In business, setting financial goals is crucial, but achieving them requires more than just wishful thinking. One powerful method to reach your profit targets is reverse engineering—a strategic approach where you start with your desired profit and work backward to determine the sales and operational targets needed to achieve it.

In this blog, we’ll explore the concept of reverse engineering profits, using a real-world example of how we helped one of our clients, a marketing agency, increase their profits by £30,000.  As business strategists not just accountants, we regularly follow this method, with our clients so that they can gain clarity on what needs to be done to achieve their financial goals and build a more robust business strategy.

Setting the Profit Target

As more than yearend accountants, we meet regularly with our clients to discuss their strategy and growth plans. At one such meeting our client came to us with a clear goal: they wanted to increase their annual profits from £100,000 to £130,000. This £30,000 increase represented a significant growth target, and they were keen to understand the actions required to reach it.

Step 1: Understanding the Current Financials

Before diving into strategies, we revisited their latest management accounts  to remind ourselves of the current financial situation. Here’s a breakdown:

• Current Profit: £100,000 per year
• Desired Profit: £130,000 per year
• Current Fixed Costs: £55,000 per year
• Current Gross Profit Margin: 55%

To achieve the new profit target, we first calculated the monthly profit required:

Monthly Profit Target: £130,000 ÷ 12 = £10,833 per month

This monthly target would guide our next steps in determining the necessary sales and operational targets.

Step 2: Calculating the Required Turnover

With the desired profit in mind, we needed to establish the turnover required to maintain the same gross profit margin and cover the fixed costs.

Given our client’s current gross profit margin of 55%, we calculated the required turnover to achieve the £130,000 profit:

Required Turnover:

First, we added the desired profit to the fixed costs: £130,000 (profit) + £55,000 (fixed costs) = £185,000

Since the gross profit margin is 55%, the cost of goods sold (COGS) would be 45% of the turnover.

To find the turnover:

Turnover = £185,000 ÷ 55% = £336,364 per year

This meant our client needed to increase their turnover from £218,819 per year to £336,364 to achieve their profit goal.

Step 3: Determining Client Volume

Next, we looked our client’s current client base to understand how many new clients they would need to achieve the increased turnover.

Current Turnover: £218,819 per year

Average Fee per Client: £8,000 per annum

Current Number of Clients: 27 clients

To reach the new turnover target of £336,364, we calculated the number of clients needed:

Required Number of Clients: £336,364 ÷ £8,000 = 42 clients

At this stage our client’s financial data indicated that they would need an additional 15 clients to reach their new turnover target.

Step 4: Exploring Alternative Strategies

The prospect of acquiring 15 new clients was daunting for our client, and understandably so. In the competitive landscape of marketing agencies, finding and retaining clients is no small feat.

Recognizing their concern, we explored alternative strategies that could reduce the number of new clients needed while still achieving the desired profit increase.

As business strategists rather than just year-end accountants we were able to discuss alternative strategies, including:

1. Increasing the Gross Profit Margin by Reducing Costs

One of the most effective ways to boost profits is to improve the gross profit margin. This can be achieved by reducing the cost of goods sold (COGS) or operating expenses. By streamlining operations, negotiating better rates with suppliers, or finding efficiencies in their service delivery, our client could potentially increase their gross profit margin from 55% to a higher percentage.

For instance, if they could increase their gross profit margin to 60%, they would need less turnover to achieve the same profit. This would reduce the number of additional clients required to 38 rather than 42, making the target more manageable.

2. Increasing Prices for Specific Clients

Another strategy we discussed was increasing prices, particularly for clients who had been with them for a long time or were receiving more services than initially agreed upon. Price increases can be a delicate topic, but with the right approach—such as highlighting the value delivered and the rising costs of doing business—clients may be more receptive than anticipated.

Even a small price increase could have a significant impact on overall profitability, reducing the need for new clients.

3. Improving Automation and Systems to Maintain or Reduce Overheads

Automation and system improvements can also play a crucial role in increasing profitability. By investing in technology that automates routine tasks, the agency could reduce their overhead costs or reallocate staff time to higher-value activities.

For example, implementing a more efficient CRM system or marketing automation tools could lead to better client management and more effective marketing campaigns, thus driving growth without a proportionate increase in costs.

Step 5: Implementing a Comprehensive Strategy

With these alternative strategies in mind, we worked with our client to create a comprehensive plan. The plan focused on:

• Optimizing their current operations to reduce costs and improve margins.
• Implementing a phased pricing strategy to gradually increase fees for existing clients.
• Exploring new market segments to attract higher-value clients who could potentially contribute more revenue per account.
• Investing in technology to streamline processes and reduce the burden of manual tasks.

By taking a holistic approach, our client was able to reduce the number of new clients needed to reach their £130,000 profit target. Instead of needing 15 new clients, the combination of improved margins, price adjustments, and operational efficiencies meant they only needed to add 10 additional clients to hit their goal.

The Power of Reverse Engineering

Reverse engineering is a powerful tool for business owners who want to achieve specific financial goals and it’s a technique that we as proactive accountants and business advisors love. By starting with the end in mind—your desired profit—you can work backward to determine the necessary turnover, client volume, and strategies required to reach that target.

For our marketing agency client, this approach not only provided a clear roadmap to achieving their £130,000 profit goal but also opened opportunities for improving their overall business model. By focusing on both revenue growth and cost management, they were able to set realistic targets and implement strategies that made their goals achievable.

If you’re looking to set and achieve your own profit targets, consider reverse engineering your sales and operational strategies. It can provide the clarity and direction needed to take your business to the next level. And remember, you don’t have to do it alone working with a knowledgeable business advisor like Beansprout, can help you navigate the complexities and unlock new opportunities for growth.