Many business owners focus on driving sales but do not really understand why and how this sales focus drives their profit and growth goals. Revenue that grows significantly that is matched or even exceeded by expenses means that you are putting forth much effort to generate minimal return. In the event of expenses exceeding revenue, this means your better off shutting your business down and sitting at home doing nothing…unless you (or someone else) can figure how to turn it around.
Sales figures can be deceiving. High sales dollars mean nothing if sales volume does not align with the company’s costs and profit required to fund growth and/or the goals of management. Business owners and managers often do not look beyond sales volume dollars as determinants of the success of their businesses. This is a natural reaction since increases in sales are what grew their businesses in the first place.
- Choosing whether to increase sales or decrease costs as a preferred profit strategy requires a basic understanding of how financial statements are affected by changes in sales volume or reductions in cost. Let’s look at a comparison of sales volume increases versus cost reduction:
REDUCE EXPENSES OR INCREASE REVENUE?
|Cost Reduction||Profit Level – % of Sales||Required Sales Increase|
- For example, when operating at a 2% profit level, the impact of a $1,000 cost reduction on the bottom line (pre-tax profit) is equivalent to a $50,000 sales volume increase.
- To maximize profits, a reasonable mix of effort in increasing revenue and controlling costs must be established. For costs that are not direct costs but Operating (“General and Administrative” or “Overhead”) Costs, each dollar of cost reduction goes directly to the bottom line. However, of the variable costs (direct costs are incurred in order to make the sale), only a fraction of sales volume dollars go directly to the bottom line.
Clearly understanding the current impact of your sales on your bottom line is critical. You can use this information to address your cost of goods sold and drive down the cost of sales or increase your capacity usage (if you have a plant or other very large assets) to drive down the cost of operation per product sold. Alternatively, you could stabilize your revenues and focus on cutting overhead or miscellaneous costs to drive profitability. Being more informed helps you accomplish your goals.