variety of factors, but the summary general ledger (GL) postings didn’t provide an answer.
Pulling raw data from the company’s production system allowed a comparison between the estimate and the actual cost of production of each item shipped in the prior week. This information was available from their enterprise resource planning (ERP) system.
Initial variances were calculated at between 15% and 35% for each production run, which in most cases exceeded the planned margin. Each production run was scrutinized to determine the specific cause(s) of the variance.
Digging into each of these production orders showed a variety of issues, including:
Each issue was discussed individually with the Operations Vice President and Production Manager.
Responsibility for production improvement was then assigned to the Production Manager, and the weekly production variance report was reviewed by the Production Manager with team leads.
The reports identified that production problems weren’t unique. They were nearly epidemic. Greater scrutiny of the causes, with variances being reported daily, brought the issues of cost overruns to prominence.
With everyone keeping their eye on the ball, the number of production problems dropped. This resulted in cost variances being reduced to less than 5% in 90 days.
That reduction drove a dramatic change in profitability, since removing wasted materials and wasted time turned each printing press into a profit generator.
Monthly results showed an immediate turnaround, with net income moving from a loss of $125,000 to a profit of $490,000 in the first year, an increase of over half a million dollars.
As this case study demonstrates, profitability is the most important measure of a business’ success. A CFO can help ensure your business’ profitability is at its best. Continue reading for more CFO Simplified client success stories, then get in touch with our team of experts today.
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