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Home > Performance Management Best Practice > Five Routes to Greater Profitability for Small and Medium Enterprises

Performance Management Best Practice

Five Routes to Greater Profitability for Small and Medium Enterprises

by Thomas McKaig

Executive Summary

  • Use your business plan as a road map for your company’s success.

  • Remember that increasing revenue does not automatically mean increased profits.

  • Keep your costs in check.

  • Use quality initiatives throughout your organization.

  • Profitability depends on human issues, not just balance sheet measures.

Introduction

Although the routes to profitability discussed in this article are particularly important to the small or medium-sized enterprise (SME), they are broadly applicable to firms of any size. When reviewing these five key steps, ask yourself how many you can implement in your firm—or in your division or team if you work in a larger enterprise.

Review the following five points, and see how your business stacks up.

Five Routes to Greater Profitability

1. Use your business plan as a road map, day in and day out

Some entrepreneurs view their business plan merely as a document to raise initial capital. After this has taken place, the plan gets pushed aside as day-to-day events become more pressing. In other cases, the entrepreneur may never have prepared a formal business plan, as the initial capital was raised from their own resources or from other friendly sources. Both these situations represent lost opportunities to benefit from what a business plan can provide. A good plan helps you to define your objectives and lets you know where you stand in relation to those objectives. It helps managers at all levels to allocate scarce resources. It also helps you to take corrective action when circumstances change—as they will.

Don’t keep your business plan to yourself—share it with your employees. A good business plan can improve priority setting for your employees, can promote action orientation, and can improve coordination between groups, divisions, and teams (see route 5).

Even though entrepreneurs are bombarded by people promising the one best business plan (just as job seekers are constantly exposed to sources promising the one best business resume), there is no real magic in creating a business plan. Any plan should include:

  • A summary of why the company is in business (its mission), and how it is different from its competitors (its competitive advantage).

  • An industry analysis, including the nature of the industry, and the economic and regulatory trends that can or may affect it.

  • A market description, noting the current and future size of the market, and the strengths and weaknesses of competitors.

  • A description of the product or service being offered, and how it will be produced and sold.

  • A marketing strategy.

  • Management and human resources, and any particular staffing issues.

  • Financial forecasting for the short term (less than one year), medium term (1–3 years), and long term (3–5 years).

  • Key benchmarks or milestones, both quantitative and qualitative, for the next six months, one year, and three years.

The future almost never unfolds in the way we predict, which means that a business plan is not a static document. A good plan will actually lead to increased flexibility to meet changing circumstances while keeping focus on the main objectives of the firm. Management should review the plan at least annually, look to it for guidance whenever necessary, and make changes when circumstances warrant.

2. Don’t chase revenue

One of the realities for a business of any size is that even though revenue might be the top line on the income statement, it is not always the most important line. Increasing revenues do not automatically mean rising profits. The best illustration of this is the numerous small and medium-sized dot-com companies of the late 1990s that never survived long enough to become larger companies. They constantly searched for growing revenues, or growth of market share, assuming that profits would somehow naturally and eventually follow from this top-line growth. It didn't, and they went out of business, even if they enjoyed near total domination of a particular market segment.

Profits are what ultimately matter, not revenue. Although increasing revenue may bring profits, you can actually increase profits by reducing revenue and focusing on the key products or customers that are most profitable. Ask yourself what would happen if you decided not to chase those marginal customers that you may currently have. It is possible to get lean and see your profits rise. In these tough economic times, remember that growing revenues demands increased capital, which may not be available to your firm today at terms that you can live with.

3. Minimizing costs is at least as important as maximizing revenue

The start-up small business entrepreneur is often an expert at controlling costs—by making do or by doing without, or by postponing major expenditures. This skill can often be lost as a firm grows, but it is remains important whether the firm employs 2, 20, or 200 people.

In these tough economic times, look to carry less inventory, examine the potential for savings through cash management, and look at savings that may be available in your existing supplier contracts. Ask your suppliers what they are willing to give you to keep your business. Entrepreneurs are used to pushing and asking for discounts and better terms, but this is a skill set that often falls by the wayside as a firm grows.

For some firms, labor is a major cost component. Examine the feasibility of offshoring some functions, or outsourcing others. Defer bonuses if necessary, both for labor and for management. Make cuts strategically. Cutting an arbitrary 10% from each department is almost certainly suboptimal. One department may have plenty of slack, so you may be able to cut by 20%, whereas another—perhaps your accounting or other support service—might be very tight and should not be cut at all.

An issue related to costs and revenues is the profit margin of your firm. Look at yield management issues, if applicable, and look at the prices you charge. Can these be increased (for added revenue); can they be cut (to gain market share); or can your pricing terms be adjusted?

4. Use quality initiatives when dealing with stakeholders, especially employees and customers

Quality has become such a buzz word that for many people it has little meaning any more, or they misinterpret the word as a synonym for expensive. We tend to think that only expensive products have quality, or that only expensive company processes can produce quality goods and services. Neither of these is true.

According to Armand Feigenbaum, quality initiatives are a powerful tool to increase overall business profitability and the positive cash flow of a business. Quality can help in three ways. First, it can help the salability of your product or service by producing a product that meets your customers’ wants, and at a price that allows you a substantial profit. Second, it can aid in the producibility of your product, as quality control helps in both the designing and the manufacturing of a product. Finally, quality contributes to the productivity of your firm, since it emphasizes positive control of quality rather than reactive detection and reworking of any failures. Quality initiatives also help in the incoming materials area of your firm, increasing production rates by reducing wasted effort.1

5. Work to align the interests of employees with your organization

Non-balance-sheet issues can be very important to your bottom line. However, many entrepreneurs are not managers, and some may have difficulty understanding that not all their employees are as willing to work 24/7 like the company’s founders and first employees.

Employee benefits are one way of attracting and retaining employees. However, traditional benefits are particularly difficult for small and medium-sized firms, which cannot offer the same types of employee benefits that their larger competitors can. For example, almost no new SME can offer a traditional defined-benefit pension plan to its employees, as it is simply not cost-effective to do so. Complex health and dental plans, which need a large employee base, may also not be feasible for the firm. A small firm may, then, offer an employee share ownership program (ESOP) if its shares are publicly traded. This can take the place of other benefits the small firm cannot offer, and it can also help to align the interests of the employee with the organization as a whole.

Not every potential employee is willing to trade the safety of a pension plan for stock in the firm, so a key component of any human resource strategy is to pick the right people through the hiring process. Choosing people who understand the entrepreneur’s mindset will help to ensure a proper fit in your organization. Having the right people on board will make motivation and employee retention much easier.

The small or medium-sized firm is often characterized by an environment where job titles are constantly changing, and where written job descriptions do not always exist. In such a situation, it is particularly difficult to keep employees focused on your goals and not theirs. One method that can help is management by objectives (MBO). This is often merely thought of as a way of assessing employee performance, but in fact it is much more. The MBO process is a four-step procedure whereby the manager and employee jointly set out clear objectives for each employee (having regard to the firm’s overall objectives, as defined in the business plan), jointly establish a plan by which these objectives will be met, identify clear standards for measurement, and define a method for reviewing performance results.

Such a process helps all employees to get to know the organization’s objectives and how each person fits within the organization, it aids coordination between divisions of the growing firm, and it frees senior management time for matters other than day-to-day tasks of employee supervision.

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Further reading

Books:

  • Balderson, D. Wesley. Canadian Entrepreneurship and Small Business Management. 7th ed. Whitby, ON: McGraw-Hill Ryerson Higher Education, 2008.
  • Carnall, Colin. Managing Change in Organizations. 5th ed. Harlow, UK: Pearson Education, 2007.
  • Carpenter, Mason A., and W. Gerard Sanders. Strategic Management: A Dynamic Perspective. Concepts and Cases. 2nd ed. Upper Saddle River, NJ: Prentice Hall, 2009.
  • Feigenbaum, Armand V. Total Quality Control. 3rd ed. New York: McGraw-Hill, 1991. (See also 4th ed, published 2004.)
  • Timmons, Jeffrey A., and Stephen Spinelli. New Venture Creation: Entrepreneurship for the 21st Century. 7th ed. McGraw-Hill Irwin, 2006.

Reports:

Websites:

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