As a small business owner, you want to maximize your business’s profit and increase sales volumes. Typically, if your business charges higher prices, your profit per sale is higher, but your overall sales volume decreases, potentially decreasing profits. When your business charges lower prices, your sales volume tends to be higher, but you make less profit on each sale. So what do you do? Finding the best balance for your business is crucial to maximizing profit.
What Are Margin and Volume?
Margin refers to the difference between your business’s revenue and the costs you incur to generate that revenue. For example, say your business generates revenue of $1 million. If it incurs $800,000 in costs, your margin is $200,000. The margin is often stated as a percentage, so in this example, the margin is 20%, because $200,000 is 20% of $1 million.
Volume is the quantity of products or services you sell — think of it as your revenue. In the above example, your business volume is $1 million.
So what’s a good level of margin? It depends on the industry that your business is a part of. In some industries, 5% is a great margin, while in others, a 5% margin indicates a poorly run business.
Why Should You Maximize Margin?
A relatively small increase in costs can cause a relatively large decrease in your profit. That’s why the maximizing margin is so crucial to your company’s success. What exactly does that mean?
To continue with the above example, suppose you bring in an additional employee at a total cost to your business of $50,000. That’s about a 7% increase in your business’s costs ($50,000 divided by $800,000). However, your profit drops from $200,000 to $150,000, a 25% decrease. The small increase in costs caused a much larger drop in profit.
Similarly, a relatively small decrease in your costs can lead to a relatively large increase in profits. Suppose that, instead of hiring another employee to help with all the work, you cut your advertising costs by $50,000. By cutting your costs by about 7%, you increase your profit from $200,000 to $250,000, an increase of 25%.
Maybe you read those examples and thought, “Sure, but if you cut the advertising costs, your sales volume may decrease.” Typically, that’s true. But does the decrease in advertising cause a decrease in sales volume that’s large enough to reduce your profit rather than increase it? It’s often hard to know ahead of time.
It’s possible that the decreased advertising won’t affect your sales volume as much as you expect. The only way to know is to try it — and it’s a good idea to track your advertising ROI to see what the actual effects are. Another thing to look at is in this example: If decreasing your ad budget decreases your sales volume, maybe it also leads to other cost reductions. Making fewer sales typically means lower employee-related costs and less spending other things, such as supplies.
Sometimes seeking to maximize your profit by cutting costs is a no-brainer. If you can cut your costs on print cartridges without sacrificing print quality by switching to a generic brand, your margin increases without a decrease in sales volume, and your business profit increases. Likewise, if you can generate additional margin by switching to a product line that costs you less and that customers like just as much, you increased your margin and made a good move.
Using Industry Statistics as a Guide
To make decisions about margin versus volume is to look at statistics for your specific industry. Consider using benchmarking — or compare your company to others in your field to see how your sales and costs compare — to see what the most profitable, highest margin businesses in your industry are spending in various cost categories. These can provide you with useful targets in your business planning and help you strike the perfect, most profitable balance between margin and volume.
When you’re a small business owner, every dollar counts in both sales and costs. Keeping your eye on all the financial areas in your company is essential. 5.6 million customers use QuickBooks. Join them today to help your business thrive for free.