Do you want to increase profit for your business?
Many businesses focus on lead generation, enhancing foot-traffic, increasing sales and optimizing cash flow etc.
However, I am puzzled by how few business leaders teach their respective employees to increase profit, both in terms of gross and net profit margins.
By discovering this blog, I believe you understand the importance of profit generation, or have begun your journey to mastering the art of profit accumulation. However….
Is your team on the same page as you?
Over the course of my career, when I have asked most executives ‘what is profit?’, I generally receive a puzzled look as if asking a trick question.
Most executives don’t really understand the difference between sales revenue, gross-profit and net-profit (if you don’t believe me, ask your colleagues ‘what is profit?’ before challenging them with ‘how to increase profit’.
The financially literate understand the concept of gross-profit as the money remaining after paying for the cost-of-sales, and that net-profit is the money left over after paying all other fixed and variable operating expenses and taxes.
But even then – I like to dig a little deeper by asking, ‘what value does profit actually bring to a company – why should you even care?’
Many don’t truly understand the value of profit; this is a serious challenge for senior executives no matter the size or sector of their operation.
If either yourself and your employees don’t have a full understanding of profit, how can your thoughts and actions be geared to truly increase profit and maximize customer lifetime value?
It’s the equivalent of an airline pilot navigating their plane without understanding where or how to land – very unnerving!
It is my opinion that all employees, from the lowest to the most senior ranks, should have a very clear understanding of:
- the company’s purpose and values (I have a dedicated article explaining how this can increase sales revenue).
- the meaning of gross-profit, net-profit, their corresponding margins and how they’re calculated .
- how increased profit can be used to fuel further business growth.
- and finally, how profit directly impacts the employee’s personal and career growth..
Jacques Nasser, a former CEO of Ford Motor Company, believed that it was absolutely essential that his employees understood the value of profit.
So much so that he went as far to commission the services of Ram Charan to write and distribute a book called ‘What the CEO Wants You To Know’
I highly recommend picking this book up if you want to learn more about this subject.
So, how should you get your colleagues up-to-speed on profit?
Through numerous one-on-one sessions with business executives, I have discovered that the use of a particular analogy, one that is relatable and simple to comprehend, works best to drive home the concept so that they can think effectively to increase profit for their organisation.
Rather than trying to explain profit as a business concept, I choose to instead demonstrate how profit is equivalent to one’s personal savings – this shift in perspective typically causes the penny to drop!
I make an example as shown below, where we take the income of an imaginary (but relatable) ‘Employee X’ that receives a set salary every month and we proceed to create their personal ‘Income Statement’.
Each month, this employee must purchase petrol and food etc just to be able to work effectively – we label these expenses as their ‘cost-to-work’ (as compared to a company’s ‘cost-of-goods-sold‘, because if they do not spend this money, it will be difficult for Employee X to do their job effectively (and protect their long-term employment!).
Once the cost-to-work has been deducted, we are left with Employee X’s gross-savings which can also be shown as a percentage ‘gross-savings margin’. We then list and begin to deduct other ‘living expenses’ such as their rent / mortgage payments, car loans, utility bills, insurance costs etc.
I then proceed to show how employee X’s personal income statement is equivalent to a company’s income statement (in this case, we shall refer to the example company as ‘Company X’ and compare the two income statements side by side below):
Your employees can see that there are differences between the terminology used, but that the overall concept is the same. Businesses generate their income typically from ‘sales’ whereas employees receive ‘salaries’.
Where people refer to their ‘savings’, businesses refer to their ‘profit’ – but the concept of money coming in, and then going back out as expenses with some left over (savings or profit) is the same.
Representing the gross and net profit as ‘margins’ (percentages) are also useful for employees to understand and calculate, because now they can quickly compare how adding or subtracting costs can impact their overall savings / profit earnings in relation to the income generated.
How should you teach employees to spend their profit?
This is the real magic question – the following paragraphs help executives to think about their personal savings and employer’s profits in a totally new light. And for employers, this is where the real returns from this exercise begin to pay dividends.
Referring to Employee X’s personal income statement again, once an executive has been through the process above and has subtracted all of their costs from their income, we’re left with their net-savings, of which, this employee has the following choices:
- Save: They can place their earnings in a bank account, effectively do nothing with it but see the value of money depreciate over time due to inflation – I’d like to point out that many employees also do not understand the true meaning of inflation so it’s worthwhile to go into detail that inflation globally is about 3.64% currently and that most banks do not offer interest rates above this amount (therefore, you effectively lose money as you save)
- Purchase Liabilities: They can purchase luxury goods such as cars, electronics, effectively to ‘keep up with the Jones’ – not only do these purchase eat away at their hard earned savings, they tend to increase a person’s monthly expenses (for example, a new car must be serviced and wear and tear items replaced). This approach is extremely dangerous in challenging economic climates
- Purchase Assets: They can invest in assets such as stocks, property, businesses and tradeable items which can benefit from appreciation in value as well as be their own sources of generating cash-flow (for example, rent for acquired properties). I have written an extensive guide on the rules to make more money and generate wealth here.
I cannot stress the importance of spending time to teach executives not only the concept of gross and net-profits, but that of cash flow and how to use cash flow to acquire assets to increase profit yet again (and so on, and so on).
People and businesses should use their income and profit earnings to accumulate even more profit earning assets to begin leveraging the power of compounding.
Robert Kiyosaki’s famous ‘Rich Dad, Poor Dad’ is a great book to explain how people should visualize cash flow. However, the concept highlighted in Rich Dad, Poor Dad is also very applicable to their work in business.
Many executives prior to doing this exercise, do not truly consider the ‘return-on-invested-capital’ also known as ‘ROIC’ before they sign-off budgets and spend the company’s hard earned cash / profit reserves.
Therefore, they are likely to budget and spend in areas that will not increase the company’s income, and or improve the company’s gross and net-profit margins.
Why is this so? For two reasons I believe:
- It’s not their personal money so there’s less attachment to it (they would think twice if it first came out of their personal savings)
- They do not understand the principles of profit and cash flow as described in this article, therefore they are unable to think critically prior to spending. I have an extensive list of books for additional reading that will help further on these principles.
By the end of the exercise, executives not only feel they have a better grasp on how to manage their personal finances, but begin to understand how their daily actions at work ultimately impacts their company’s:
- Top-line revenue from sales
- Costs-of-sales and gross profit margins
- Operational expenses and net profit margins
- Cash flow and decisions that lead to compounding growth / wealth
Essentially, the employees and employers are on the same page, and both camps have become much better at developing decisions that positively impact their company’s bottom-line. To take this even further, I recommend reading my article to drive sales by aligning yourselves on company values.
Now gather your staff in the conference room and start teaching!
This article is meant to act as a true north and act as a foundation to help teach employees about earnings and how to increase profit.
The main thing now is for you to gather your staff, and run them through the exercises in this article.
I assure you, you will see new energy and creativity from your team, not only in their working lives, but in their personal lives as well. It is when they feel alignment between these two worlds that their work satisfaction increases because their personal sense of control over their lives improves as a result.
If you would like to discuss the concepts highlighted in this article, and how best to apply them to your business, please do not hesitate to get in touch.
End.
