Reading the latest business news, you might be surprised to find articles highlighting large corporations with increasing sales and decreasing income. This prompts the question, how is it possible for a company to sell more but make less?
Business managers often assume if the company can increase its sales, it will have an increase in income; but that is not necessarily the case. In fact, it is not as unusual as some may think for a company to see a decrease in income with an increase in sales.
The reasons are many but here are a few of the most common:
When a company prices its products or services too low to cover its variable and fixed costs, they are creating a problem. Demand may be high at a low price point and sales may be increasing, but if the company is unable to reduce its fixed expenses, it’s a recipe for disaster.
A company with high fixed costs may find its profit margins squeezed when sales fall. When sales are up, the company’s per unit cost will decrease due to economies of scale, but this may also leave the company more vulnerable. Ultimately, it is best for a business to have as many expenses variable as possible. Variable costs allow a company greater flexibility, and the ability to offer the lowest price possible with expenses matching the sales cycle.
But how can a company convert its fixed costs into variable costs? A review of their fixed costs is the first step.
As companies grow, they have a tendency to add to staff quicker than necessary. One of a company’s largest expenses is payroll. When looking at making fixed costs variable, consider the possibility of reducing headcount and utilizing contractors instead of full-time employees. Another option is to pay hourly instead of salary, which also allows the company to control labor costs with changes in demand.
Similarly, when a company expands production or adds to staff it usually requires more equipment. Rather than purchasing equipment, look at the options available for leasing. Lease payments are often lower than the cost of a purchase and can help conserve cash for other uses – payroll and payables.
Examine fixed costs for redundancy. Are all of the company’s fixed costs still necessary for running the operation? Can you find any duplication? Then, determine if some costs can be consolidated. For example, if the company has multiple locations, try to negotiate better pricing on services or goods used to run the business at all locations. Negotiating with one vendor to purchase material for the company, rather than allowing each location procuring their own items, can help control and reduce costs.
Selling lots of widgets may sound great, but a business needs to evaluate the profitability of each line item to determine if the sales mix actually makes good business sense. Low yielding line items should be shed if scarce resources can be allocated to produce higher yielding items. In some instances, selling less or, rather, selling more goods with higher profit margins, is best.
Knowing what your costs are and controlling them is crucial to a company’s long term success. By converting fixed cost, the costs that don’t change with sales or production, to variable costs, the company will be in a better position to respond to changes in sales—up or down.