It’s easy to drown in financial metrics.
Revenue, gross profit, gross margin, net profit, operating expenses, fixed expenses, EBITDA, cash flow, return on equity, debt coverage ratio, etc…
Which ones do we care about?
There are only two that matter to franchisees.
1) Contribution margin and 2) Fixed expenses
Armed with these numbers, we know our break-even sales of a new location, and how much sales we need to make $10,000 (or $100,000) more per month.
Here’s how it works:
Picture a waterfall of cash 🙂
Sales pour in the top:
Every dollar gets a haircut based on the variable expenses.
It doesn’t matter if $1 or $1,000,000, every dollar is getting the same percentage removed.
What remains is the contribution dollars.
Contribution dollars then fall into a fixed expenses bucket.
After the bucket fills up, every incremental contribution dollar falls out, becoming net profit.
Just like water pouring onto the ground after the bucket is filled.
Every month, the bucket is emptied, and the refilling process is started again.
Terminology:
Variable Expenses = costs that go up & down along with sales. Expressed as a percentage of sales:
Example: COGS 25% + Payroll 17% + Royalty 10% + Credit Fees 3%
- Total Variable = 55%
Contribution Margin = 100% – Variable Expenses %
- Ex: Contribution Margin = 100% – 55% = 45%
Contribution Profit = Sales x Contribution Margin
- Ex: Sales $100,000 x Contribution Margin 45% = $45,000
Fixed Cost
- Remain constant regardless of sales volume
- Rent, management salaries, most insurance, base technology costs, accounting, etc.
- Present even with zero sales
Contribution in Action
This business is doing $50,000 in sales.
After 40% variable expenses, we’re left with a 60% contribution margin.
$50,000 x 60% = $30,000 contribution profit.
After $25,000 of fixed costs we’ve got $5,000 in net profit.
What happens after we increase sales by $10,000?
Contribution profit goes up by $6,000 (60% of sales).
The Fixed Expenses bucket is already filled.
All $6,000 of contribution profit overflows right to the bottom line, increasing our net profit $6,000 from $5,000 to $11,000.
A 20% increase in sales = 100%+ increase in net profit.
You want your business to make more money?
Drive incremental sales and focus on filling the bucket.
You don’t have to move mountains
Small changes compound.
Cheers!
Brian
P.S. Want to learn more?
This is just a small part of a workshop covering contribution profit in detail, sharing real-life examples from my business.
