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Profit planning is the process of developing a plan of operation that makes it possible to determine how to arrange the operational budget so that the maximum amount of profit can be generated. There are several common uses for this process, with many of them focusing on the wise use of available resources. Along with the many benefits of this type of planning process, there are also a few limitations.
The actual process of profit planning involves looking at several key factors relevant to operational expenses. Putting together effective profit plans or budgets requires looking closely at such expenses as labor, raw materials, facilities maintenance and upkeep, and the cost of sales and marketing efforts. By looking closely at each of these areas, it is possible to determine what is required to perform the tasks efficiently, generate the most units for sale, and thus increase the chances of earning decent profits during the period under consideration. Understanding the costs related to production and sales generation also makes it possible to assess current market conditions and design a price model that allows the products to be competitive in the marketplace, but still earn an equitable amount of profit on each unit sold.
There are several advantages to engaging in profit planning. The most obvious is evaluating the overall operation for efficiency. If profits for the most recently completed period fall short of projections, this prompts an investigation into what led to the lower returns. Changes can then be made to the operation in order to increase the chances for higher profits in the next period.
Necessary changes that may be uncovered as part of the profit planning process include increasing or decreasing the employee force, changing vendors of raw materials, or upgrading equipment and machinery that are key to the production of goods and services. In like manner, the need to restructure marketing campaigns so that more resources are directed toward strategies that are providing the greatest return, while minimizing or even eliminating allocations to strategies that are not producing significant results, may also become apparent as a result of this type of planning. Even issues such as changing shippers or making slight changes to packaging that trim expenses may be identified as part of the profit planning process.
While this is a useful process in any business setting, there are some limitations on what can be accomplished. The effectiveness of the planning is only as good as the data that is assembled for use in the process. Should the data be incorrect or incomplete, the results of the planning are highly unlikely to produce the desired results. In addition, if the findings of the process do not result in the implementation of procedures and changes in the relevant areas of the business, the time spent on the profit planning is essentially wasted. For this reason, profit planning should be seen as a starting point for operations and not simply recommendations of what should be done in order to increase profit margins.
Relying on overly optimistic profit planning can be deadly for a company or organization. I've worked for far too many companies that take ridiculous profit projections into account when planning budgets and wind up in trouble when they realize they don't have enough cash on hand to keep operating under a current budget.
Being optimistic is great to a point, but folks have to face reality at some point, too.
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