Profit is critical for long term sustenance of any business. Shareholders / Owners are happy to invest in businesses that produce sustainable profits. While planning for any business this objective must be kept in mind. Often, management gets carried away with other objectives without worrying about profits - for e.g. they focus on brand image, market share, top line growth, book size etc. at the cost of profits.
While drawing up the business plan, a key question to be dealt with is on what is the break even period and when will the business deliver sustainable profits to deliver returns to the shareholders. Everyone understands that a business becomes profitable only after a critical book size is reached. However, one should have clarity on what is the level of operations which is necessary to deliver profits.
This profit focus leads the management to focus on all elements which drive profits which are outlined below:
(a) Volume of business
(b) Pricing
(c) Cost of funds
(d) Fee income opportunities
(e) Sourcing cost
(f) Cost of operations and technology
(g) Manpower costs
(h) Losses on account of defaults, frauds etc.
Each of the above are dynamic and linked to market forces. For instance, pricing has to be competitive and attractive to ensure high volumes and high quality portfolio. Pricing also decides how much penetration of market and therefore can be achieved. When each item listed above is seen individually and collectively, the business can become an efficient player. And at every stage of the business growth these have to be carefully monitored and analysed.
Too often, there is a temptation to drop prices below competition to make our product look attractive. There is also a temptation to pay the distribution channel handsomely to attract volumes. A long term player will not succumb to such temptations. Only short term mindset will encourage compromising on quality standards and building book only based on price advantage.
Productivity is a key measure which can be used to evaluate performance of employees, channel, branches etc. It is a useful tool to compare performance between various units and even across organisations if suitable information is available. This can be used to pay more attention to laggards and to improve their output. I remember an instance when I found one branch consistently under-performing and on visiting that branch to identify problems, I came across many obvious issues. I found the manager in charge was distracted with personal issues. Also, as opportunities for funding new assets were limited in that location, we began funding used assets and also focused on transferring loans from other banks to our bank and thus improved productivity significantly.
It is important also to monitor profitability by branch, by individual product etc. Many times organisations get confused due to a large number of products and branches and are unable to ascertain which ones are contributing to the overall profitability and which ones are a drag. it could also be due to poor systems or methods of allocations / apportioning of revenues. Sometimes, managers with vested interests also mix up costs / revenues deliberately so as to continue doing unprofitable businesses and have large empires.
Quality of portfolio is also a very important aspect which has a direct bearing on profitability. In the quest for building a large book, one should not loose focus on underwriting or credit buying. Profits come only when the customer is repaying regularly. Some organisations play on the borderline cases where the likelihood of defaults is high. The rationale for doing this is to collect higher amounts as penalty and default interest. However, this should be done very selectively and only after being sure that the collections costs are not higher than the incremental income. In any case, one should restrict the portfolio of such sub-prime cases to a manageable percentage of the overall book.
This blog would be incomplete if I do not mention the importance of cost consciousness. Every organisation should be wary of incurring costs. Every cost proposed to be incurred is to be evaluated in terms of benefits it will deliver. A tight process of budgeting should be followed with a close and periodical review of costs. Inter branch / unit comparison of costs should be done. Delegation of authority should clearly identify who is empowered to incur costs and to what extent.
I would love to hear your views on this blog. Please feel free to leave a comment on the blog or send me a mail at vish.sesh@gmail.com and I will quickly respond.
Subscribe to:
Post Comments (Atom)
1)break even period/Profit – not to forget to mention, whenever planning have some flexibility (urs!), have a sensitive analysis as the both depends on lot of outer factors.
ReplyDelete2)profit focus: u gave all the factors.. but for me the profit depends on only one thing.. just a simple thing.. ur man power..
- how they motivate themselves,
- how they contribute,
- how they adopt to situations,
- the ideas they bring to fit the situation,,
we only need an ear to hear..
if they commit – the business is always committed..
3)drop prices:
use B/E analysis..
nothing wrong in reducing the price to sustain in the local market and to retain regular customers.. at least we have to fit into the customers shoes too. If they could offer – they nvr mind to admit a little cost..
me have an account with a private bank (feel its of urs!!).. whenever me put some FD, me nvr bother abt the rate of interest as its their business policy – how me could expect more? But me would like to have a relation with them regularly though me would lost a 0.5% or 0.75% But every time – if anything best comes – they use to call me first!! (that 0.5% or 0.75% - me feel an opportunity cost!) be flexible and innovative.. incur some cost in one place and cut it out in some other place. U only behind the scene – as the customers love to watch only the play!!
4)Productivity: me again writing – it depends on ur employees only – take care – they themselves would bring great opportunity..
5)profitability by branch, by individual product:
(managers with vested interests also mix up costs / revenues deliberately..) –
just ask them some questions..
- which product you want?
- which you could sell so easily?
Then customize a product – as they are sit in a large empire – the profit is immense!!
Morality: if they not change – U change(!) – as the only motto is profit –
(don’t cry – business policy?? Will u run with the same set of policy in moon? then, why not to your own branches!! Try – u may wonder..)
6)CoSt: feel this article is written from the point of view of the service sector.. for the manufacturing sector - for arriving the cost, one of the best forgotten tool is – use of the central excise return!! Yes.. the centra excise return covering, in fact all the aspects of the cost that too so minutely (they bothering abt their revenue!).. if u summarizing, grouping and arriving cost from there – u may wonder - how easy it is.. just make them as the base record..
(These are my opinions - what me seen, feel - when me swim.. don’t bother!)
thanks for sharing..
Thanks for your invitation!!
ReplyDeleteI wish you luck with your new blog...