As turnaround specialists, our expertise is in helping management teams determine and lead the direction of change in their companies. By developing strategies with specific and measurable goals we focus on what really matters so organizations can prosper.
Often surprising is the number of companies that seemingly operate at odds to this simple approach. With confused compasses, management teams will formulate strategies that encourage employees to react to short-lived events or respond to noise in their organizations. It’s best to avoid falling into this common trap by setting goals that will enable management to gain a sharp perspective and focus on what really matters.
Consider the following steps:
- Review Year-End Income Statement. A key starting point in establishing financial goals, this document breaks down sales revenue, cost of goods sold, operations and administration costs and demonstrates the operational effectiveness of a company for the past 12 months. Often companies commit time to reviewing their yearly fiscal results with a misguided perspective. Unfortunately, last year’s P&L are lagging indicators, showing how the company did but offering little insight into what’s to come. Instead, use this template as a basis to model alternatives and determine the most desirable outcomes. This model will help identify how changes to key drivers will impact the bottom line.
- Identify Key Performance Indicators (KPI). Once the key drivers on the P&L are determined, the next step is to identify KPIs that stand behind those drivers and what manipulation is required to improve results. In some cases, companies focus on sales growth and miss the obvious. Tasking the VP of Sales with increasing revenue may not be as effective as holding the individual accountable for improving Contribution Margins.Additionally, even a healthy Contribution Margin can have its impact trumped by ineffective expenditures on some rogue administration expenses. Unmonitored cellphone plans, travel costs, unhedged currency positions, etc. are all candidates to swallow the profit from the last big sale. Departmental teams should own a fixed budget for each variable on the P&L and those should be tied into overall strategies and corporate goals.
- Approach P&L from an Arm’s-Length Perspective. Finally, examine the P&L like an external auditor not as a management team with a vested interest. Ask what changes to specific variables translate most profoundly to the bottom line.
Once the management team appreciates that targeting specific lines on the Income Statement facilitates building strategies that could shift those numbers in the company’s favour, they can proceed to re-engineering the P&L and setting specific financial goals as follows:
- Establish Income Before Tax and Bottom Line. What income before tax defines a successful company performance? In addition, there needs to be a balance between maximizing tax efficiencies and the need for financing. For example, were there previous years’ losses that can be carried forward to offset taxes on profits this year? Does the company need additional financing so that financial statements are prepared to satisfy the lenders?
- Identify Total Operating Expense. Which unnecessary expenses need to be eliminated this year? Conversely, will increased marketing spend contribute to higher revenue and better profits?
- Determine the Required Gross Profit Margin. If the margins were 40% last year and 50% before that, it may be realistic to set the margins at 45% or a three-year average. If this variable is susceptible to market inputs, such as price of steel, fuel, etc., pick a number as a compromise. Setting a Gross Profit Margin and Gross Profit in dollar terms will provide guidance in producing the required top line.
- Review and Deconstruct the Top Line. With this goal in mind, determine which combination of existing and new business will likely generate this increase. Ensure that internal sales strategies, commission plans, staffing and organizational structure are all aligned to produce the desired outcome for client acquisition, organic growth and baseline protection.
Creating an alternative model of last year’s Income Statement or P&L is crucial to identifying this year’s financial goals. Task teams to improve key drivers, formulate strategies, and establish action items for each strategy that will help achieve financial goals and steer your company in a desirable direction.
This article, by Alma Johns, has also been published in Canadian Metalworking’s web site.