If your not sure where your profit comes from how do you know where to direct your time and effort? I'll always remember one business I reviewed where the owner was struggling to meet customer demand and felt as though he was running around in circles. When we analyzed the profitability of his customer segments we discovered one was actually generating a loss of around $14,000 a year. Unfortunately he had been running in circles for a long time. The following month it all became too much for him and he gave in. Years of hard work (misdirected effort) had taken its toll.
Total profit is total revenue less total variable and total fixed expenses. But when you try and break it into components things become a little more complex. For example, you have two product lines, A and B.
- You sell both products for $1.00.
- Both cost you $0.40 (lets assume this includes all associated variable costs).
- This gives you $0.60 from each sale to cover your fixed costs.
Based on this you may consider that each product provides the same percentage profit. But what if product A requires twice as much floor space. Shouldn't each product A contribute twice as much towards your fixed location (floor space) cost as each product B? In real terms this would make product B more profitable.
To determine where your profit comes from each expense should be allocated against product lines or customer segments based on the relative consumption of the resource provided by the expense. It's a user pays system. This applies to any expense, fixed or variable. A tool that will help you do this is Bizpep's (www.bizpeponline.com) Profit Contribution Breakdown software. To get the best return for your effort you need to know where your profit comes from. Until then you are just running in circles.