Issue link: https://www.e-digitaleditions.com/i/66147
Money Matters Bridging the Profit Divide By Dr. Alber t D. Bates Pr esident, Profit Planning Group Historically, the top-tier firms have always generated higher profits than more typical firms. Now, they are gen- erating a lot more profit. Slowly, but steadily, the profit divide is widening. Quite understandably, most firms T aren't particularly concerned about something as vague as a profit divide. Instead, they are looking to ensure their economic viability today so they can continue to compete in the future.The assumption the typical firm makes is that it can catch up in subsequent years. The reality is that the higher-profit firms are not only enjoying better results today, they are building a profit advantage that will be increasingly dif- ficult to overcome in the future. This report will examine the nature of the profit divide and some of its implica- tions for FEDAmembers. Itwill do so by looking at two different issues: The Implication of Different Profit Levels (an analysis of how higher prof- its today pave the way for much higher profits in the future); and Making Desired Profitability a Reality (an examination of the essential steps that firms must take now to get on the right side of the profit divide). The Implication of Different Profit Levels To understand the implication of dif- ferent profit levels for future perform- ance, it is necessary to reviewsome sim- ple information for the typical FEDA member. That information and some assumptions about the future are shown in Exhibit 1,which is presented in two sections: Current and Potential Results.The current figures in the first 28 FEDA News & Views he economic challenges of the last several years have created a "prof- itability divide" in the industry. column of the exhibit reflect the typi- cal FEDA firm. This entity has sales of $12,500,000 on which it generates a profit of $200,000, or 1.6 percent of sales.To generate this level of sales and profit, the firm invested $4,200,000 in total assets. This produces a pre-tax return on assets (profit before taxes divided by total assets) of 4.8 percent. The remainder of the top half of the exhibit demonstrates the performance of firms with higher rates of return on assets. The middle column reflects a 15.7 percent ROA, which is the level currently being generated by the high- profit FEDA firms. Finally, the last col- umn shows a 20 percent return on assets.This is the performance level that the Profit Planning Group has suggest- ed as an industry goal for many years. It is truly outstanding performance. It should be noted that in all three current scenarios, the sales and total assets are identical.Only the profit num- bers are different.This is very close to the reality of the industry at present. The bottom half of the exhibit reflects the potential results the firm could achieve in five years.The results rest on two assumptions. First, it is assumed that the firm reinvests half of its pre-tax profits back into the business to increase its asset base. Secondly, the increase in the asset base will be used to support equally higher sales.That is, if the asset base is increased by 5 per- cent, then total sales can be increased by 5 percent. Neither of these are per- fect assumptions, but do reflect the long-term performance pattern in the industry. The key result is that the typical firm has reinvested enough profit dol- lars to increase sales from the current $12,500,000 to $13,843,514 from internally generated funds. This is an increase of 10.7 percent. In very sharp contrast, the high-profit firm with a 15.7 percent ROA has the potential to continued on page 30 Exhibit 1 The Impact of Profit Reinvestment For the Typical FEDA Member Current Results Net Sales Total Assets Profit Before Taxes Profit Margin Return on Assets Potential Results in Five Years Net Sales Profit Before Taxes Profit Margin Total Assets Return on Assets Five-Year Sales Increase $12,500,000 $200,000 1.6% Typical Results $4,200,000 4.8% $13,843,514 $221,496 1.6% $4,651,421 4.8% 10.7% 15.7% ROA Scenario $12,500,000 $659,400 5.3% $4,200,000 15.7% $17,365,093 $916,043 5.3% $5,834,671 15.7% 38.9% $12,500,000 $840,000 6.7% 20.0% ROA Scenario $4,200,000 20.0% $18,929,778 $1,272,081 6.7% $6,360,405 20.0% 51.4%