Disclaimer: I am not a financial advisor or accountant. This article is for informational purposes only. Please use the info at your discretion.
Is it hard to make the profit you want?
Are you using cost-volume-profit analysis? Last week we laid the cost-volume-profit analysis groundwork. Today we're going to go even more in-depth on cost-volume-profit analysis so that you can manage your profitability better.
But first, let’s revisit this formula to refresh our memories:
Okay, feeling good about that? If not, go back and check out the first part on cost-volume-profit analysis because we're going to be using it...
Now, let’s look at an example:
Let's say you sell 500 units at $100 a unit, with variable cost of $40 a unit. How much profit should can you expect?
First, put those numbers in the formula.
Okay, then subtract total variable costs from sales to get the total contribution margin, which we find is $30,000.
Then subtract the total fixed costs (don't forget about those!) of $15,000. And.....
Voila! $15,000 profit* if you sell 500 units. That was easy, right?
Now let's use the formula another way:
What if you wanted to find out how many units you had to sell if you wanted to make $15,000 in profit*?
Ready? Let's do it backwards....
So, we set up the formula with $15,000 as profit. Then we add our fixed costs, working upward.
This gives us $30,000 in total contribution margin.
Since we know our sales price per unit ($100) and variable cost per unit ($40), we can subtract to find our contribution margin per unit ($60).
Which means all that is left to do is subtract the total contribution margin ($30,000) by the contribution margin per unit ($60) to find out how many units you have to sell.
And voila! 500 units (because $30,000/$60 per unit = 500 units). Easy right?
All I did to fill out the rest of the formula was multiply the sales price per unit by 500 units and variable cost per unit by 500 units to get the total sales and total variable costs.
Why this matters:
Okay, so you can totally do this. It's easy, but it's essential.
Because if you sell items with a small contribution margin, you are making less profit than you would be if you sold items with a higher contribution margin. If your fixed costs are higher than they need to be, then you're not as profitable as you could be. If you don't manage this, your business could be failing when it doesn't have to be. How you manage your cost-volume-profit can make or break your business.
Is making a profit hard right now? Work on this. Play with the formula using your own numbers - change the variable costs, the sales price, and the fixed costs to see how you can maximize profit.**
Managing your business using cost-volume-profit analysis isn't only important in order to know how much you're going to make. It's vital to making your business as profitable as possible.
*This cost-volume-profit analysis only gives you profit before taxes. You'd have to add another step at the bottom that takes into account your tax rate to determine profit after taxes. Wah, wah.