SUPER TOOLS IN SMALL BUSINESS MGT

03 Jun 2009 Leave a Comment

by richrover in Uncategorized Tags: breakeven analytics, continuous process improvement, ratio budgeting, sustainable competitive advantage

SUPER TOOLS FOR EFFECTIVE SMALL BUSINESS MANAGEMENT
BREAKEVEN ANALYTICS AND RATIO BUDGETING
By Richard Walton
5/09

In the midst of a recession, it is sometimes difficult to maintain a proactive perspective. We seem to be struggling constantly with issues of cash flow management as revenues decline, and the need to cut costs to maintain profitability. As a result, the longer term need to establish a sustainable competitive advantage is set aside while we fight the daily battles of survival.

It need not be this way. A much better alternative is to use the slow times to do some creative analytical work on the sales and cost data available through your accounting system. For a small investment in time and effort, it will be possible to see clearly where your major market strengths are, and focus your attention on building and maintaining them. There are two tools we will use in this exercise. They are: 1) Breakeven Analytics, and 2) Ratio Budgeting.

First, Breakeven Analytics. This tool requires the perspective of the whole system, in which the average gross profit margin is measured as the dollar contribution to pay administrative overhead. For example, if the GPM average is 40%, and the administrative overhead is $100,000 monthly, then .40 cents of every dollar of sales is available to pay overhead, which means that $250,000 in monthly sales (at the average GPM of 40%) will produce a contribution margin of $100,000 and thus the firm will break even. But since not all products will produce the same margin, we will need to develop BEA on the entire product line, so that we can identify the higher margin products.

To use this tool creatively, we need to focus our marketing efforts on high margin products and services on a consistent basis. The key is to constantly improve the value proposition offered to the customer through the product-service mix by a laser like focus on quality.

Second, Ratio Budgeting. This tool requires the perspective of the whole system, in which the costs of each element of production is measured as a percentage of total sales. The power of this approach can be shown by the calculations taken from a firm doing $5mm in business annually. If the labor costs are 25% of sales, and materials are 30%, then a 1% saving in labor will yield $12,500 annually, while a 1% reduction in materials costs will yield $15,000 annually.

To use this tool creatively, we need to focus our production management effort on continuous process improvement, which is another way of saying higher productivity and thereby lower costs. The key is to have a steadily decreasing cost of production as well as a steadily increasing value proposition for the customer. Thus, even n these times, we can have a sustainable competitive advantage through continuous process improvement