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08:12 on Wednesday
27 October 2004

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Improving Profits: Another Way

Business | Articles | Feature

Improving the Bottom Line
In these difficult times, most companies are feeling the squeeze. With the slowdown in the economy, profits are under pressure and it is getting harder and harder to maintain and grow the bottom line.

But there is another way to improve profits, one that many businesses overlook. In fact, in our experience, 89 % of companies are not fully exploiting this simple way of improving their profitability.

The "Top Down" Approach
Company accounts are invariably presented in a "top down" format, starting with sales, and ending with net profit. So when reviewing their profitability, most companies focus their efforts in the same way, with the primary emphasis on improving sales and maximising margins.

And there is no doubt that sales and margins are critical for the success of any business. Quite simply, without the sales and without the margins there would be no bottom line.

Short Term Cash Flow
But, when seeking to improve profitability, increasing sales and margins can have their problems. First, increasing sales usually involves spending money on marketing and promotion, and this expenditure can often be quite large. What is more, this spending has to be incurred "up front", while the increase in sales may be more gradual. So it can have quite a negative short term impact on cash flow.

Deferred Profit Improvement
Secondly, increasing sales may take some time to feed through into increased profits. This is because, given a gross margin of say 30 %, then every 1,000 increase in sales will give only 300 increase in gross margin. And so it may take several months for the increase in sales to generate sufficient gross margin to cover the initial marketing and promotion spend, and show a net improvement in the bottom line.

Margins and Competition
Much the same considerations also apply to gross margins. With the slowdown in the economy, more and more companies are resorting to cutting prices in order to maintain sales and market share. Which means that margins are now under greater pressure than ever.

The " Bottom Up" Approach
So what if we turned the company accounts upside down ? What if we presented them in a "bottom up" format, with net profit at the top, and working down to sales ?

We could argue that this would make a lot of sense, since business is all about making profit. So it would be logical to put them in top place.

Focus on Costs
If we did this, then the most likely outcome would be that we would begin to focus more on costs, and the impact that they have on profitability. And this increased focus on costs would help us to see more clearly that the most direct and efficient way to improve the bottom line is by reducing costs. It is direct in that every saved goes directly to the bottom line as extra profit. And it is efficient because of its "profit leveraging" effect, which means that a relatively small percentage saving in costs can often result in a much larger percentage improvement in profit.

Hidden Costs
But first let us clarify that we are not talking here about staff costs : that is well beyond our scope. Nor are we talking about direct purchases : that has to be a business decision. Rather, we would like to focus on all the other necessary expenses of running a business, expenses such as communications, electricity, gas, water, office supplies, waste disposal, insurance, fuel costs, and so on.

These expenses are often shown individually in the accounts, so that they may at first appear to be relatively small. But when added all together, most businessmen are surprised to find that collectively they can amount to almost as much as their staff costs.

The Impact of "Profit Leverage"
Now imagine that these expenses could be reduced by 10 % , 15 %, 20 % , or more , which is the typical range of savings that we usually achieve. This, in terms of 's, can often amount to a substantial sum. And when this is added to profit, it can make a very welcome improvement in the bottom line.

But when we consider percentages, the improvement in profit can be even more dramatic. Because of "profit leveraging", a 10 % saving in expenses can often result in a 20 % improvement in profit, as the following example illustrates.

Base Case

10% Saving

20% Saving





Cost of Sales 700 700 700

Gross Margin




Staff Costs








Net Profit






Given that even such small savings can have such a dramatic impact on profitability, I think it may be worthwhile to take a closer look at some of these expenses. So, over the next few weeks, I would like to review some of the major items, and outline the current state of the market, giving some guidelines on what you should be paying, and how much you could save.

Please click here for a special offer of a free "health check" of your communication and energy expenses.

February 2003




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Article by:
Gwyn Williams, BA, MSc, FCA.
Tel: 01733 205561

Cost Management Consultant affiliated to Auditel ( UK ) Ltd.

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