An Income Increasing Approach to Profit Management
By: Michael Gallagher
North Dakota District Office
Improving the profit performance in your business is a common and consistent goal for most small businesses. In many cases, individuals become overwhelmed by the task or develop an attitude that makes it difficult to achieve the desired outcome (improved profit). Improved profit can be achieved in a manageable, stepped approach that over time will yield the desired result. To increase profit, you need to either increase sales or decrease costs. It's just that simple! It is probably best to try a little of both. In this article we will address the first issue, increased sales. In a future article, we will look at cost reduction techniques.
When you get right down to it, there are only two ways to produce more money. You either sell more or you raise prices. Before you decide which approach to use, it may be wise to determine how much sales will have to increase or what price increase is necessary to achieve your desired profit. If you are currently making only $10,000 a year and you want or need to show a profit of at least $30,000, you need to calculate the sales level needed to reach that goal.
If you want to compute the additional sales necessary to reach your target profit goal, use the following calculation. Let's use the example of a retail off sale bottle shop and assume the cost of goods sold are 74% so that the gross profit margin is 26%. If we have to cover 25% for taxes including state and federal income tax as well as social security or self-employment tax, we would see that our target sales increase is $96,154. Remember, we are looking for a $20,000 increase in profit to the goal of $30,000.
Additional Profit Desired + Tax Provisions / Gross Margin = Additional Sales Needed
$20,000 + $5,000 / 0.26 = $96,154
If our current sales are $424,800, we would need a 22.6% increase in sales to reach our target profit level.
Additional Sales / Current Sales = Percentage Increase
$96,154 / $424,800 = 22.6%
As we had mentioned before, the other option is to raise prices. To determine how much we would have to increase prices to reach our target profit goal, we would do the following calculations.
Profit Objective + Tax Provision - Current Profit after Taxes = Additional Income Required
$30,000 + $5,000 - $10,000 = $25,000
Additional Income / Current Sales = Percentage Price Increase
$25,000 / $424,800 = 5.9% increase in sales
Now we have a benchmark to shoot for. As I mentioned earlier, the best approach may be to increase sales through effective marketing techniques and to raise prices modestly.
There are all kinds of self-help books, training sessions and other programs that focus on marketing ideas. Effective marketing helps to increase sales. Next month I will offer ideas on areas to consider in a marketing strategy for your business. I will also discuss the fact that not all sales are equal - you want to increase sales, but you want to increase those sales that maximize profit without a significant or equal increase in costs. It can be a challenging but rewarding experience for the business owner. In many cases it may be trial and error. It also offers the opportunity to effectively manage your business for profit.
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Mike 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 email@example.com.