Many small business owners would like to expand, in order to generate higher sales and increase profits. But before making moves to buy new equipment, expand your plant or implement a new business idea, you need to fully understand how the profit angle works.
Many times an expansion plan boosts sales but not profits. You wind up working longer and harder for nothing.
Business owners may think that if they lose a little bit on each deal, they can make it up on volume. That sounds good but may prove difficult in reality. To prevent problems, analyze these three factors of success.
Fixed and Variable Costs: Break down your costs as either fixed or variable. Fixed costs don’t change over any reasonable time period while variable costs are related to sales. (The more sales, the more variable costs.)
Contribution Margin: Contribution margin is what remains from sales after you deduct the variable costs. So if your product sells for $10 and your variable costs run $8, your contribution margin is $2. From that margin, you cover fixed costs and add to your profits.
Breakeven: Now calculate your breakeven, or the amount of dollars and time it takes the contribution margin to match fixed costs. You don’t realize a profit until the contribution margin exceeds fixed costs. Until then, you’re in the red.
Once you calculate these factors, you’re ready to analyze the impact of expansion. And remember, it’s a good idea to talk to Filler & Associates about how cash flow, liquidity and profitability could change, depending on business conditions.