We are often asked the question – How can we increase profit? If you’re looking for ways to increase your profitability, you have to focus your attention on the 4 profit-determining factors: price, volume, variable costs and fixed costs.
Let’s look at each of these 4 factors under 3 headings—the factor, the possible action you could take to enact change, and the required conditions that would have to occur to increase profits.
It’s important to note that profitability can be increased by taking action to increase or decrease any of the 4 factors, as long as some conditions are met. Let’s have a look below.
|Price||Increase||Sales volume could either remain unchanged or decline. If sales volume declines, the decline would have to be less than the offset created by the price and resulting profit increases.|
|Decrease||The sales volume would have to increase sufficiently to compensate for the decline in price. If sales volume increases as a result of the decreased price, there is a possibility of a decrease in the per-unit fixed and variable costs because of increased economies of scale.|
|Variable Costs||Increase||The increased variable costs should lead to or be a result of improved product or service quality. The market would have to accept a higher price, or the heightened quality would have to attract enough new buyers to offset the increased variable costs.|
|Decrease||The sales volume would have to remain unchanged. The decrease in variable costs could not be allowed to affect product or service quality, which would have a consequential effect on sales. If they did decline, the fall in gross profit would have to be less than the decreased variable costs.|
|Sales Volume||Increase||The price could either remain unchanged or decline. If the price were reduced, the reduction would have to be less than the offset created by the volume and resulting profit increases. Another possibility is to achieve a reduction in per-unit fixed and variable costs due to increased economies of scale.|
|Decrease||A savings in fixed costs would have to be achieved by reducing the size of the business, or production levels would have to be evaluated to find variable cost economies of scale. This savings would have to be greater than the reduction in gross profit due to the decreased sales volume.|
|Fixed Costs||Increase||The increase in fixed costs should lead to or be a result of improved product or service quality. The market would have to accept a higher price, or the heightened quality would have to attract enough new buyers to offset the increased fixed costs.|
|Decrease||Sales volume would have to remain unchanged. The decreased fixed costs could not be allowed to affect product or service quality, which would have a consequential effect on sales. If they decline, the fall in gross profit would have to be less than the decreased fixed costs.|
The interesting thing to notice about the previous summary is that no single factor can be considered without considering its impact on, or the impact from, each of the other factors.
The second thing to notice is that a profit improvement strategy may involve either an increase or a decrease in each of the 4 factors. There is no standard formula for improving profitability; it depends entirely on specific circumstances and the relative strengths and weaknesses of your business.
The third thing to notice is that a favourable change in price and/or your variable costs improves your gross margin per dollar of sales. On the other hand, a favourable change in your sales volume and/or your fixed costs indicates greater productivity. Therefore, the overhead you incur in running your business involves lower costs per dollar of sales.
In other words, any profit improvement strategy must focus on either or both of 2 things:
- Achieving a higher gross margin per dollar of sales by increasing price and/or reducing variable costs.
- Achieving greater sales per dollar of fixed costs by increasing the productivity of those things that have a fixed cost.
So that we can put everything into perspective, let’s consider the profit improvement potential that would arise from a modest improvement in each of the 4 factors.
We’ll use the figures previously given as a base. To demonstrate the powerful effect of small changes, we’ll make a 5% improvement in each of the 4 factors.
Base % Change Result
Price 100 5% increase 105
Sales Volume 100 5% increase 105
Total Revenue 10,000 11,025
Variable Costs ($60) 6,000 5% decrease ($57) 5,985
Gross Margin 4,000 5,040
Fixed Costs 3,000 5% decrease 2,850
Net Profit $1,000 $2,190
To find out more about the above and how we can help you focus on the things you can control please speak to us.
We also have proprietary software that we can use to analyse your business and that will highlight how small changes within your business (no matter what industry you are in) can have profound effects on your profit.
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