Profit Planning

What Is Profit Planning?

Profit planning refers to setting up a profitability goal for a particular budgeting period and the steps undertaken by a business to achieve it. It is an essential process of running a company, as businesses are all about profits, and firms follow many measures to attain desired profitability levels.

It involves setting a target profit level for a specific budgeting period, which can be quarterly, half-yearly, or annually. Budgeting and profit planning are closely interlinked with the latter being a significant component of the former. It involves the collaboration and input of all departments, employees, suppliers, investors, and other stakeholders to set a target profit level, plan, organize, control, and achieve it.

• Profit planning can be defined as the firms deciding a target profit level and laying down strict procedures to attain the goals.
• The target should be set by considering existing conditions, current capacity, and forecasts. The procedures should collaborate with all stakeholders and allocate responsibilities. Performance should be monitored regularly to identify any deviations and adopt necessary measures.
• The objectives of profit planning include easy attainment of profits, setting benchmarks for future growth, capital creation for future endeavors, employee motivation, satisfaction, etc.

Profit Planning Explained

Profit planning and control are essential but often overlooked in management, yet it plays a pivotal role in the success of businesses. It involves setting realistic goals, creating a comprehensive plan, fostering collaboration among various stakeholders, and conducting regular assessments to achieve desired profits.

However, intricate details and too many factors affect this process, making it complicated. Also, sometimes the management sets too high a goal, with companies realizing halfway that they are unattainable. It leaves the employees disinterested and even frustrated. Not being able to achieve a goal after working on it for months will demotivate everyone.

To facilitate effective profit planning, it is crucial for management to clearly define the responsibilities of each department in attaining the target profit level. Team leaders or department heads should meet regularly and track progress. They should inform their team members of new developments and how much more should be done.

Moreover, the management must remember that target profit levels and execution steps should be updated if the firm has undergone radical changes or has economic constraints. A rigid plan and unattainable goal will harm as much as no plan or goals.

Therefore, the management has to take due care and avoid such mistakes, which make the whole process pointless. Communicating with company stakeholders and making them understand the importance of their contribution towards objectives of profit planning will foster workforce commitment. The company must also evaluate various alternatives and scenarios before deciding on a target level.

As mentioned, budgeting and profit planning go hand-in-hand. Therefore, planning revenue and expenditure leads to planning business profits. Nevertheless, the difference is that budgeting does not stress the steps to achieve, the responsibilities of organizational units, approved systems of control, etc.

Steps

So, let us see how companies can systematically execute profit planning.

Step #1: Establish target profit level

The management can decide how much profit they want to make in that budgeting period. It can be quarterly, half-yearly, or annually. However, a realistic goal based on the company's past performance, capacity, planned activities, and forecasts is always better as it is more achievable.

Step #2: Plan how to achieve the target

Profitability can be achieved by increasing market share, cutting costs, launching new products, or entering new markets. The firm has to decide how it would attain the targeted profitability. Once it has made the decision, it has to plan the execution of the necessary steps.

Step #3: Controlling

Once the firm is on the path to making the planned profits, it must follow a control system that regularly monitors the company's performance (monthly, quarterly, etc.). If any deviations from the target are identified, the responsible executives must make appropriate corrections and bring the business operations on the right track. It can be done by managing cash flows and taking corrective actions wherever required.

Step #4: Determine profitability

Profit is calculated as the excess of revenue over expenditure. Companies should estimate if they have achieved their target profit level at the end of their budgeting period. The firm might face more significant issues that require immediate attention if the target still needs to be achieved, despite the management's best efforts and regular checks.

Examples

Consider the following examples for more clarity on the concept.

Example #1

XYZ Glasses is a glass manufacturer from Detroit, Michigan. The company earned a profit of $250,000 in 2022. It recently bought a factory in Oregon to expand operations to the West. With increased capacity, it aims to profit $325,000 in 2023. It is how the company plans to achieve its target.

The company has also hired a few sales representatives to increase its clientele in the West. Further, they are also planning to start shipping their products to customers in Canada. To maintain their costs, they have decided to manufacture orders worth more than $20,000 only after they have been placed.

Example #2

Automobile manufacturer Ford Motors estimates that its electric vehicle unit Model e will start returning profits by 2026. Ford Model e had a profit margin of negative 40% in 2022. Ford Motors has laid out its plan to make an 8% EBIT profit margin in 2026.

Ford has decided to expand its production capacity to 2 million units annually by 2026, contributing 20 points of margin improvement. Secondly, Ford's energy-efficient designs significantly reduce battery costs, thus adding 15 points. Thirdly, Ford aims to decrease battery-cell manufacturing costs, thus providing 10 points. Finally, the company is also eyeing incremental gains by selling software and services, which will add 3 points.

Despite the automaker's plans, some experts claim its projections are optimistic.

Importance

Profit planning and control are essential in a company's budget. Budget is all about financial management, of which profits are significant components.

1. It helps companies achieve profitability by outlining everything from setting a goal to reaching the target level. However, companies should put in a lot of commitment and work religiously towards their goal.
2. It serves as a benchmark for the company's growth. If a company makes $100,000 in profits, it can strive for higher profits the following year. The motivation is higher if the company has reached its target level because it would want to keep working harder for the future.
3. It aids in cash management. What do companies do with profits? Net profits are stored in company reserves or used to expand operations. If a company is working towards its goal, it can plan and finance these activities without borrowing or raising additional equity.
4. It is a source of motivation for employees and pushes them to contribute more. It also creates a sense of being a part of something larger. To instill and grow this feeling, companies must keep their employees posted about how far they are in achieving their goals and highlight significant contributions that have made a difference.
5. While working towards profitability, companies also realize other concerns or essential factors that went unnoticed before. For example, the company can finally let go of a store that isn't bringing them enough profits!

Frequently Asked Questions (FAQs)

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