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Many small business owners believe they should focus first on growing their business revenues with larger contracts, clients and the like so the business will produce the greatest amount of cash.
If indeed, a greater amount of profit remaining at the bottom of the Profit & Loss Statement is what a business owner is striving for, then one should consider undertaking this exercise before attempting to grow the business by increasing sales.
By doing so, they will be learn there are two ways to increase profit in a business.
How to Calculate the Amount of Additional Revenue is Needed to Increase Net Profit
First, ask yourself the following question and make the assumption your answer is as outlined in the example:
How much additional profit do I desire to earn in the next twelve months?
Second, determine the Net Profit Percentage your company typically earns at the end of each year.
The net profit percentage is the NET PROFIT from the bottom of your Income Statement divided by the GROSS REVENUE at the top of your Income Statement. (Net Profit ÷ Gross Revenue)
EXAMPLE: $85,000 Net Profit ÷ $720,000 Gross Revenue = 11.80%
Next, determine the Additional Gross Revenue (sales dollars) which is needed to increase the business net profit by dividing the answer to the first question by the answer to the second question.
EXAMPLE: $25,000 Desired Additional Net Profit in the next 12 months ÷ .1180 Net Profit Percentage (aka Net Profit Margin) = $211,864
In this example, a business owner will need to grow the business by $211,864 in a given year with a 11.80% Net Profit Margin to end up with $25,000 additional net profit in the next twelve months.
Should a Business Owner Try to Increase Business Revenue?
Following this example, a business owner can answer if more sales is the best way to achieve more profit by answering this two part question:
- If I want to add $25,000 to my bottom line or net profit, what would I have to do to reduce my costs by $25,000?
- AND is reducing overhead easier to do than increasing my company revenues by $211,864?
Only the entrepreneur knows the answer to the last question. He or she is the one who wakes up in the middle of the night with worries about making payroll, personnel issues, inventory and servicing matters.
While growing a business’s via increased sales is a business goal many entrepreneurs share, the exercise defined above has proven to be valuable to many.
By computing the amount of additional sales it takes to increase the business’s net profit and considering what costs may be reduced to achieve the same goal, a business owner gains great clarity surrounding how to increase profit in a business.
There are only two ways to achieve greater profit and better cash flow. And profit and cash flow generated from a business are the two biggest factors to increase business value.