Several years ago I was recruited to work with a privately held government contractor. This was a research company with multi-year, multi-million dollar grants and contracts. The company was fast approaching 300 employees and was struggling with many growth-related issues. The problem as defined by the client was accounting and finance related issues.

As time and the project revealed, the problem was not simply the lack of an adequate accounting system, it was more fundamental: It was how they were doing business. The processes throughout the company were ad hoc, inconsistent and lacked alignment in goals, controls and management oversight.

The Beginning

On a cold autumn day I received an email from an existing client with a referral to a new client we’ll call “Beta.” Beta was interested in getting a new accounting system to “fix the financial performance issues” and “generate growth.”

At the first meeting with the controller, VP of Operations, and the head of sales, the conversation turned to having more accounting detail and visibility to the costs of each project and doing business. Those were the goals set for the project and we settled on a start date where I would begin assessing the organization’s existing systems, processes and needs related to growth.

The Findings

The client organization had a full complement of executives and managers of the 300 or so employees; one third of them were management or executives. Then there were the administrative support staff: everything from two IT groups, to project management, customer relations, human resources, purchasing, and administrative assistance, which added up to 150 administrative people. Then there were the “revenue generators”: scientists, researchers, lab workers, and product development. Of the 300 or so employees, this group accounted for 25% of the organization.

Accounting systems could be termed antiquated at best. Their current software had not been updated in eight years and most things were done in spreadsheets outside the accounting software. Even more startling was the fact that finance and accounting information was restricted to only 10 of the 300 employees. The owners could see the info. Two VPs could see the info. And finance could see it. Who couldn’t? The sales group who quoted cost of projects to potential clients. Project managers and department heads couldn’t. In fact, even the human resources department had no visibility to review salaries, bonuses or raises.

In addition, there was zero accounting for resources: time, purchases or facilities. When it came to determining how profitable a project was, nothing was project-specific except the science. Purchases for project specific items were in reality charged not to the project, but to all the projects based on bid costs. Dedicated staff costs were spread across every project the company had. Administrative costs were assigned to projects based on the other costs that had been spread to the projects … and so no one knew or could determine the actual costs of a single project. They didn’t know what was overspent or under spent. They had no idea where the profits of the company were coming from.

Profitable?

When it came time to make changes to the system and the processes of costing, pricing and reporting on performance, you can imagine that few were on board to change how they did business. Even the owners, founders and senior management couldn’t understand why they needed to have cost information by project or why someone doing a bid or proposal couldn’t just set a price regardless of cost. After all, they were “profitable.” The key answer was that they were profitable for now. At the rate of hiring and the decline in profit margin for the company, if things didn’t change drastically, in two to three years they would be losing money—lots of money—on the bottom line.

Understanding Profitability

When it comes to profitability, how do you know where you make money and where you lose it? How do you know when it is better not to bid on a project because the price you will be paid will mean you lose money not only on the project but in the overall business? You must understand your numbers.

Project profitability can tell you if you made money, if you budgeted correctly and if you assigned the right resources. It will let you see if you priced the project correctly to make money on the project and on the bottom line.

Many a contract-based company that looks only at the profitability of the company as a whole will find that when they get into the detailed costs and profits on a project by project basis, they would have been more profitable (in total dollar terms) if they hadn’t accepted certain projects. Another company I worked with was generating $20 million in sales and $200,000 in profits for the organization. When we broke the sales and costs down into business segments (e.g., government and private sectors) we found that the government sales lost $200,000 and that private commercial sales had generated $400,000. If the company had not received the government contracts at all, they would have had another $200,000 in their pocket! Or alternatively, if they had visibility to the project costs, budgeted each project with real costs of salaries, systems, materials, etc. they may have been able to generate $200,000 in profits on the government side of the business.

No matter how you look at it, the company would be more profitable with more visibility to the underlying financial returns and costs on each business unit and project. It is critical to understand that the profitability of a company taken as one number can conceal where you are making money and where you are losing money on individual business units, product lines, projects and customers.

Small Changes, Big Returns

There are several things organizations can do to get more visibility to how they make profits:

  • Identify costs and revenues by at least one of the following (and preferably two: one customer/project/product and one operational area):
    • Customer
    • Business unit
    • Line of business
    • Product
    • Project
    • Department
  • Track and review actual projects and activities, versus those planned or budgeted
  • Understand the relationship between costs/price/profits
    • Costs are what you pay for resources
    • Price is what you can charge the customer based on
      • Competition: what everyone else is charging
      • Value: what the customer is willing to pay for what is being offered
    • Profit: the difference between cost and price

When it comes to the profitability of your business, rarely will price or revenue be dependent upon what it costs you to deliver the “product” to the customer. You do however need to be aware of your costs, because the one thing you may be able to control is your cost structure and ultimately your profitability. Rarely can you set the price and let the costs take care of themselves.

Copyright ©2010 Lea A. Strickland, F.O.C.U.S. Resource, Inc.

All Rights Reserved

 

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