By: Michael Gallagher, Former 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

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

Figure 3 - Sales

Figure 4 - Cost of Goods Sold

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

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 raising prices, 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 positive contribution to the bottom line.

You should also look at other ways to increase sales, including more effective marketing strategies, but do not miss the point - if you are underpricing 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.

Mike Gallagher joined the U.S. Small Business Administration in 1984 as a Business Development Specialist.  He served as the North Dakota District Director from November 2013 through February 2017.  A graduate of the University of North Dakota, Mike is a Certified Public Accountant and a former business owner.  The SBA North Dakota District Office can be reached at north.dakota@sba.gov.