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Improving the net profit of your business

Updated on August 4, 2015

improving the net profit

Introduction

Improving your net business profit before taxes is the ultimate idea for most small businessmen today. A larger net profit means more money in the owner's pocket, and greater success for the business. However a lot of small businessmen don't understand the best ways to achieve this greater net profit. First we need to classify the business costs that lower this net profit.

There are two types of costs that all businesses incur. The first are fixed costs and these are mostly set up when you open the business. The second type are variable costs and these increase as your business increases. When you subtract these two costs from gross revenues you end up with your net profit. In this article we will look at what makes up these two types of costs and how to lower each one. The first type of cost we will consider are the fixed costs.

Controlling fixed costs

Fixed costs are usually established when the business is first opened. These fixed costs include the rent, utilities, advertising, insurance, accounting, and managerial costs. These costs will remain pretty steady no matter how much business you do. You need to understand how much as a percentage of gross business these fixed costs should be for your business to order to be successful. A lot of small businessmen have no idea what this percentage should be.

As an example we will look at the fixed costs of a pizzeria. The first is the rent for the store and if you are running a carryout and delivery pizzeria you should need a 1,000 sq ft store. With a cost of $1.25 per sq ft per month this cost would be $1250.00 a month. The second cost is the utilities which would include around $500.00 for electric, about $200.00 for natural gas, about $150.00 for the phone bill, and about $75.00 for the water bill. The advertising would be around $500.00, bookkeeping would be about $100.00 a month, insurance would be about $125.00 and managerial costs would be about $2,000.00 a month. If this is the total fixed cost it would be $4900.00 a month.

If we figure that the fixed costs should be 25 percent of gross revenues for a pizzeria, that means we should be doing at least $19,600.00 in gross sales each month to be a successful business. As we increase the gross sales from this amount each month we become more successful. From this we can see the fixed costs will become smaller as a percentage the more we increase gross sales. We can also see that the fixed costs are pretty well set when we open the business. Next we need to look at variable costs and how to control them.


Controlling variable costs

There are two components to variable costs the first is the cost of goods and the second is the hourly labor cost. These are both variable costs because as sales increase they both increase. If the business is successful each will be a fixed percentage of the gross sales. The more successful you are the smaller the percentage for each one will be. This is because you are more efficient in managing your business. Again we will use the example of a pizzeria to prove the point.


In a well run pizzeria the cost of goods shouldn't be more than 30 percent. This cost as percentage increases as a cost as your sales increase. That is why it is a variable cost. The second variable cost is the cost of hourly labor. You need more hourly labor as your sales increase, however the busier you get the smaller the cost of hourly labor is as a percentage of gross sales. This is because you are operating more efficiently. A common percentage for this hourly labor cost is 20 percent, however I have seen this cost go as low as 13 percent on busy days. As you increase your gross sales the hourly labor cost as a percentage will tend to drop just like the fixed costs. Also as the hourly employees gain more experience they tend to become more efficient in doing their job which lowers your hourly labor cost as a percentage of gross sales.

The way to lower the cost of goods cost is through more shrewd shopping with your vendors. The sales people for these vendors can sense when you aren't paying close attention to your food costs and they will start to increase the prices on the goods they sell. Constant vigilance is the best weapon in keeping your food costs down. Sometimes you can also buy goods in larger lots and save money on certain non perishable goods. These are the main ways to control your cost of goods


Summary

The way to increase the net profit of any business is to lower one or both of the variable and fixed costs as a percentage of gross sales. The fixed costs are the easiest to lower as a percentage of gross sales. The only thing you have to do is increase sales. You can even lower the sales price some, as long as you get more than the variable cost on the finished goods. Again we will use the example of a pizzeria to prove the point.

The variable cost of a pizza is about 50 percent of the finished price of a pizza at normal prices. If you add the fixed cost you add another 25 percent to the total cost for a total of 75 percent of the cost of a finished pizza. That means you could subtract 15 percent from the finished price of a pizza and still make a net profit on each pizza. That means you could offer a coupon for 15 percent off on a pizza on a Monday, Tuesday, or Wednesday and still make a net profit. This would lower the fixed costs and the variable labor cost because you are increasing the gross sales. On the weekends you could offer a 10 percent off coupon on certain more expensive specialty pizzas to increase weekend sales. As I said before when you increase sales you lower the fixed costs and the variable labor cost as a percentage of gross sales thus increasing the net profit.

The only way to increase the net profit of a business is to lower both the fixed and variable costs. In this article we have explained how to do this. Here is hoping you can do this in your business.

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