Introduction to Profit Planning
Definition of Profit Planning
Peter Drucker says "Profit is a condition of survival. It is the cost of the future, the cost of staying in business". Process of developing a profit plan that outlines the planned sales revenues and expenses and the net income or loss for a time period.
Profit planning requires preparation of a Master Budget and various analyses for risk and what-if scenarios. Tools for profit planning include the Cost-Volume-Profit (CVP) Analysis and budgeting. Profit planning is simply the development of your operating plan for the coming period. Your plan is summarized in the form of an income statement that serves as your sales and profit objective and your budget for cost.
Advantages of Profit Planning
Profit planning offers many advantages to your business. The modest investment in time required to develop and implement the plan will pay liberal dividends later. Among the benefits that your business can enjoy from profit planning are the following:
1. Performance evaluation
The profit plan provides a continuing standard against which sales performance and cost control can quickly be evaluated.
2. Awareness of responsibilities
With the profit plan, personnel are readily aware of their responsibilities for meeting sales objectives, controlling costs, and the like.
Cost consciousness
Since cost excesses can quickly be identified and planned, expenditures can be compared with budgets even before they are incurred, cost consciousness is increased, reducing unnecessary costs and overspending.
Disciplined approach to problem-solving
The profit plan permits early detection of potential problems so that their nature and extent are known. With this information, alternate corrective actions can be more easily and accurately evaluated.
Thinking about the future
Too often, small businesses neglect to plan ahead: thinking about where they are today, where they will be next year, or the year after. As a result, opportunities are overlooked and crises occur that could have been avoided. Development of the profit plan requires thinking about the future so that many problems can be avoided before they arise.
Financial planning
The profit plan serves as a basis for financial planning. With the information developed from the profit plan, you can anticipate the need for increased investment in receivables, inventory, or facilities as well as any need for additional capital.
Confidence of lenders and investors
: A realistic profit plan, supported by a description of specific steps proposed to achieve sales and profit objectives, will inspire the confidence of potential lenders and investors. This confidence will not only influence their judgment of you as a business manager, but also the prospects of your business' success and its worthiness for a loan or an investment.
Limitations of Profit Planning
Besides profit planning has vast advantages in it but it has some limitations :
1. Profit plans are based upon estimates. Inevitably, many conditions you expected when the plan was prepared will change. Crystal balls are often cloudy. The further down the road one attempts to forecast, the cloudier they become. In a year, any number of factors can change, many of them beyond the control of the company. Customers' economic fortunes may decline, suppliers' prices may increase, or suppliers' inability to deliver may disrupt your plan.
2. The profit plan requires the support of all responsible parties. Sales quotas must be agreed upon with those responsible for meeting them. Expense budgets must be agreed upon with the people who must live with them. Without mutual agreement on objectives and budgets, they will quickly be ignored and serve no useful purpose.
3. Profit plans must be changed from time to time to meet changing conditions. There is no point in trying to operate a business according to a plan that is no longer realistic because conditions have changed.
Successful business performance requires balancing costs and revenues as illustrated by the following model:
Costs of the future (profit) + current costs (expenses) = Average revenue per unit sold x sales volume
