Rod McQueen said it best in The Last Best Hope: "Volume is vanity, profit is sanity, and cash flow is reality."
Growing companies pursue new revenues, but volume isn't the same as profitability. There's also the question of whether the company can pay for the assets - current expenses and capital property - it uses in achieving growth.
The income statement tracks revenues and expenses over a period of time - a month, quarter or year. A pro forma income statement is simply a forecast of expected revenues and expenses.
Revenue: Sales and other income
Expenses: Expenditures made to generate revenue
Net Profit: Revenue minus expenses
Each growth strategy has an impact on the relationship between these three crucial items.
Growth strategies can sometimes have negative effects on income statements.
Increases in revenue may not offset changes in overheads or the increased risk of higher accounts receivable. Even if per-unit overhead costs remain constant - which is not often the case - volume rises may not be sufficient and net profit falls.
- Example: A specialty coffee shop sells 1,000 cups of coffee every day at $2 each. Each cup of coffee costs $1.50 for the ingredients and cup, so they are making 50 cents on each cup or $500 a day in gross profit. If the owners decide to lower the price by 10% to $1.80, they are now making 30 cents on each cup. They must therefore sell 1,667 cups of coffee each day to maintain their $500 profit (assuming constant overhead costs, which is unlikely.) That's an increase of 67% in sales to offset a 10% drop in price.
Depending on your profit margin, you may need to substantially increase your sales volumes simply to maintain your profit level, so carefully consider whether you'll be able to make up the difference either through increased sales or through after-sales options and add-ons.
Marginal outlets can bring down the whole chain at the beginning. Shared overheads can reduce net profit for the chain to less than that of the flagship outlet. The second danger is a general downturn in sales - marginal outlets quickly drain the chain's resources.
- Management Rule #1: Develop a strong management training program - don't base the assignment on who's been around longest.
- Management Rule #2: If you are manager of the flagship outlet, you must become chain manager and hire a manager for the first store. You are not ready to branch out until you find a manager for your flagship store.
- Management Rule #3: Set high minimum profit expectations for new outlets. It's incorrect to assume that revenue from lower performance outlets drops directly to the bottom line due to shared overheads.
Shipping, warehouse and travel costs can wipe out new revenue.
- Define objectives: Treat the new market as a start-up and do a complete costing.
- Set timelines: Taking too long to establish the market can endanger long-term profit and cash flow.
- Be strong locally first: If you can't focus on your expansion, neither old nor new locations will be successful.
Product Line Expansion
Track cost of new-product sales separately to determine if it is worth the resources it consumes.