WHAT IS PROFIT AND HOW TO IMPROVE IT?

Profit is what’s over after you’ve paid all your expenses. It is a consequence of what happens in and to your business.   Some of these things are within your control and some of them are outside your control.   

There are four specific factors that determine profit.  These are:

A sample Profit Statement can look like this (with varying sales):

Thus:

If you are looking for ways to increase your profitability then you have to focus your attention on the four profit determining factors-  price, volume, variable costs and fixed costs.    Profitability can be increased by taking action to increase or decrease any of the four factors, as long as the required conditions are met.  

There are three things to note about this summary:

In other words, any profit improvement strategy must focus on either or both of two things:

IMPROVING GROSS MARGIN

Remember your gross margin is the difference between the price of your product and what it costs you to buy or make it.  Therefore , the only way to increase your gross margin is to sell at a higher price or buy at a lower price.   In most cases, but not all, you will have limited scope to buy at a lower price.   For this reason your selling price is the critical variable.  

You should be aware that to a price discounting policy to capture sales can be a dangerous policy for the financial health of a business.  The following table illustrates how much you have to increase sales by if you reduce your prices:

That is, if your Gross Margin is 30% and you reduce price by 10% you need sales volume to increase by 50% to maintain your profit.  Its unlikely such a strategy will work .  

Many small business people regard price as the only factor influencing the buying decision of their customers.  Sure , there are some customers who may only buy at the lowest possible price but this does not apply to all customers and it may be that a premium price can be achieved if the product or service is marketed in such a way that the customer perceives added value and you promote other features and benefits that you can offer your customers. For example better quality, longer warranty, satisfaction guarantee, 24 hour accessibility, more convenient location, greater resale value etc.  

IMPROVING PRODUCTIVITY

This is all about getting more sales per dollar of fixed costs.  It can be achieved by either or both, increasing your sales at a faster rate than your fixed costs increase or reducing your fixed costs without affecting your sales.  

Advertising your product or service is one of the best ways to increase your sales.  Effective advertising means getting the most out of your advertising dollar and includes:

Fixed Costs must be incurred for you to remain in business.   In the short term they do not change as your volume of sales increases. Some of these costs are discretionary in the sense that you can make a decision to reduce them simply by cutting back. Others, however, are committed and you cannot avoid them.  

The critical thing with each fixed cost is to ask yourself the following questions:

You will notice that all of these questions are directed towards what you are getting for what you are spending.  They are not simply concerned with whether or not you can eliminate or reduce cost.    Take wages for example.  In difficult times people will often think of dismissing staff.   This may be appropriate but should be considered carefully, as it may be more appropriate to invest more in staff training to show them how to improve customer service and how to sell more to customers.  

ILLUSTRATION OF INCREASING PROFIT  

It is startling what effect relatively small changes can make to your bottom lines.  The following illustration indicates that , in these circumstances that profit increased by more than double with change factors of only 5% for the number of customers, the frequency of purchase, the average sales value and an increase in the Gross Margin %, and a 10% change factor in fixed costs: