Nothing like an incredible trip to Italy to put life into perspective; Am I doing what I love? Should I add more to my plate or just focus on one thing? Questions like this have been circling my brain since I returned from Italy and, although it took me a week to adjust back into the swing of things, I am thrilled to be back at it.
I keep getting these pushes to start my Live Business Workshops ASAP as opposed to waiting for the new year. So many of my clients are seeking clarity when it comes to the MONEY in their businesses. Therefore, today I thought I’d share a quick snippet on a mighty tool called Contribution Margin.
Contribution Margin (CM) is a tool used to tell you how much additional revenue you would need to generate should you decide to invest in something; For example, hire a new employee, purchase a new software to make your business more efficient, purchase a new piece of equipment, so on and so forth.
Here is a very basic process and formula to help you do just that:
1. Determine your DIRECT costs. This means, the cost directly related to making a sale. You theoretically, would not incur this cost unless you made a sale.
a. An example is a skateboard
i. Say I sell a skateboard for $100.00.
b. The cost of the actual wood would be my direct cost.
i. Say that it costs me $40.00
c. To convert it to a percentage, you divide cost by sale amount
i. $40/$100 = $0.40 or 40%
d. A service example is a coach. The direct cost would be the amount you pay yourself for that session. I.e. - $100 for an hour session and you pay yourself $30. That would mean your Direct Cost for 1 unit is $0.30 ($30/$100 = $0.30 or 30%).
2. Determine your Contribution Margin
a. Using the skateboard example above, subtract direct cost from $1.00 in sales
i. Sale $ - Direct Cost $ = Contribution Margin
ii. $1.00 - $.40 = $0.60 or 60%
b. $0.60 is my Contribution Margin
i. $0.60 of EVERY dollar I sell is left to pay my overhead (expenses that will come out of my business whether I have sales or not; rent, payroll, utilities, etc.)
3. Now, you may have more than one product/service. Do this for each product/service you have and when you are thinking of increasing expenses determine what product/service it is for and you that specific CM. If its for all of them, determine the average (message me if you need help finding an average)
4. This is how you use your CM to determine how much ADDITIONAL revenue you need to generate in order to pay for your new “expense”
a. I want to hire someone that will cost me $1,000 per month
b. New Expense/CM = Additional Revenue Generated
c. $1,000/$0.60 = $1,667 additional monthly revenue needed to pa for this new expense
Any time you are looking to increase expenses this is ONE great tool to use to help you make your decision. The last thing you want to do in business is blindly make a choice to spend money without thoroughly understanding the MONEY implications; how it will affect your cash flow, your profitability, your stress, etc.
