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Improving Profit

Bridget Holmstrom - Monday, May 25, 2015

Profit is a simple equation:

Revenue less costs equals profit.

Or at least we hope that equals profit and doesn't result in a loss.

So improving profit can only happen when revenue is improved or when costs are reduced.  Revenue is a function of the number of transactions multiplied by the selling price of each transactions.  This equation can be applied to all industry sectors and types of business.  In a retail shop it is the number of items sold times the selling price of each item.  For consultants it may well be the number of (billable) hours or days multiplied the price of each hour or day.

Increasing revenues means either increasing the number of transactions or increasing the selling price of each transaction or both.

The other side of the equation are the expenses incurred by the businesses.  These expenses may be directly related to producing the product or service or may be incurred as a result of doing business.  These latter expenses may include professional insurance, premises rent, business rates and so on.  The reason for the expenditure, for the discussion here is immaterial.  In order to improve profit, costs must be reduced.

 

 

Basis

Increase Average SP

Increase

No of sales

Reduce Costs

Number of transactions X

10

10

20

10

Average selling price

10

15

10

10

= Total Revenue

100

150

200

100

- Costs

75

75

75

50

= Profit

25

75

125

50


The table shows the implications of changing each of the different alternatives individually.  Of course it may be that the aim is to increase both the number transactions and the average selling price and to reduce costs.  As you can see from the table below the improvement in the level of profit has improved dramatically.  In fact there has been a 10 fold improvement. 

 

Number of transactions X

20


Average selling price

15


= Total Revenue

300


- Costs

50


= Profit

250


Increasing transactions

Increasing the number of transactions can come from two different points.  The first being increasing the number of customers.  The second alternative is to increase the number of sales that each customer takes.  The most difficult of these two alternatives is, as we all know, increasing the number of customers.  It is much easier and certainly cheaper to increase the number of transactions that each existing customer takes rather than increase.  

Increasing the number of customers will mean that the business must look at the effectiveness of processes that increase the number of leads (prospects or potential customers)  and the processes that convert these leads into customers, or the conversion rate.  Because in order to increase the number of customers you need to increase the number of leads and improve the conversion rates. 

The next blog will look at the profit implications of increasing the number of leads and improving the conversion rate.