The one single formula that matters in Business
Many of us do not forecast our annual profit. Mainly, this is because the regular financial formulas do not reflect our fast-moving reality. But, if we agree that having a certain plan is better than having no plan, here is a formula that will allow you to achieve two goals: anticipate future gains & measure past results.
If you have ever heard about business strategy processes, this is the formula you have most likely encountered:
This formula, led you to 3 possible different strategies:
Good Strategies. Wrong Formulas.
This is the most common strategy for increasing profits. Usually, the fixed costs are the costs that are specifically targeted. Salaries, rent, utilities, license and insurance fees are only a few examples of the constant heavy business costs that we bear, whatever the quantity of goods or services sold might be. That is the reason why more and more businesses turn to freelancers, opt for co-working spaces or externalize services (HR, Finance, Strategy). Decreasing fixed costs became a priority.
1.Reduce Cost
2.Increase Quantity
Investing into new markets and/or expanding services are often the key for selling more of your products. The first real estate company I gave CEO services to had just reduced their costs. So, we decided to turn to American prospects (new market) as potential buyers instead of targeting the French ones and open a new department of assets management (new services) instead of pursuing with only real estate properties. Revenues increased by 14%.
3. Raise Price
Four parameters can perfectly justify a higher pricing model. Reputation (a worldwide brand), Innovation (a disruptive product), Convenience (a tailor made service) or Sympathy (the look and feel for a product or a particular human contact for a service). Innovation processes have, for example, allowed us to introduce a new bio-fertilizer for the leading global phosphate company, OCP. Revenues increased by 9%. The only problem, which is a big one, is that we lack the necessary tools to measure the impact of those strategies in the long term. That is why another formula is required for the leaders who are interested in anticipating annual profits (at the beginning of the year) and measure results (at the end).
THE ONE SINGLE FORMULA
This formula, first introduced by Jean Luc Doumont, better reflects our day-to-day reality and fast moving world. If a potential project/client is likely to close, our responsibility is to forecast the revenues of this single deal as follows: Amount you might gain * probability of getting it. Here’s an example of 3 reasonable deals forecasted: $150,000×0.7 (to close a project) + $500,000×0.3 (to close an investment deal) + $300,000×0.7 (chances to get a specific job) = $465,000 is the forecasted number that represents realistic annual revenues (not profit!).
However, we miss the last part that is critical to set the profit: the amount of costs to achieve those deals. I would suggest you calculate it at the same way: the probability of closing the project*variable cost the project implicates + current fixed costs. Variable costs might be the number of business trips you’ll take to close a project ($20,000), the intermediary people you’ll pay to close an investment ($50,000) or the vocational training price you’ll bear to get a specific position ($3,000). The fixed costs (salaries, utilities, rent,…) are here anyway. Taking our above example, it gives: $465,000 (revenues objective) – [FIXED COST + 0,7*2 0,000+0,3*50,000+0,7*3,000]= 433,900 – Fixed cost. Now, take a pen and make this calculation for the next 6/12 months, this will create a reasonable profit objective.
An Approximated Plan Is Better Than No Plan
Business life is dynamic and, of course, depends on many various factors that might influence the above estimation. Of course, your actual profits (which I hope for you will be much higher) are not exactly the result of the equation. But, it gives an excellent indication to work with and to be driven by. Because, as a popular
chess adage says, "A bad plan is better than no plan (at all)”. We could put it this way: “An approximated profit plan is much better than no plan”. Take action: Anticipate gain today, measure results in 6 months.