1. Determine a targeted return on invested capital
Start by setting a target net profit. Understanding how it is calculated is key to figuring out what is the right target for your business.
Also called net income, net profit is the measure of sales revenue retained by your company after operating expenses, interest expenses and income taxes have been paid.
To measure your return on invested capital, divide net profit by total invested capital (long-term debt plus shareholder equity). This is also an important measure because shareholders want to understand how much better off they are investing in your business compared to other alternatives presented to them.
2. Calculate the target gross profit margin you will need to achieve this profit goal
Take your projected net profit and add forecasted selling, general and administrative expenses as well as interest and tax expenses. This will give you a forecasted gross profit. In coming up with your expense projection, plan to keep a tight rein on costs, but remember you might want to beef up selling and marketing spending to deliver more revenue and help achieve your goals.
You’ll then want to calculate the difference between your targeted gross profit and last year’s actual gross profit. The gap between these two numbers is what you have to make up through a combination of higher sales, increased productivity and improved material utilization.
Periodically, you should take time to calculate your business’s gross margin and compare it to that of other companies in your industry.
Benchmarking in this way can:
- indicate how your business is performing versus similar companies
- help you identify opportunities to increase profitability
You can get free industry financial performance data on the Innovation, Science and Economic Development Canada website.
3. Prepare a sales forecast by month and product line
Your target gross margin will determine the level of sales you need to strive for. The sales forecast is calculated by dividing gross profit by the gross margin percentage you strive to earn for your business.
Use the exercise as an opportunity to contact your customers to ask about their purchasing intentions and validate your target revenue. This is where you may find that you need beef up your sales and marketing efforts and perhaps spend a little money to make more sales.
Estimate the sales you expect to receive from customers and the additional sales you will need to generate through a marketing and sales program.
4. Forecast cost of goods sold
Target sales less your target gross profit will determine the forecast cost of goods sold. Compare this target to previous years and make adjustments—you may find that you have to make productivity improvements and, then again, have to determine whether additional investments are needed to realize those improvements.
5. Meet with your management team and develop a plan
Here’s where you and your team agree on specific actions to boost sales, improve labour productivity and tighten supply and expense management.
It can help to make specific people responsible for delivering results in their areas. Also make sure to take a close look at your pricing strategy and inventory management. Questions to ask at this point include:
- Are you charging customers enough?
- Are you working to increase sales of your highest margin items
- For lower performing items, do you have a plan to boost your margins or eliminate them?
Create three to four different scenarios and set your action plan that you and your management team collectively agree on.
6. Execute on your plan
Closely monitor your progress in implementing your plan and adjust as necessary through the year.
It’s essential to seek out and listen to the input from your employees when looking for innovative ways to improve your business and achieve goals. Make sure the employees know you want their ideas.
