The margin we make over the cost of providing a product or service is the money we have to contribute to pay overheads (relatively fixed) and then when we have covered those, to our profits.
I'll talk about breakeven another time but this time I wanted to touch upon two examples where it is easy to get confused by the impact of sales versus margins. These are bad debts, and promotional campaigns.
Lets take bad debts first. Of course this does not apply to you if you get cash payments on delivery, or better still, payment before delivery. A significant proportion of businesses invoice their clients on delivery of the product of the service. Your Terms of Trade may vary anywhere between 7 days to 6o days. Here I'm talking about when you require payment, not when you actually get paid. Unfortunately we often find that the bigger the client, the slower the payment. So what happens when we have a bad debt?
Say your sale was $1,000 and your Gross Margin was 35% ($350). The sale goes bad for what ever reason and the client does not pay. Now it is easy to assume that you have to make another sale of $1,000 to recover your position. Easy to assume, but wrong!
To get back that $1,000 you have to make enough profit to get the money back, because a significant proportion of the new sale will, as before, be the cost of providing the cost or service. And that amount we can calculate by dividing the sales figure ($1,000) by the Gross Margin (35%). And that gives the princely sum of $2,857, all of which ignores the cost and effort of achieving the new sale.
So it makes sense to set yourself up so that this situation does not arise. Policies and procedures help, as does getting paid up front, or at least a reasonable down payment. In these days of multiple credit cards, securing a credit card imprint can be useful. In other words get the client or someone else to cover the debt. You are not in the banking business.
And so to promotional campaigns. Much the same situation applies, except that it is harder to measure.
If you do decide to calculate return on a marketing campaign: when comparing cost to returns, "returns" should be your profit not your gross sales. If you spend $1,000 on a marketing effort and generate $1,000 in sales, you are losing money; you are out the cost of product or services that you sold for $1,000. You have only broken even on a marketing campaign that costs $1,000 when you have sold enough product or services to generate a $1,000 PROFIT. How much sales that requires depends completely on your products and your profit margin.
Some profit losses are pretty obvious - so you fix them.
BUT, what if you don't know profits are leaking, cash out the door?
Possible leaks could be anywhere.
Are there some clues or symptoms that are tell-tales?