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So what is a profit?

The important thing to note is that profit is “what’s left over.” In other words, profit is a residual. It is the consequence of what happens in and to your business. Some of these things are within your control and some of them are outside your control. If you’re going to have any effect on your profit, you have to focus on those things over which you have control. . . . So, what are they?

To answer this question, it is helpful to understand that there are only four
specific factors which determine your profit:

1. The price you charge for the products and/or services you sell.

2. The quantity (or volume) of products and/or services you sell.

3. The costs you directly incur by producing or buying the products and
services you sell. (We call these variable costs because they increase or
decrease as your sales increase or decrease.)

4. The costs you incur whether you make any sales or not. (These are best described
as fixed costs because they do not change with changes in sales volume—at least
not on a day-to-day basis.)

Let’s put these four things together. And for simplicity, we’ll assume you have only a single product. (The conclusions we come to will apply whether you have 1 or 1000 products.)

If you sell 100 widgets, your total variable costs will be £6000. And if you sell 50 widgets, the total variable cost is only £3000. (It varies directly with your sales volume.)

It costs you £60, and you sell it for £100. What you sell the widget for is the price. What you pay for it is a variable cost.

Now, if you sell a widget for £100 and it costs you £60, you’ve made a profit of £40 on each sale. We call this the gross profit or gross margin. We use this term to remind us that we still have to meet our fixed costs before we end up with a net profit.

If you sell 100 widgets and make a gross margin on each one of £40, your total gross margin is £4000. And if your fixed costs for such things as rent, leases, wages, insurance, etc. amount to £3000, you end up with a “net profit” of £1000. On the other hand, if your fixed costs are more than £4000, you’ll incur a loss.

This post was brought to you by Mathew Aitken at Companies Made Simple

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