Most businesses require only a moderate increase in sales volume or selling prices or moderate decreasing costs, to obtain a substantial increase in net profit. This point is demonstrated in the table below.
Let's assume that this is the first draft of your profit plan for a particular year and is summarised in the column on the far left of this table. You are not satisfied with this profit plan and you wish to increase profit for this year by 50%, which is quite a substantial increase.
How net profit can be lifted by 50% by changes in sales volume, selling prices, or costs.
As shown in table 1 above this objective can be achieved by:
Increasing sales volume by 10% (assuming no increase in the indirect costs, or costs in handling the extra volume); or by:
- raising selling prices by 5%; or
- reducing direct cost by 10%; or
- reducing indirect cost by 12.5%
Examine your alternatives
You can construct the equivalent of table 1 for your business, by examining ways in which you can deliberately alter volumes, prices, and costs to lift net profit by the amount you require.
It should be noted that in the above table it is not intended to imply that raising net profit by a substantial amount can be accomplished easily. Each of the four alternative methods Illustrated in the above table requires dedicated commitment and hard work. However, the purpose of table 1 is to demonstrate the alternatives available for raising net profit.
The advantages of raising selling prices as a means to increase profit are:
A price increase is typically the fastest way to increase profit. Assuming that sales do not drop away, additional profit accrues immediately the price change becomes effective. By contrast, it usually takes considerably more time to increase sales volume, especially in a highly competitive market.
Less time and effort
The time and effort needed to make a price change is typically less than is required to increase sales volume or reduced costs.
The effect of cumulative improvements
So far we have considered changes in sales volume, prices and cost independently of each other. But if small improvements are made in each of these areas at the same time, the cumulative effect of these improvements on net profit can be substantial. This principle is demonstrated in table 2 below.
In table 2 our business has increased sales volume by 2%, raised prices by 2% and reduced overall cost by 2%. Although each of these percentage changes is small, the cumulative effect is to lift net profit by a substantial 49% from $50,000 to $74,300.
Your alternatives for profit growth
Again you can construct the equivalent of the above table for your business to examine the overall growth in net profit which could be achieved through small improvements in volume, prices, and costs.
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