UK: Where Has All The Profit Gone?

Last Updated: 8 May 2001
Article by John Quinton

Firstly ……..

One of the problems our small businesses face is that their own Agenda for success – making as much Profit, (rather than just income), as they can from their limited resources - is not the same as that of either the Government, which simply wants ‘Business’ to help them, (and gratuitously), to achieve whatever social policies the presently ruling party has, Companies House, which likes neat paperwork, regardless of whether or not it reveals anything helpful, or the Inland Revenue which, apart from conning us into doing much of their work for them, needs to extract as much cash from our businesses as it can.

If the Government, Companies House or the Inland Revenue push so hard that achieving our own Agenda becomes impossible, who cares? They certainly don’t, but we just might. The resources available to them to enforce the extraction of as much as possible are, unlike ours, unlimited and unaccountable by the standards our businesses must meet.

Faced with such an array of hostile forces, is it actually possible for a small business to succeed? What does it have to do to defeat the powers of darkness? ‘Shed a little light’, I hear you say.

What ‘They’ Need ..

Most Businesses are unaware of the cost of meeting any contract they have, and therefore play Russian roulette with their profits. Many depend upon their Statutory Accounts, or whatever statement their Accountant produces annually and in retrospect to satisfy the Inland Revenue, to tell them whether they were profitable in any particular year. But that measure of profitability can hide the performance of a company that is about to die. In fact, more Companies fail through Cash Flow problems than through a lack of, (apparent), profit.

The fact is that the normal methods for reporting financial performance have been designed with ‘their’ interests in mind, and not ours. They are intended to aid regulation and public disclosure, rather than to improve business performance.

What ‘We’ Need ..

What tells a business how it is doing is regular financial management reporting – based on Management, rather than Statutory, Accounting principles – of what is happening now, rather than what is thought to have happened in the last full year, (which might have ended up to a year ago). And the more topical and timely Management Reporting is the more likely it is to show the present (profit), performance of the business and to highlight, or give warning about, problems which have to be faced.

(Financial) Management Reporting.

But even then, and given an accurate report of more or less current performance, the interpretation of a Management Report requires a bit of basic information about Cost Accounting – the determination of the costs of particular parts of the company, including its infrastructure, the mechanisms it uses to develop itself and the processes whereby it plans, delivers and monitors its delivery of a service or controls its production.

This is the process which requires, firstly, an understanding that the whole cost of running the Business, from buying and running the boss’s BMW to paying for the paper clips, via the purchase of materials and the payment of wages, must be recovered from whatever Invoices the business can submit to its clients and persuade them to pay.

Some essential activities, such as IT, the maintenance of records and the manager’s salary are simply costs that have to be borne – and they are grouped, by department or section, into what are known as Cost Centres.

Other activities, which might comprise making a widget from a piece of metal costing 10p and selling it for £1, are known as Profit Centres because what they do has added value and created a profit. A business might contain 10 Cost Centres, (of which Accounts will itself be one), but will generally contain a smaller number – sometimes only 1 – Profit Centre.

However many Profit Centres, or Cost Centres, there are, the Profit Centres must add value and produce work which can be sold at such a price as will produce a margin sufficient to pay for all the Cost Centres and still leave Profit.

Costing Techniques.

There is a technique, variously known as Full or Absorption Costing, or Activity Based Costing, (ABC, in the jargon), which, for any product or service, works out what proportion of the costs of each Cost Centre supports the individual units of work of each Profit Centre, and then adds that to the cost of the materials and labour used to reveal the true profitability of each Profit Centre.

Typically, a business might make something, install and then maintain it at a Client’s site, and offer to supply spares or special consumables as required by the use of the product. That could be 3, 4 or 5 Profit Centres, depending on whether of not installation and maintenance are equally profitable and whether or not selling spares is more profitable than, or as profitable as, selling consumables.

So, it is very important to know the profitability of the several Profit Centres, not only so that management can avoid having one which subsidises another but so that it can see what changes in its business, or marketplace, it would need to make to, firstly, optimise and then, secondly, maximise its profit. Which is where this article started.

Understanding these Cost Accounting and Management Reporting techniques requires intelligent effort, rather than a degree in mathematical logic from Cambridge. This is much more applied common sense than accounting wizardry.

Typical cases within the writer’s personal experience, where this kind of thinking turned a little into a lot include:

  1. A company which made £250,000 a year on a secondary activity selling spares, but an equivalent loss on its main activity of designing, installing and maintaining oil pipeline flow monitoring equipment. It had 4 Profit Centres, only one of which worked properly. Prices of spares were increased and cost measurement and control measures introduced to every other part of the company through a simple form of ABC.
  2. A company with two unrelated activities, and only 2 Profit Centres, which made £350,000 on one activity and lost £400,000 on the other. Once it knew that it could make an easy, and informed, decision to have a Profit of £350,000 a year, instead of a loss of £50,000, for roughly half the effort, it was transformed. The unprofitable activity was sold off to a Company that needed the extra volume to spread the cost of its already existing cost base.

The Tail Piece

You might think that such a logical and, as it happens, relatively simple technique should be freely available to anybody who wants it. But it isn’t. There are no good books or courses. It is still the topic of many an MBA dissertation, and perhaps on that account alone jealously guarded, and something much studied by undergraduates around the world, as the Henley Business Partnership’s own e-mail postbag shows.

Perhaps its protection as an activity requiring high intellect is an aspect of the now familiar culture from which spring brilliant solutions to problems we don’t have and, because none of them ever thinks to ask, which leaves the real problems of business, which are inherently simpler, disregarded. No knighthoods or political advantage to be gained by solving those.

As in so many other fields there is much airy talk about cost analysis and cost control, but little action. Perhaps that is because putting the technique to practical use requires an understanding of the fundamentals of business, rather more than formal accountancy training, plenty of commonsense, access to Excel and an ease with simple maths at about GCSE grade C. Are these rare skills? If they are then I am more out of touch than I thought I was. I wouldn’t give you tuppence for one of those MBA dissertations. They must be worth just about as much as a degree in knitting.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.