Earning More Profit - Not All Sales are Equal

By: Michael Gallagher
District Director
North Dakota District Office

The usual solution for increasing profit in a business is to increase sales. After all, increased sales volume is good - right? That's not always true as not all sales are equal; you want to increase those sales that maximize profit without a significant or equal increase in costs.

To be effective in this area, you have to be able to analyze your product mix and understand how each product line makes its contribution to the bottom line.

To help illustrate the point, let's look at an off sale liquor store. In most businesses, there is a product mix that results in different margins. To fully analyze these areas, you have to determine what your inventory and costs are for each of the different product lines. Admittedly this will take some additional time and effort to analyze, but it should yield benefits in improving your business management and profits.

In a bottle shop there are generally four lines: beer, wine, liquor, and miscellaneous. Beer has the lowest margin and wine has the highest. Based upon this example, I have built our sample business, Profit Off Sale, Inc., and will use it to show you what a typical store may look like and how various changes can affect the bottom line.

Profit Off Sale, Inc. currently makes a profit of $241 on sales of $424,800. Their gross profit margin is 21% or $87,425, and operating expenses are $81,184. The product mix and associated costs and margins are detailed below (Figure 1).

Figure 1

Department % Sales Beg. Inv. Purchases End Inv. Cost of Goods Sold CGS % Inv. Turn
Beer 48% $203,904 $11,555 $172,818 $11,055 $173,318 85% 15
Wine 18% $76,464 $5,735 $46,628 $6,485 $45,878 50% 8
Liquor 29% $123,192 $12,781 $101,899 $12,431 $102,249 83% 8
Misc. 5% $21,240 $3,186 $16,030 $3,286 $15,930 75% 5
Totals 100% $424,800 $33,257 $337,376 $33,257 $337,376 79%  
                 
Inventory Turn     10.14          

As you can see from their current situation, they are making different margins and have different sales in each of their departments.

The owner is unhappy about the profit and justifiably so as he and his family have put in over 150 hours a week in the business. He believes that he may have to increase prices, but is concerned about the impact in lost sales. He is not sure how much of an increase he should have and if he should increase all of his prices or just a few. Let's look at an example where we increase prices by 5%, but lose part of our sales (Figures 2, 3 and 4).

Figure 2

  % Old New
Sales   $424,800 $403,560
Cost of Goods Sold 79% $337,375 $303,638
Gross Profit   $87,425 $99,923
       
Operating Expenses   $87,184 $87,184
       
Net Profit 0.1% $241 $12,739

 

Figure 3 - Sales

Department

 Percent Price Increase Original Sales Dollar Sales Increase from Price Adjusted Sales Percent Sales Loss B/C of Price Dollar Sales Loss B/C of Price Net Adjusted Sales
Beer 5% $203,904 $10,195 $214,099 10% $20,390 $193,709
Wine 5% $76,464 $3,823 $80,287 10% $7,646 $72,641
Liquor 5% $123,192 $6,160 $129,352 10% $12,319 $117,032
Misc. 5% $21,240 $1,062 $22,302 10% $2,124 $20,178
Totals   $424,800 $21,240 $446,040   $42,480 $403,560

 

Figure 4 - Cost of Goods Sold

Department Original CGS Sales Loss (10%) New CGS Old CGS % New CGS %
Beer $173,318 $17,332 $155,986 85% 81%
Wine $45,878 $4,588 $41,290 60% 57%
Liquor $102,249 $10,225 $92,024 83% 79%
Misc. $15,930 $1,593 $14,337 75% 71%
Totals $337,375 $33,738 $303,638 79% 75%
           
New Sales $403,560        
Original Sales $424,800        
Change in Sales -$21,240        
           
New CGS $303,638        
Old CGS $337,375        
Change in CGS -$33,738        
           
New Profit $12,739        
Old Profit $240        

In this situation, we increased our prices across the board by 5%, resulting in a 10%, or $33,738, decrease in sales. Yet we increased profits by $12,499 - or over 5,000% increase in profits.

You may be saying this is all fine and well, but your customers would be more sensitive to a price increase and you would lose more than ten percent. OK, how much would you lose?

In the example below (Figure 5), we are holding our fixed costs, or overhead, constant at $87,184.  Also remember that in all the instances below we are looking at a 5% price increase. Although we are looking at 10%, 20%, and 24% decreases in sales, we actually did not see that much of a decrease in dollars as it is partially offset by the price increase.

Figure 5

  Original Situation 10% Loss of Sales 20% Loss of Sales 24% Loss of Sales
Sales $424,800 $403,560 $361,080 $344,088
Cost of Goods Sold $337,376 $303,637 $269,900 $256,405
Operating Expense $87,184 $87,184 $87,184 $87,184
Profit $240 $12,739 $3,996 $499

In other words, we would have to lose over 24% of our original sales volume before we would actually lose any money by increasing prices 5%. Now before you start running around with the price gun, consider whether or not you need to raise all of your prices, or if certain departments need price adjustments to assure that they are making a contribution to the bottom line.

You should also look at other ways to increaes sales, including more effective marketing strategies, but do not miss the point - if you are under-pricing your products or services, you may be giving away your labor and sacrificing your profits just because you fail to consider the option of a reasonable and equitable price increase.

Michael GallagherMike Gallagher joined the U.S. Small Business Administration in 1984 as a Business Development Specialist.  He was chosen as the Deputy District Director in 2005 and the District Director in November 2013.  A graduate of the University of North Dakota, Mike is a Certified Public Accountant and a former business owner.  He can be reached at michael.gallagher@sba.gov.