For many businesses as revenue grows profit of the business falls, leaving the owner and the management team wondering whether the growth in revenue was worth it. The reason for this fall in profits is that revenue did not increase sufficiently to cover the cost of additional infrastructure and operating costs that were incurred to support the revenue growth.
For example, a business does company registrations. They charge R500 per registration and the company has a single employee that earns R15,000 a month to do the registrations. This employee can do a maximum of 84 registrations per month.
At maximum capacity the business can invoice 84 registrations at R500 each, giving a revenue of R42,000 per month, less a salary cost of R15,000 which leaves a profit of R27,000.
Now if the company wants to grow it’s going to need to hire an additional staff member to do the further registrations. This will immediately increase the fixed costs of the business from R15 000 to R30,000 per month for two staff members.
If the number of registrations only increases to 100 per month, then the company would generate revenue of R50,000 (100 x R500) less costs of R30,000 (2 staff x R15,000) leaving a profit of R20,000 which is lower than the R27,000 profit earned before the increase in revenue. The company has increased revenue with a fall in profits. In fact, the company needs to increase revenue by 36% to 114 registrations per month before profitability will be the same.
If the company can increase registrations to the maximum of 168 for two employees it will generate R84,000 in revenue less costs of R30,000 generating R54,000 in profit a significant increase on the previous levels of profit. However, many businesses don’t generate sufficient additional revenue for the increase in costs leaving it with lower or only slightly better profits than before.
To avoid this scenario a company must carefully manage its investment in additional infrastructure and operating costs. The following are three ways to do this:
- Forecast revenue and cost for profitable growth
- Managing net profit margins
- Managing your employee/productivity ratio
