Volume Vs. Margin
December 15, 2003
How Much Do I Have to Sell?
By: Linda Leigh Francis
Are you too busy these days? Or not busy enough? How much is enough? How do you determine the sales volume needed to meet your needs? The answer is in your monthly financial statements. But, if you are like folks I know, when your monthly profit and loss statement and balance sheet arrive you look only at the bottom line before you slide it into a drawer.
Today's column covers how to use the information on your balance sheet and your profit and loss statement (P&L) to figure out how much you need to sell. So, look at a copy of yours as you read along.
Your balance sheet is a current snapshot of a business. It lists assets (what you own), liabilities (what you owe), and owner equity (the difference between the two). Note that listed under liabilities are installment payments for vehicles, equipment and mortgages. In a sole proprietor or partnership, an owner’s draw is reflected in owner equity. However, in a corporation, the officers’ salaries will be on the P&L. Don't blame me if this is confusing, blame the 15th century Italian monks who invented the system!
A P&L, reflecting a period of time, usually a month and year to date, is divided into 3 parts: Income, direct expenses, and overhead expenses.
*The income section reflects the money coming into a business.
*Direct expenses, also called variable expenses, will vary from month to month based on your volume. Direct expenses are expenses incurred while doing a project--field wages, materials, subcontractors, job related vehicle expenses.
*Overhead expenses are ones you have whether you do any work or not--rent, insurance, office manager, estimator, etc. These costs should stay about the same month to month. You may need to divide wages of a person between direct and overhead expenses-- yourself, for example, if you provide labor on the job (a direct expense) and also work part-time in the office running the business (an overhead expense).
Review your P&L and make sure your expenses are in the right place. Why you ask?
Gross Profit & Gross Profit Margin
Do this. Subtract your direct expenses from your sales. You get gross profit. Now divide gross profits by sales. You end up with a percentage called gross profit margin (GPM). If you omit some direct expenses or incorrectly place them in overhead, then your gross profit and GPM will appear larger than they really are. Why is this important?
Write down your annual overhead number from your P&L. Add to it the expenses on your balance sheet--add the monthly installment payments plus your draw and multiply the total by twelve. Add to this figure the profit you want to make for the year. This total of expenses is the nut you need to crack with your annual sales volume.
Sales Volume Required to Cover Expenses
Now divide this total by your GPM. The result is how much you need to sell to cover your total expenses, including profits at the given GPM. For example, if your overhead plus profit is $150,000 and your GPM is 30%, you need to sell $500,000 in work for your company to cover the overhead, payments, and your profits.
If, however, you placed your expenses incorrectly within your P&L, you could think your GPM is 40%. Thus, your sales goal appears to be $375,000-- a $125,000 difference!
Using your own numbers, figure out what you need to sell this year to meet your needs.
If the sales number is higher than you can manage, you have several options.
*reduce your overhead
*reduce your profit goal
*increase your GPM by decreasing direct expenses
*improve productivity (which could decrease direct and/or overhead expenses)
*increase your sales prices.
However, the point to remember now is that if you are doing $1,000,000 in sales at a 20% GPM or $500,000 at a 40% GPM, your bottom line profits will be the same. This is very important to keep in mind. Do yourself and your business a favor and know what you need to sell and at what margin. Go out and get that! Remember, it's your margin, not just the volume that counts.
Be smart and know what these two-- volume and margin-- need to be for you!
Linda Francis teaches workshops and seminars on business management and it the author of Run Your Business So It Doesn’t Run You. For information on her seminars or to order her book, call 707-485-0162, or e-mail firstname.lastname@example.org.
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