All management groups want their companies to be able to withstand the ups and downs of the business cycle without compromising their ability to grow. The key to this goal is optimizing profit targets. Although most organizations put some effort into quality improvement plans, I've found that the reason these efforts fail is because they don't have a strong foundation for creating good goals or strategies to achieve them.
It is especially important to create such a framework when the economy is in bad shape. An economic downturn can lead to disappointment in income and income expectations. Inflationary pressures can increase wages, commodity prices and operating costs, thus eliminating profits if not addressed quickly through inflation or other interventions. Higher interest rates tighten the screws further, negatively impacting returns on invested capital, especially for businesses with unhedged variable-rate debt.
This doesn't mean it's time to panic. Tough times require leadership to change company processes, material contracts, ingredients, price, etc. provides opportunities to improve performance and create strategies to achieve better results while achieving key objectives. Distributing resources as much as possible allows management to act quickly and safely in front of the head. If a recession does not occur or other developments occur, your company will be in a better position to benefit from new investments.
In this article, I describe a four-step process that businesses can use to develop and leverage optimization results in the face of high inflation and high interest rates. I focus on EBITDA margin to eliminate the non-cash effects of depreciation and amortization, which are less directly affected by the profitability of the project.
As Yogi Berra famously said: “If you don't know where you're going, you better watch out because you won't get there.” When you analyze this advice, you see that it applies to all strategic planning. When dealing with profitability, management should not attempt to achieve short-term improvements at the expense of long-term goals.
I often see management teams setting goals without understanding the reality of their business. Traditionally you analyze historical data to predict future results, but this can be detrimental to your organization. Viewed in isolation, historical data cannot tell you everything about your business potential, especially when conditions change or based on your company's past performance, it will suffer in the long run. If you focus only on what you've done before, you'll set goals that are far below (or worse, above) what you can achieve.
For example, a company's management might see that the business's average EBITDA margin over the last three years was 13%. Margins have fallen to 9% this year, partly due to other factors. Management has released a plan to return EBITDA margin to 13%, setting a target based solely on historical data.
Does not describe the true potential of EBITDA margins. There is an opportunity to make 15% or 17% profit, but if company leaders do not understand this possibility, the company will not achieve these goals. At the same time, these percentage points will be worth millions of dollars to stakeholders. Let's examine what you should do instead of relying on historical sources.
Looking at the example below we can see that (creative name) is ABC Co. - The Human Resource and payroll software company currently has an EBITDA margin of 15%, compared to the historical five-year average of 13.5%. But ABC Company executives shouldn't think they can rest on their laurels.
By pulling data on a company's competitors and conducting additional business and market research, it is possible to determine the business average of EBITDA margins as well as the margins of similar companies. Public companies have easy access to this information; For private companies, you can only access it through paid services such as D&B Hoovers, IBISWorld or Pitchbook. If your business is having trouble getting this information or finding the right information, a financial and strategic advisor can help provide the basic information, perform the analysis well, and draw conclusions.
For example ABC Co. Currently ABC Co. It may establish some key conditions for confirmed EBITDA margins: best-in-class, best-performing, comparable to the industry average or the average of similar companies; Management can begin measuring performance against these criteria to determine what can be done with this information.
ABC We believe that the company's management has developed the following criteria to evaluate the company and determine the relevant goals. This benchmark compares ABC Co. the current performance of best-in-class companies, the industry average of high-performing companies, and the average of similar large companies. When doing this exercise, you need to create a foundation for similar reasons.
After establishing the criteria and objectives, management can move on to the next step in the strategy development process: identifying the operating means to achieve the brand's outcome objectives and then testing those objectives for success.
Based on my experience with different clients, I know that leadership will focus on reducing operating costs and using cost reduction methods as a way to improve results. There is no doubt that operating costs and efficiency are important factors in any strategy. But if management ignores the role that revenue and gross profit play in ensuring profitability, it renders the organization ineffective as there will be insufficient time to improve product mix, production costs or selling prices. These developments could have a significant impact on EBITDA margins.
Regarding the income statement, I like to make a method of determining leverage so that income is the first thing to examine. Guiding questions at this stage of the process should be:
1. Which revenue has the biggest impact on EBITDA margins?
2. Which of these regimes has the best governance?
3. Which of these conditions is most easily managed? Can it help manage your business and build a profitable business?
Although the answers for each organization will vary, the most important ones generally come from the following:
Product Offering: Evaluation products can provide opportunities to increase overall profit, which will translate into: EBITDA profit margin. Key metrics to consider include product mix, product quality, unit cost, return cost, cost of goods sold, and sales volume or completion of sale.
Sales: These measures can identify opportunities to improve the sales process (as measured) based on sales volume, volume with more products, shortening sales time, and more profitable closing prices.
Customer satisfaction: Customer satisfaction is often overlooked and does not appear directly on the income statement; however, Net Promoter Score, Customer reviews, customer churn, and average annual service contact per customer are important indicators of success. But customer satisfaction is key to maximizing profits: Having a satisfied customer can lead to lower customer turnover and return rates.
Operational Efficiency: This is the primary goal of most operational efficiency, but it should not be the sole focus. There are always ways to increase efficiency and reduce operating costs. Examples of metrics to measure include operating costs, employee salary as a percentage of revenue, revenue per salary, and return on equity on advertising spend. There will be many opportunities for development in different sectors. For example, a manufacturing company can analyze materials, machine uptime, uptime and usage, while a financial services company can analyze credit timing, fraud detection and customers. These focus areas provide a comprehensive assessment of organizational performance and factors affecting operating margins.
After internal and external evaluation, ABC Co. Conducted the following analysis highlighting some of the factors affecting EBITDA margin performance. We can see that internal performance, competitors, and business performance play a role in the evaluation.
As you can see, ABC Co. offered valuable information to help determine future expansion outcomes. The main points that emerged from this analysis are:
1. Improved communication about assets, as demonstrated by the lower percentage of customers purchasing subscriptions after the free trial period.
2. Adjust your pricing strategy to show competitive pricing and lower pricing based on revenue per dollar of salary index.
3. Improving sales training and processes such as increased sales and average cost of complaints will have a negative impact on revenue.
4. Improve customer experience and satisfaction as demonstrated by high churn rates and negative customer shares in reviews and feedback.
5. Organizational development, strategic planning, and other compensation and workplace culture as reflected by minimum income per dollar and High-performing people.
Once the greatest opportunity areas have been identified, the next step is to use sensitivity analysis to discover which areas pose the greatest risk to EBITDA margins and which capital has the greatest opportunity for improvement. This analysis allows management to begin developing plans to eliminate deficiencies and increase profits. Although the ideal business would focus on all developments at the same time, this may not be possible in practice. It is important to plan ahead to allocate resources to the projects that will be most effective.
In this step, consider the following for each improvement:
1. How much control is available over time
2. The amount of time needed to change processes that affect revenue
3. Assuming the best case scenario, the biggest improvement What is really needed to achieve
4. How much impact How useful is each measurement?
In my experience, the best way to achieve this is to use Excel. A dynamic operating model, where the drivers are still the performance factor, is additionally included as independent variables in the model. Although the development of the operating model is beyond the scope of this article, I would like to point out that setting the key operating levers as independent variables allows the control to measure the impact of each variable separately, thus establishing its sensitivity to EBITDA margin and delivering the highest performance. Important < br>
Let's continue our example: After selecting the operating levers (different variables) and completing the model, ABC Company management calculated the precision of the table below. The benchmark measures the percentage change in EBITDA margin for a 1% improvement in each operating option. Historical data and the relationship between various business lines and EBITDA margins can provide additional detail.
As we can see, increasing the percentage of customers subscribing to the company's best products can increase EBITDA margin more than other levels. A 1% increase in sales mix results in a 0.5% increase in EBITDA margin, while a 1% increase in customer growth or a 1% decrease in customer acquisition costs results in only a 0% increase in EBITDA margin It causes an increase of .1.
Once demand is determined, the next task is to determine the maximum demand for each measure. Remember the aspects mentioned earlier: level of control and time spent. For the sake of simplicity, we assume that all start-ups have similar opportunities and that improvements in one area will help others and ultimately create a larger impact. (For example, reduced churn means greater customer satisfaction, which helps reduce customer costs and increase customer growth.)
If we take revenue per paycheck as an example, we can see that a 1% improvement would lead to : a development. increase profits by 0.4%. Some of the options to increase this index are:
1. Increase the cost of signing up new customers while retaining existing customers to increase revenue.
2. Optimize your selling price to increase your revenue.
3. The business model has been revised to provide sales promotion with the right targets.
4. Reduce employee turnover and related costs.
5. It has many advantages; The important thing is to do this for each initiative, allowing management to leverage desired outcomes and prioritize its options. ABC Company After creating best-case scenarios, base-case scenarios, and worst-case scenarios for each initiative, we came to the following conclusions.
Assuming these are new ventures ABC Co. Leadership weighs each situation based on probability assessments. If you have historical data from previous campaigns, this can also be used to assign weights to each status.
ABC Co. calculates the average weight of each event. Management is able to achieve the desired result of improvement in EBITDA margin for each indicator it analyzes. Because we believe time and control level are not considered in this document for the sake of simplicity, we prioritize ideas from most relevant impact (good sales mix) to low impact (customer growth).
After deciding on the plan and setting priorities, management must now communicate the action plan to the rest of the organization and initiate action. As always, this requires care and planning. Even the clearest plans will mean nothing without effective communication strategies, resources and the ability to support success.
The following are important points:
Project Management Hierarchy: A clear project hierarchy ensures accountability and enables communication and decision making. I apologize for contributing to the work. A clear role allows management to see where conflicts exist and take action quickly to resolve them.
Open, clear communication: This is a management principle more widely used than best results. Clarifying the project strategy and expectations in a consistent and transparent manner will help create a sense of ownership and ownership among the staff responsible for the project. Additionally, encouraging feedback and employee participation can uncover new and innovative solutions that managers may not have considered.
Performance Review: Periodic review shows the importance of the job to the employees. Lack of management control will lead to lack of employee control, leading to stagnation and failure.
Resources and support: These projects are important projects. The ability to quickly update plans and make adjustments is crucial. New methods or tools must be developed or implemented. Management must be committed to providing the group with everything it needs to achieve the desired expansion, otherwise the effort will fail.
With transparency and adequate resources, team members will be equipped with everything they need to stay motivated and achieve their goals. Motivated to improve the overall performance of the organization. As we can see in the example above, assuming all measurements are made, ABC Co. The expected EBITDA margin will increase by 8.1%. Based on the company's 2023 revenue, this equates to an additional $1.6 million in EBITDA. Even reaching just half of the above target would increase EBITDA margin by 4%.
By using the four-step approach outlined in this article, your organization will be able to achieve a successful strategy for making good money. Best of all, it can be used as an iterative tool to encourage more successful plans until you reach your goal.
The benefit of this approach is that it identifies the best ways to increase profitability (this will do more than reduce operating costs) to ensure that resources are allocated appropriately, quickly and reliably. Once the optimization process begins, the procedures defined in the implementation phase help management quickly detect and resolve problems.
I recommend incorporating revenue optimization into your organization's annual plan so that milestones can be maintained. If a bankruptcy were to occur, your organization would be in the best position to protect against it. Barring an economic downturn, your organization will be ready to invest more effectively in growth plans. However, your company will be preparing for what lies ahead.
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