Modern businesses usually plan ahead before time. This is important for the businesses to be able to pay its expenses and solidify their liquidity status. Just like any other cost of the business, the process of profit planning is used to manage profits, that when further analyzed can be considered a cost. Profits are an essential part for the survival of the business. The business has a bleak future when it does not make any profit. Peter Drucker bring out this when he states that ‘profit is the cost of the future, the cost of staying in business’ (Balakrishnan, 2002). Profit planning has been defined by the business dictionary as the setting of income target for the coming period through the construction of an income statement that states the expected sales and the expected gross profit putting the prevailing market conditions in mind. To accomplish this role the process uses budgets of different kinds are prepared and when put together a business plan is formed. A budget is a business document that shows explicitly how resources, financial and others are meant to be used over a specified period of time. Budgets are meant of work under the principle of budgetary control. Profit planning involves coming up with future business plans and coming up with budgets that show how these plans are going to be met. This differs from the process of profit control as these are those steps taken by the management of an organization to ensure that those objectives set for the achievement of the profits realized are met (Berman, 1961).
Budgets are important in the process of profit planning because it act as a channel of communicating the plans and expectations of the business by the management. They also help the managers in the business to think ahead and plan on how to realize of more profits. The absence of a budget might make the managers to result in management by crisis. The process might also bring to the surface the potential shortfalls that stand in the way of the business and making profits. It also ensures a unity in direction in that all efforts in the business will be directed in reaching the ultimate goal of making profits. This is not to say that the process does not have hindrances. When not well handled it can lead to the business community feeling they are under pressure and also gives rise to inter departmental conflicts especially when resources have been spent and targets are not being obtained (Cheatham, 1987).
The process of writing a profit plan starts with having a sales and profit summary through the preparation of an income statement. The plan has a number of uses in an organization. The plan will help bring out the areas in businesses that are unsatisfying. This is usually the gaps that exist between the final income statement and the profit plan. The business can then take corrective measures that can be taken to correct these short comings. This also enables the organization know if there will be a need to increase resources or personnel. For example, an increase in production might have the indirect implication that the company’s production staff might be overwhelmed and this sends the signal that more staff needs to be employed. This will also help the business make prior plans that would lead to saving the cost incurred when purchasing the raw materials to be used. The profits the organization expects to make might mean that the business might need alternative sources of extra capital which might lead to more production that translate to the realization of the expected profits.
The process of profit planning should be continuous in nature where by the business operations should be constantly under watch to ensure that they are in line with the plans that were made. The need for additional production resources and staff is always being assessed and steps should be taken to meet them. The need for the organization to seek financial help from within and outside of the organization is also looked at.
The first step of planning for profits begins at the forecast point of the business expected profits and loss. Profits cannot be considered in isolation since they are closely drawn from sales. Decisions taken on either of these are bound to affect the other, i.e. increasing pricing might lead to more money being realized from sales and this leads to increase in profits. The process should there fore start with a sales forecast. The volume of sales will help the business have an idea of things. One of these is the changes that will be experienced in the expenses that are directly related to sales like sales commissions. A substantial increase in the number of sales might have a significant increase in the fixed costs in the business. Some of the areas are like areas to do with keeping of records, especially if records are to be kept for individual customers. The storage space for the goods before they are sold might also need to increase.
A realistic sales forecast draws a balance between the businesses achieving its potential from the opportunities being offered by conditions of the market. It should give an idea of what the business can do at that point of time and have plans of the actual doing. The business fore cast should be realistic enough to be used as a basis to evaluate performance at the end of the business period. It also has the steps that the business is going to take in order to acquire the intended market share in the market. The sales fore cast is an important consideration since it will have a hand when making important decisions like the addition of personnel, borrowing of credit, adding of storage facilities and determining how the employees are going to be remunerated. This will also convince potential inventors that the business is on a journey to make profits and attract their investments. Just like any other forecast, this should be supported by an action plan that is neither over nor under ambitious.
A sales forecast begins with the analysis of how much the business sold during the past year. This is easily done by first putting the sales into different categories. Then the factors that affected the different sales categories are looked at. These factors include promotional plans, plans for expansions, new product introduction in to the market, trends in the market, government policies and inflation. The comparison of the previous gross profit realization and the current levels is done on the ground of certain key issues. One of them is the objectives that had previously been set and those in current use. This will help the business identify how well it has been doing. The business should also compare itself with the other businesses in the same industry as businesses do not operate in isolated conditions. If the business will be operating under the belief that its circumstances are different it will not succeed in the process of profit planning.
When a business embraces the concept of financial planning it will benefit in a number of ways. The business will have a way to continuously evaluate performance especially in matters concerned with sales (Fish, 1967). The personnel, through the performance plan are usually aware of the duties and the responsibilities they are to meet in making the business achieve profit. The budgeting process makes the business to be more conscious in relation with expenses as it looks at the expenses even before they occur. The business will put a check on excess spending and also look for processes and procedures that are more cost friendly. When undertaking the process of profit planning problems can be identified and solved before their actual occurrence. Since it involves planning for the future, the business can have growth and expansion plans well in advance. The process also aids financial planning as the business will need to think of how to deal with the profits realized. A business with a strong profit plan is treated with more credibility with investors and potential lenders as it is a sign of credible leadership and ability to make bigger financial realizations.
The process of planning for process is however not without hindrances. The processes based on estimates and the conditions of these estimates might change as the business year progresses. This might affect the success of the plan. The business also requires the support from all the stakeholders and reluctance of one of the parties might lead to the failure of the plan (Christopher, 2000). The business need to prepare a new business plan for each year as recycling business plans might be detrimental as the market is dynamic. All in all, profit planning is vital in the survival of a business enterprise. It acts as a benchmark and the business will always have a point for references. Corrective decisions are made just in time and this reduces the chances of the business making losses. The business management function is made easier as duties are allocated to individuals and expectations communicated in an effective manner.
Balakrishnan, R. (2002). Integrating profit variance analysis and capacity costing to provide better managerial information. Issues in Accounting Education: 149-161.
Berman, N. (1961). Profit analysis practices in an oil refining company. N.A.A. Bulletin: 63-68.
Cheatham, C. (1987). Profit and productivity analysis revisited. Journal of Accountancy: 123-130.
Christopher, W (2000). A hands-on approach to profit management. Journal of Cost Management: 10-12.
Fish, E. (1967). Profitability reporting in a professional consulting firm. Chicago: Bantam Books.