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In past articles, we have finally developed the tools necessary to rationally evaluate the past performance of the business, and a way to look into the future based on your plans for the business in a realistic and meaningful way. We can price anything properly, assuming we are honest about what our real costs are, and we have a way to plan for profit.
It’s time to go back a bit, once again.
What do you want… really?
Whether you use the Net Profits from your business to live on or you pay yourself a salary to establish your base income, it’s time to ask a basic question. What is a reasonable Net Profit Margin? Is it 5%… 10%… 15%… 30%…? Remember that Net Margin is after all expenses, both COGS and G&A have been taken care of. What is reasonable for your business? What do other businesses in your niche come away with?
This is an important question!
You need to establish from the start what your financial goals are. You must do the math we went over and see how your business operates, what affects the bottom line most, and see what your real Net Margin is. Is that adequate or reasonable? Every business is different, but I have seen in small business that most owners set that goal somewhere between 5% and 15%.
Once you have established the answer to this question, go back to Part 9 and read the last section again regarding pricing. Notice that you are asked in the formula for pricing to plan for a Net Margin (in that example I used 15%). You also need to go back to the Financial Plan and see what your real Net Profit Margin is. Are you operating to give you that margin? Probably not. Make a copy of that tool and start manipulating the numbers to give you that result. Do you need to increase Sales by a few percent? Are your COGS too high? Can you trim G&A? Play with the numbers to see how each affects your Net for the year. Be realistic. Can you really double sales in one year? Probably not. Can you cut G&A by 50%? Not likely.
If you are way off your goal, you have to make a multi-year plan. Maybe to double sales in three years or five. Maybe to cut COGS by 2% relative to sales. This is what it means to be a real business owner. Being ‘gung ho’ about your product or service is all well and good, but an owner’s primary responsibility is to operate the business! And this is how it’s done, through hard work, spending hours over numbers, and making plans… and then carrying them through.
Now we come to the fun part… how to make more Net Profit than what you planned on!
A Rational Incentive Plan for Employees… “cost-free”
Right up front, I need to emphasize that no incentive plan for employees is cost-free. However, consider this:
If you have set your Net Profit Margin goal at 10%, make a decision that this amount is what you are happy with and defines financial success. Commit to that idea. If you can’t, please stop reading now. What I will outline is based on that idea, and if you cannot commit to accepting that your goal is completely satisfactory and means that your plans have succeeded, you cannot fairly and reasonably execute an incentive plan that will mean anything substantial to your employees. Move on and I wish you well. You will probably need my services down the road to fix a broken business.
If you are still with me, how can I claim that an Incentive Plan is “cost-free?” If I can tell you how to enable and encourage all your employees to own their jobs, to care deeply about quality and service, to band together and make every operation more productive, to be involved in decisions concerning safety and working conditions as well as saving money at every turn, is that worth doing? And if that can happen, you are likely to make more net profits through savings, fewer safety issues, fewer quality issues, and higher productivity – all resulting in a higher Net Profit Margin than stated in your plan.
My whole notion is this – Any Net Profits over your Planned Profit Margin that result from employee efforts should be shared with the employees on a quarterly basis.
That’s it! That’s the whole idea. If your employees dig in and your business ends up with 14% net, why should YOU keep all of that 4%? Most owner do, and they are entitled to it, I guess, but why should employees care about productivity or safety or excess waste or any of that if they get nothing for it?
Many owners come back with “I pay them, they SHOULD care!”
Maybe. I submit this: Most employees are paid their base pay to show up each day, breathe in and out, and do the basics of their work. That’s it. It doesn’t matter how well they are paid. It doesn’t matter if they get free donuts and coffee. It doesn’t matter if you give out Thanksgiving turkeys every year. Oh, they will like that stuff well enough, but what does any of that have to do with what’s important to a business? Nothing at all. An incentive plan that’s done right will energize employees to care, to manage themselves, and to produce more without complaint or morale issues.
I know it sounds like magic, but it’s not. Set it up so they all can see what their contribution to the effort is, ensure that each group is responsible and accountable for only those things they can do something about, give them tools to succeed, and stand back. It’s an amazing thing to watch. It is the key to a self-running business.
Remember back in Part 1 where I talked about working less, having the time or the money to enable that dream I told you to put on your wall? Remember that? This is how you get there!
I know this is a bit of a cliff-hanger, but I want everyone to absorb this lecture fully and completely before moving on to how to accomplish this amazing thing that will transform your business. Think about the Business Plan, the Org Chart, the Job Description, and the planning tools we’ve discussed. We are going to use all these things to set up an Incentive Plan that makes you more money, creates a self-running business, enables employees to be involved in how they do their work, and rewards them for it.
Next time… The Incentive Plan
Please contact me offline at firstname.lastname@example.org with anycomments, suggestions or ideas for future articles that you may not want to share here.
- What Is Net Profit? (brighthub.com)
- How to Calculate Gross Profit Margin (brighthub.com)
- Profit Margin vs. Markup (markwinstein.com)
- Accounting Forecasting Tips for Seasonal Firms (brighthub.com)