Most businesses with low profits and erratic cash flow get here because operations are out of control. The first sign of operating problems is late deliveries. The second sign is never-ending quality issues, with the third sign being Direct Labor given “busy work” that makes Direct Labor a fixed, not a variable cost when sales are slow. Any combination of these three signs will always manifest themselves in declining Gross Profit.
A business with a continuously decreasing Gross Profit is a business in trouble. Correct for this by holding your Operations team accountable for the results they are producing. Do this, and you will see an immediate improvement in both Cash Velocity and Cash Quality. Fail to not hold them accountable for the Gross Profit being generated, and you will run out of cash on your way to going out of business.
Overview
The role of operations is to convert a sale into a profit. The sales delivery processes represent the make-or-break part of the business. The book Discipline of Market Leaders by Michael Treacy and Fred Wiersema describes how customers search for operational excellence, product leadership, or customer intimacy as three sources of value.
A business is more likely to maximize the available Gross Profit from each sale when it structures the operating policies, procedures, and processes around one of the following disciplines:
Operational Excellence that leads with process-centric and operational competency. The focus is …
BEST TOTAL COST.
Product Leadership leads with quality and product differentiation. The focus is …
BEST PRODUCT.
Customer Intimacy is relationship-centric and customer-responsive. The focus is …
BEST TOTAL SOLUTION.
Operating teams that fail to work to the market discipline their business model is structured to deliver will waste money, have quality problems, and be late on deliveries.
A weak operations management team is the reason why most businesses fail to make the money they should. You can spot a weak management team because they allow direct costs to increase unchecked as a percent of sales. They are quick with excuses for quality issues and why orders are late. Their inability to do the work is why those in sales struggle more than they should getting work. The office staff has difficulty getting paid because the documentation for customer invoicing is haphazard.
The best operations have management teams that own their accountability for meeting the Gross Profit goal. They immediately address unplanned changes in direct costs. They know what their order cycle time is and don’t let quality issues repeat. They collaborate with sales, so they are set up to deliver orders on time. They make it easy for finance to invoice customers for completed work while making sure the subcontractors and material suppliers aren’t overcharging in their invoicing.
If you aren’t satisfied with your business’s Gross Profit, you likely have an operations problem. You confirm this by ensuring your product and service pricing is competitive in your market. If you are priced below the market, you are handicapping your Gross Profit because you aren’t charging enough.
The second check on whether you have an operations problem involves the costs being assigned to your Cost of Goods Sold (COGS.) If you have indirect and nonoperating costs sitting between Net Sales and Gross Profit on your P&L Statement, you are overstating COGS while understating your overhead costs. Don’t do this. You need your COGS to reflect your variable and direct operating costs. Nothing more.
Your Gross Profit needs to accurately reflect what it costs you to convert sales into your first level of business profitability. An accurate Gross Profit enables you to hold your Operations team accountable for how much it costs the business to do the work. It also tells you how much you can afford in overhead, which is the accountability of the Finance Manager and ownership. This is not the burden of the Operations team. Their job is to cover the burden by maximizing the Gross Profit generated to cover your overhead at a profit to you.