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What is Profit Planning?

Profit planning refers to the process by which a business sets specific financial goals and strategies to achieve a targeted level of profit. It involves analyzing costs, sales projections, and market trends to develop a plan that maximizes revenue and minimizes expenses.

Profit planning helps businesses make informed decisions, allocate resources effectively, and monitor their financial performance to ensure profitability and sustainable growth.

The relationship between components related to profit shows that profit is excess of revenue over expenses [Net Income (Profit) = Revenue (Income) minus Expenses (Costs)] and revenue comes in the form of cash and accounts receivable and there are two types of expenses i.e. fixed and variable.

The fixed expenses include periodical expenses regardless of operational effect and include items such as rent, insurance depreciation, etc. whereas variable expenses vary according to the level of operations and include items such as product labor and material, sales promotion cost of delivery, etc. The expressions of profitability indicate a certain relationship between revenue and expenses.

A decline in profit margin should be the catalyst to search for a cause, such as an increase in expenses; discounting or pricing errors caused by a decline in per unit sales revenue; or a change in business operations.

Planning for profit requires considering important fundamental aspects such as developing an understanding that liquidity provides maximum flexibility; the income statement needs to be viewed in relation to the balance sheet and the cash flow statement; and managed, under control growth leads to planned growth.

Process of Profit Planning

A brief explanation of the process of profit planning is given below:

1. Determine Goal of Profit
2. Determine Planned Sales Volume
3. Estimation of Expenses for Planned Sales Volume
4. Profit Estimation
5. Compare Estimated Profit with Profit Goal
6. Determine Alternatives to Improve Profits
7. Determine How Expenses Vary With Sales Volume Changes
8. Understand How Profits Vary With Sales Volume Changes
9. Analyze Profit Alternatives
10. Finalize and Implement Strategic Plan

Determine Goal of Profit

The target value for profit should be based on the realistic and planned results of Entrepreneur Company’s strategic plan.

Determine Planned Sales Volume

Determine Planned Sales Volume Required for Achieving the Profit Goal: Planned sales volume to achieve the profit goal can be determined by utilizing operating and sales budget forecasts. This is because these forecasts influence decisions on materials purchasing, production schedules, financial resource acquisition, plant and equipment procurement, personnel enumeration, along employment and inventory planning.

Such forecasts should be derived from well-developed, realistic determinations of market conditions, market trends, industry trends, competitive analysis, competitive edge, market segmentation, promotion strategies, pricing strategies, distribution, inflation, and so forth.

Estimation of Expenses for Planned Sales Volume

The entrepreneur should make use of previous years’ figures if it is an existing company. For start-ups, analyze similar companies in the industry and tap published research to come up with realistic estimates of Expenses.

Entrepreneurs should make adjustments in expense projections based on, changes in economic conditions; ratio of expenses to sales level change; production methods improvements and efficiencies; reasonable salary levels; materials to produce products; and labor to produce products. Once he arrives at the cost of goods entrepreneur needs to compare it to the industry average for accuracy.

Profit Estimation

Entrepreneurs should subtract the expected expenses from estimated/projected sales income and arrive at a projected profit.

Compare Estimated Profit with Profit Goal

If there is a wide discrepancy between estimated profits and profit goals continue with the following steps.

Determine Alternatives to Improve Profits

Entrepreneurs must explore ways to boost profits, such as modifying sales strategies, enhancing product quality, improving availability, and revising pricing policies.

Cost-cutting measures like better control systems, increased productivity, re-designing products, and utilizing idle capacity should also be considered. Reducing unit costs, internal production of certain parts, and strategic outsourcing are effective strategies.

Determine How Expenses Vary With Sales Volume Changes

Entrepreneurs should analyze how expenses change with varying sales volumes. They should experiment with different sales levels to understand the relationship between fixed and variable expenses. It’s essential to find the optimal product mix and unit sales.

Entrepreneurs need to be mindful that extreme sales volumes can be costly due to increased efforts, while low sales volumes lead to additional costs like idle capacity and underutilized skilled labor. Entrepreneurs should also consider changing economic conditions, inflation, customer preferences, and market shifts, which can impact unit costs.

Understand How Profits Vary With Sales Volume Changes

Entrepreneurs should Use different Sales Volumes to determine the resulting Break Even Point and the Profitability.

Analyze Profit Alternatives

Entrepreneurs should analyze profit alternatives by using the information generated in Steps 6, 7, and 8 and take into consideration profit-increasing alternatives, such as Sales Price Changes; Change Advertising / Promotion Strategy; reducing variable Costs; Increasing/decreasing quality of Products; Finding the right mix of Products; Eliminate Low-Margin Products; Bundle High Margin Spare Parts with New Equipment and so on.

Finalize and Implement Strategic Plan

The entrepreneur should Measure the effectiveness of the Strategic Plan’s implementation over time to keep track of the company’s resulting Return and Profit Margin. Entrepreneurs should also try to Implement Tax Savings Strategies to retain more Earnings for future Opportunities and Expansion.

FAQs Section About the Profit Planning