Many businesses don’t realize the hidden profit potential that exists within their organization.
By unlocking this potential, and reframing how they look at their organization and P&L they can often increase their profits significantly contributing to enterprise value and shareholder wealth.
There are a number of ways to unlock hidden profit potential.
One way is to integrate operational and financial datasets together and create a new set of ratios or KPIs.
Moving beyond financial data helps uncover the true behaviours and actions taken to drive operational performance. “What gets measured, gets improved”.
Another way is to create operational P&Ls and incorporate Activity-Based Costing methodology to define various margins, the main one being, contribution margin. This insight into contribution can help unlock hidden costs and help organizations make new decisions to streamline processes and drive profitability.
Finally, incorporating hurdle rates or cost of capital on Net Assets into your P&L equation (Economic Profit calculation) will help determine whether you are adding or detracting shareholder wealth from the enterprise as a whole. Decisions around investment and resource allocation can be evaluated in order to meet investors’/bankers’ expectations.
The Profit Insight Architecture (PIA) is a management tool that links an organization’s strategy, business model, operations, and financial performance. The PIA provides a comprehensive view of how an organization creates value and generates profits.
The PIA has three key components:
The Value Creation Framework:
The Value Creation Framework (VCF) is a tool that helps organizations identify and assess the factors that create value.
The Profit Formula:
The Profit Formula is a tool that links an organization’s strategy, business model, operations, and financial performance.
The Performance Management System:
The Performance Management System (PMS) is a tool that helps organizations track, monitor, and improve their performance.
How to leverage economic profit to drive business value
Economic profit is the difference between the revenue generated by a business and the costs of all the resources used to generate that revenue. When a business generates an economic profit, it is creating value for shareholders.
There are a number of ways to leverage economic profit to drive business value. One way is to use economic profit as a metric to make decisions about where to invest resources. By investing in activities that generate economic profit, businesses can increase their value.
Another way to leverage economic profit is to use it as a guide for pricing products and services. By charging prices that cover the costs of all the resources used to generate revenue, businesses can ensure that they are generating an economic profit.
Finally, businesses can use economic profit to inform their decision-making about which products and services to offer. By basing decisions on economic profit, businesses can ensure that they are offering products and services that generate value for shareholders.
Written By Lance Tylor
Lance is a business finance professional with a passion for helping businesses grow. He is a Charted Management Accountant (CMA) within Canada and in the UK and has had several roles within the Office of Finance. His experience has always been focused on business strategy, performance management and business process improvement (leveraging the latest technologies).