How to Use the Profit Template for Decision-Making Analysis - dummies

How to Use the Profit Template for Decision-Making Analysis

By John A. Tracy

The profit template is very useful for decision-making analysis. To demonstrate, suppose that you’re under intense competitive pressure to lower the sales price of one product you sell. This product is one “slice” of the total activity reported.

Suppose that during the year (2013) you sold 1,000 units of a product. Your competitors are undercutting your sales price, so you’re thinking of cutting the sales price 10 percent. You predict that the price reduction will boost sales volume 25 percent and increase your market share. Seems like a good idea — or does it?

You should run some numbers before making a final decision, just to be sure. Cutting the sales price reduces the margin per unit. Therefore, the new margin per unit would result in a percentage drop in margin per unit.

If a 25 percent gain in sales volume cannot make up for the plunge in margin per unit, you’d need a much larger sales volume increase just to keep margin the same as in 2013, and even more sales to increase margin next year. You’d better think twice about dropping the sales price.

You may gain a larger market share, but your margin might drop on this product if you go ahead with the sales price cut. Is the larger market share worth this much sacrifice of margin? That’s why you get paid the big bucks: to make decisions like this.

Another factor to consider is this: Fixed expenses (people, warehouse space, distribution channels, and so on) provide the capacity to make sales and carry on operations. A small increase in sales volume, such as selling 250 more units of the product in question, should not push up the total fixed expenses of your profit center (unless you are already bursting at the seams).

A major sales volume increase across the board would require additional capacity, and your fixed expenses would have to be increased.

This sales price reduction decision is just one example of the many decisions business managers have to deal with day in and day out. The profit analysis template is a useful — indeed an invaluable — analysis framework for many decisions facing business managers.