Consider this scenario described in a recent Business Week article:
“Letterheads Inc., an office stationery printer and distributor located just outside Savannah, Ga., should be making a 10% profit margin every year. It has a solid customer base despite the recession, and it's been able to negotiate some great price deals from paper and ink suppliers because of the recession. Those vendors have been offering the owner deep discounts because they're anxious to retain one of their few steady customers. Sounds like a recipe for a healthy inflow of cash, right?
Wrong! Sales have been consistent at $6 million a year, but the business is losing money by the fistful. Every year, overhead in each department has been creeping up, and the second-generation owner, a bright and dedicated woman named Alice, just can't seem to keep track of all the cash that's bleeding out of the business.”
Why the Boss Needs to Put Profit First by George Cloutier
Letterheads Inc should have tried using one of accounting’s simplest computations to identify potential areas to make improvements for increased profits – straight out of any accounting textbook:
Profits = (Sales – Variable Costs) – Fixed Costs
Profit = what you make from running your business, before taxes. However, since once you have worked hard to earn your profit you will want to keep it, so tips on debt structure tax help resources will be posted from time to time in future blogs. Of course if you are a corporation with shareholders… they will be very happy with increase profits too.
Sales = also called revenue. The sales figure used in this calculation is actually your net sales received after deducting customer returns, and customer discounts. Of course increasing sales will increase profit! Or will it? The CVP Calculation shown above is a quick way to determine which marketing plans will actually increase profit.
Variable Costs = these are exactly that. Variable. The total increases and decreases as production increases and decreases but the variable cost on each unit will always be the same. Of course decreasing Variable Costs will increase profits.
Variable Costs for manufacturing should at least include:
• Hourly wages paid to produce units
• Materials used directly to produce each unit
• Overhead:
---Shipping of materials and of finished product to customer
---Sales commissions
---Travel Expenses
---Utilities in building where product is manufactured
---Miscellaneous parts and lubricants used in manufacturing multiple units
---Special tools and equipment
---Cost of billing
OR
Variable Costs for retail/merchandising should at least include:
• Cost of purchasing units for resale
• Overhead:
---Shipping
---Sales commissions
---Travel Expenses
---Cost of billing
NOTE: Variable Costs for a service based business are similar to that of manufacturing.
Fixed Costs =this total works in the opposite way of Variable Costs. The total fixed cost remains the same no matter how few or how many units are produced. These are costs that remain the same each month and remain even if production stops. Therefore the more units produced, each unit will carry less burden of this cost. Yes... decreasing Fixed Costs will increase profits!
Fixed Costs should at least include:
• Mortgages, leases and rents
• Insurance
• Employee Salaries
WARNING: Of course it is important to make a profit. However do not fall into the trap of trading long term sustainability and longevity of a company for a quick profit even if bonuses are calculated by profit. Some companies make the vital mistake of cutting corners in research and development to the point designs lag. Others cut preventive equipment and building maintenance budgets so assets become antiquated or become damaged. Get the picture? Make wise decisions based on the company’s short term and long term strategies.
You are invited to comment on this information or tell us about your attempts to increase profit.
