Four Factors To Increase Profits
What You Need to Know About Managing Business Profitability
As a CPA, I am asked a lot of questions about managing a business. It's vital for a business owner to understand the basic principles surrounding the disciple of business, especially the concept of profit.
“What is profit?”
Simply put, profit is what 's left over after you've paid all of your expenses. Some things involved in the basic definition of profit are within your control and some are not. If you want to improve your profit, you should spend time working on the things you can control.
In order to understand profit, you must focus on the four factors that determine profit in a business.
- Price - what you charge for the product or service you sell.
- Quantity - the volume of products or services that you sell.
- Variable costs - the costs that increase or decrease as your sales increase or decrease.
- Fixed costs - those costs that do not change with increases or decreases in your sales.
It is my contention, however, that in the short term, all costs are fixed and in the long term, all costs are variable.
“How do I increase profits in my business?”
In order to increase profits, you must consider the four factors, the possible actions you must take, and the required conditions that would have to be applied to make this happen.
Remember that profit can be improved by increasing or decreasing any of the four factors, as long as some conditions are met. Also, no single factor can be considered without evaluating its impact on each of the other factors.
In order to understand how this works, let's consider how a 5% change to each of these four factors can affect profit.
| Factors |
Base |
% Change |
Result |
| Price |
100 |
5% increase |
105 |
| Sales Volume |
100 |
5% increase |
105 |
| Total Revenue |
10,000 |
|
11,025 |
| Variable Cost ($60) |
6,000 |
5% decrease |
5,985 |
| Gross Margin |
4,000 |
|
5,040 |
| Fixed Costs |
3,000 |
5% decrease |
2,850 |
| Net Profit |
$1,000 |
|
$2,190 |
With a small 5% change in each of the four factors of profit, net profit increased by over 110%! There may be consequential impacts of these changes that were not considered in this example, but the fact is that small improvements made to each of the four factors will combine to give a staggering impact.
It is also true that the reverse can happen. If you discount your price, allow your sales volume to slip, don't control your overhead costs, or let your variable costs increase just slightly, you can destroy a potentially profitable business.
It’s all about leverage. It can make or break any business. If you get all the small things right, then the big picture takes care of itself. The bad news is that if you don't, you’re going to be in real trouble, and it’s likely that you’ll never know why.
For additional information on maximizing profit for your business, feel free to contact me at Dan.Bowers@warrenaverett.com or (850) 682-0791.