Every business owner knows that they’re trying to make a profit. Not everyone knows exactly what profit is, the factors that affect it, and how to mximize it. This is the first part of a series on profitability in your business.
Part 2: How To Increase Profit
What is profit?
Profit is what’s left over after you’ve paid all your expenses. The important thing to note is that profit is “what’s left over.” In other words, profit is a residual. It is the consequence of what happens in and to your business.
Some of these things are within your control, and some are outside your control. If you’re going to affect your profit, you have to focus on those things over which you have control…so, what are they?
To answer this question, it’s helpful to understand that only 4 specific factors determine your profit:
1. The price you charge for the products and/or services you sell.
2. The quantity (or volume) of products and/or services you sell.
3. The costs you incur directly in producing or buying the products and services you sell. (We call these variable costs because they increase or decrease as your sales increase or decrease).
4. The costs you incur whether or not you make any sales. (These are best described asfixed costs because they do not change with changes in sales volume—at least not on a day-to-day basis).
Let’s put these 4 things together. And for simplicity, we’ll assume you have only a single product. (Our conclusions apply whether you have 1 or 1,000 products).
Suppose you sell a thing called a widget. It costs you $60, and you sell it for $100. What you sell the widget for is the price. What you pay for it is a variable cost.
If you sell 100 widgets, your total variable costs are $6,000. And if you sell 50 widgets, the total variable cost is only $3,000. (It varies directly with your sales volume).
Now, if you sell a widget for $100 and it costs you $60, you’ve made a profit of $40 on each sale. We call this the gross profit or gross margin. We use this term to remind us that we still have to meet our fixed costs before we end up with a net profit.
If you sell 100 widgets and make a gross margin on each one of $40, your total gross margin is $4,000. And if your fixed costs for such things as rent, leases, wages, and insurance amount to $3,000, you end up with a “net profit” of $1,000. On the other hand, if your fixed costs are more than $4,000, you incur a loss.
This was Part 1 in a series.
Part 2: How To Increase Profit
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