What would you rather have:
Sales increase 10% or Margin increase 4%? why?
I bet you most everyone is going to jump straight for the increase in sales – and – that may not be a bad choice.
But I wonder why everyone runs for the sales increase rather than look at the margin increase?
Maybe, the margin increase is the wiser choice? Would you know?
Let’s take for example a simple business with the following metrics:
Sales of 1 million; margin of 40%; and overhead of $300,000 for an operating profit of $100,000.
So, in simplest terms if sales increase 10% or $100,000 with a 40% margin than there should be $40,000 in extra profit – Great.
What if rather than a sales increase we increased margin 4% – which on 1 million would provide the same $40,000.
So, our decision is still up in the air as to which one to choose.
But what does it take to get that extra $100,000 in sales? What if you need to give a discount of 5%, a sales commission of 8%, your overhead increases 3% and the working capital requirements to service the sales increase will be 2%?
The net effect is an increase in contribution of only 22% or $22,000. And what if taking this increase in sales strains capacity forcing extra direct costs (overtime) further reducing the contribution?
Suddenly a 4% margin increase is looking better than the 10% sales increase.
But increasing margin does not simply happen overnight, and is not just a matter of increasing price as this can lead to losing customers. There may be a reason to have lower margin clients; such as being able to run large jobs during off peak times for better capacity utilization.
What it means is that perhaps you should look at your business as a balance of trying to maximize your margin while increasing sales.
For example: increasing sales 6% at a net contribution of 28% for $16,800, plus an increase in margin of 2.5% for $25,000 together would provide a total of $41,800.
The reality is that your business success is a combination of sales, pricing strategy, managing costs, cash flow and a myriad of other elements all linked together. Timely and accurate reporting of the right information will help you better understand this linkage and allow you to make the most informed decisions to maximize your profitability.
After all – you are in business to make money.
Want more information on accounting basics and other ways to help you manage your new business? Then make sure you look through all the content on StartUpWiser.com.