This is the tenth in a series of articles that will hopefully educate readers and illuminate the process of doing business in a simple to understand, nuts-and-bolts way.
To read all the articles in this series, click on any of the following:
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!
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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
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Please contact me offline at microconsulting@aol.com with anycomments, suggestions or ideas for future articles that you may not want to share here.
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Related articles
- 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)
PW—will call you around 7:30 tomorrow morning!! Air time 7:35…
LG – Ok. Looking forward to it.
@PW…I think many owners of small businesses often delude themselves into thinking THEY did it on their own…and forget that they really didn’t. They buy into the propaganda and myths, that they DID IT and thus THEY deserve to REAP ALL THE REWARDS themselves. I think that may be why this simple little concept of sharing the wealth with the little people (their employees) who helped them get there is lost on them.
I couldn’t agree more, it is simple…incentives don’t have to be complicated. They just have to be realistic and have to accurately understand human NEEDS and behavior.
No one is going to feel motivated to kill themselves for an employer who doesn’t appreciate the work that they are doing to help that employer succeed. This concept is so overlooked by many in the business community.
There seems to be this ridiculous notion out there that employees should be grateful to just have a job…that concept is utter nonsense. THAT isn’t an incentive. That’s just a business deal between an EMPLOYER who needs people to do certain tasks and individuals who need an income. The incentive of a paycheck it what gets them in the door and provides the basic reason why they are there…it’s not an incentive for them to do anything more than what they are paid to do and I suggest if that paycheck is not adequate and does not provide the employee the ability to be (in Adam Smith’s words) “tolerably well fed, clothed and lodged” they aren’t going to care much about their job per se…not really. They might pretend they care in front of their boss, but behind his/her back….they are bitching, pilfering and looking to get out. THUS their focus is NOT on the business….but themselves.
That seems to me…to be common sense. Everyone, wants to know “what is in it for them”. And IF people are not paid enough, and IF the incentive structure is not sufficient enough (such as bonuses, wage increases, profit sharing, opportunities for promotion…etc.) AND they are being treated badly…they aren’t going to care about the business, PERIOD.
Owners and managers of businesses too often think because THEY care (again, because the incentives of them caring is in THEIR favor) they mistakenly believe those they employ should as well. What a goofy concept for them to believe!
Amen, Abby!
Aside from the motivational issues, the financial gains year after year can be substantial.
How much does it cost for employee turnover?
How much is spent on excess waste?
How many dollars go out the door in returns or repairs?
How much does it cost for Workers’ Comp when you have had claims due to accidents?
How much is spent on supplies that get wasted or are not shopped for effectively?
How many dollars are spent on late fees and interest on Lines of Credit because of cash flow problems?
All of these expenses are “black holes” for money. These expenses create no return, have no benefit of any kind, and suck dollars right off the bottom line.
Consider: At a 10% net, you have to sell $10 in goods or services for every $1 wasted, just to get back to break even!
If you have employees that know they will share in savings on any of these issues, they will start watching all of it and more like hawks! (And the owner won’t have to!!!)
Exactly! Damn PW…you nailed it!
That has been my business philosophy all along!
Those hidden costs of unhappy and de-motivated employees can really, really cost a business! why don’t people realize this?!
It makes no sense to NOT treat employees well…and to share the wealth with them…It’s just GOOD business!
You forgot some other “black holes”:
How much does it cost to satisfy a disgruntled customer?
How much does it cost to overcome negative word-of-mouth reports and media reports of bad service and/or product?
How much does it take to lure back customers who have left because of bad experiences with your company?
I would like to see a company that actually tracks, and calculates the saved profit vs. potential lost profit, of customers that do not leave when they have a negative experience with a product or service but an employee “makes it right”. However, that statistic would not be appreciated by execs and board members who are intent on gutting customer service departments and budgets.
I can not count the number of times, when working for Cingular, when a customer told me, “Can I have *your* extension number? A lot of my friends would come back to Cingular if they knew they could talk to someone like *you*.”
A lot of businesses want to pretend that customer service is useless or pointless. They have the attitude of either “buy my product and then go away” or “this is the service we provide and you are not getting anything more”. Far too many businesses believe that if customer service is not showing a profit, then it is not worthwhile; but they refuse to track what the actual profits are.
But good employees provide good customer service. Committed employees, especially when they have an investment in the business, want to see the business do well and the customers stay happy. Happy employees lead to happy customers that lead to more business that leads to more profit – if that profit goes back to happy employees, you have a powerful engine for growth and prosperity. (which makes investors and accountants happy)
2ccp – You are absolutely correct. There are tons of “black holes” in companies, many of which are completely ignored or brushed under the rug.
I want to hit “the high spots” here, mainly because I believe that you attack the largest issues first and work your way down the list using the tools I am outlining. That is not to negate what you are saying in the least, but those issues of customer satisfaction require the right kind of tracking and survey methods that are difficult for a truly small business.
There are ways, some of them simple, that owners can do to track customer issues, absolutely.
For example, a small business owner can create a slip or a form that has a complaint on it. When used, one of the things that can be done is to classify it… is it quality, or employee attitude, or maybe price.
I will be advocating WEEKLY staff meetings to discuss status and progress of the Business Plan, and these issues can be brought up, discussed, and a resolution assigned to the right employee. It should then be followed up at the next meeting, and any changes in the organization of the system that the complaint applies to can be discussed and decided.
In ISO companies, this is very formalized, but it can be fairly simple for smaller organizations, and is very important.
BINGO! Again…good business sense!