TURNING THE DIALS

  • March 12, 2012
  • Terry Gajewski

What was the first image that came into your head when you heard “turning the dials”?  Adjusting your radio or some other type of electronic device?  Whatever it may have been, the image was essentially a machine that requires your control to make it operate in the manner you wish.  Now think of your business as a machine. What are the dials you can turn to help control how your business operates and generates profits?

In order to help achieve your profitability levels there are 3 ways in which you can do it, which we refer to as “turning the dials”. 

When creating a financial forecast I prefer to use the bottom-up methodology.  This bottom-up approach can generate a “bogey” revenue target, which are sales that need to be achieved that have not been identified or procured yet. 
Now that your unknown bogey amount has been measured, there are 3 ways that the business can lower this bogey amount.

1) Generate new sales and lower the amount needed to achieve your profitability targets,
2) Improve your gross margin, thus reducing the bogey revenue amount, or
3) Trim overhead expenditures, which reduces the gross profit target level, thus reducing the bogey revenue amount.

For the following situations, let’s use the following forecast targets:

$10,000,000.00  Revenue
$  8,500,000.00  Cost of Goods Sold
$  1,500,000.00  Gross Margin (15%)
$  1,000,000.00  Overhead
$     500,000.00  Net Income

Let’s look at dial number 1.  Let’s say you operate at a 15% gross margin.  If you were to cut overhead by $150,000, then this would result in lowering your bogey revenue amount by $1,000,000. If you have a win rate of 25% then this means bidding on $4,000,000 of potential work.

$  9,000,000.00  Revenue
$  7,650,000.00  Cost of Goods Sold
$  1,350,000.00  Gross Margin (15%)
$     850,000.00  Overhead – (cut by $150,000)
$     500,000.00  Net Income

Let’s look at dial number 2.  If you improved your gross margin by 1%, then based on a required gross profit level of $1,500,000, your bogey revenue would decrease by $625,000.  If you have a win rate of 25%, then this means bidding on $2,500,000 of potential work.

$   9,375,000.00  Revenue
$  7,875,000.00  Cost of Goods Sold
$  1,500,000.00  Gross Margin (16%) (improved by 1%)
$  1,000,000.00  Overhead
$     500,000.00  Net Income

Dial number 3 is a direct dollar for dollar reduction as new revenues directly decrease your bogey revenue target.

If you can turn one of these dials, then the company will have a decent year, turn two of the dials and you will have a great year, turn all 3 and begin the celebrations.

If you achieved both scenario 1 & 2 from above, then your following forecast will be as follows; a reduction in your Revenue goals of $1,562,500.  If you have a win rate of 25%, then this means bidding on $6,250,200 of potential work.

$  8,437,500.00  Revenue
$  7,087,500.00  Cost of Goods Sold
$  1,350,000.00  Gross Margin (16%) (improved by 1%)
$     850,000.00  Overhead (cut by $150,000)
$     500,000.00  Net Income

Steps 1 & 2 are where you should start as you have the most control over these two dials.  Step 3 is the hardest to achieve as it is outside of your control.  Like I said, a combination of all 3 can really give your company a great boost in profits, but it is more important to make sure that each step is allotted your full effort.  Tackle each one separately and devote 100% of your effort.

Article by Featured member Blogger Matt Cianciarulo, CPA, Mueller & Co., LLP