Should You Grow Revenue or Cut Expenses to Boost Profit?
The dilemma on whether to grow revenue or cut expenses to increase profitability has perplexed small business owners for generations. In frustration, many decide that they want to do both at the same time! Typically, this is not realistic.
The correct answer on whether it is best to grow revenue or cut expenses to boost short term profitability depends basically on the gross margin of the product that is sold.
As a general rule, with a higher the gross profit margin, the company will have more leverage if it invests in boosting revenue, instead of just cutting expenses. For lower margin businesses, they should focus on cutting expenses initially for maximum impact. This formula works because the same $100 of sales in a higher margin business brings higher gross profits to cover expenses.
Here is the arithmetic on whether to grow revenue or cut expenses:
Company A sells a product that has an 80% gross profit margin. This means that a sale of $100 yields $80 gross profit to cover other expenses. Company B sells a product that has a 25% gross profit margin. This means that a sale of $100 yields a $25 gross profit to cover other expenses. Therefore, with the same $100 of sales, Company A has $80 left to cover other expenses and Company B has only $25.
Alternately, if Company A has a $50 overhead expense they want to cover, they need to record a sale of $62.50 (80% gross profit margin of this is $50). If Company B has a $50 expense they need to cover, they need to record a sale over three times higher at $200! (25% gross profit margin on this sale is $50). In this case, with a lower margin, it can be more impactful for Company B to focus on cutting expenses to increase immediate profitably instead of boosting sales since gross margins at 25% are low. For them, a $50 cut in expenses is like a $200 boost in their sales!
If it takes equal effort for Company A and B to generate $100 in sales, Company A should focus on increasing sales and Company B should focus on cutting expenses since Company B will have to generate over a three times higher sales to cover the same level of expenses with their lower gross margin.
This is a just a general guideline on the decision to grow revenue or cut expenses. Each business has to decide the level of difficulty for growing revenue or cutting expenses that will have the best long term impact on the company.
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Barry Moltz gets business owners unstuck by unlocking their long forgotten potential. With decades of entrepreneurial experience in his own business ventures, he has discovered the formula to get stuck business owners and increasing their sales. Barry has founded and run small businesses with a great deal of success and failure for more than 20 years. After successfully selling his last operating business, Barry founded an angel investor group, an angel fund, and is a former advisory member of the board of the Angel Capital Education Foundation. His first book, “You Need to Be A Little Crazy: The Truth about Starting and Growing Your Business” describes the ups and downs and emotional trials of running a business. His second book, “Bounce! Failure, Resiliency and the Confidence to Achieve Your Next Great Success”, shows what it takes to come back and develop true business confidence. His third book, “BAM! Delivering Customer Service in a Self-Service World” shows how customer service is the new marketing. His fourth book, “Small Town Rules: How Small Business and Big Brands can Profit in a Connected Economy” shows how when every customer can talk to every other customer, it’s like living in a small town: Your reputation is everything! His fifth book, “How to Get Unstuck: 25 Ways to Get Your Business Growing Again” helps every small business owners move their company to the next level. Barry is a nationally recognized speaker on small business who has given hundreds of presentations to audiences ranging in size from 20 to 20,000. As a member of the Entrepreneurship Hall of Fame, he has appeared on many TV and radio programs such as CNBC’s The Big Idea, and MSNBC’s Your Business. He hosts his own radio show on AM560, and writes for American Express and Forbes.