Your sales are up. Why isn’t your business making more money?
Sales are the most visible sign that a business is working. When orders grow, it feels like progress, and often it is. But it’s also common for a business owner to have a record month and find less money left over than before. That isn’t bad luck. It usually comes down to what each sale actually contributes.
What each sale contributes
Every sale brings in revenue, but some of that revenue is spent immediately on the cost of making that sale: materials, packaging, shipping, payment processing fees, sometimes labor. What’s left after those variable costs is the sale’s contribution. It’s the part that pays for rent, salaries, software and everything else that doesn’t change with each sale, and only after those are covered does profit begin.
That’s why the same increase in sales can mean very different things for profit, depending on how much each sale contributes.
A discount that backfires
Imagine a small online shop selling a product for $50. Each one costs $30 to make and ship, so each sale contributes $20. The shop’s fixed costs are $10,000 a month. Selling 600 units brings in $30,000 in revenue and $2,000 in profit.
The owner runs a 20% discount, cutting the price to $40, and it works: sales jump 50% to 900 units. Revenue rises to $36,000, the best month yet.
But each sale now contributes only $10, because the $30 cost didn’t change. Nine hundred units contribute $9,000, which doesn’t cover $10,000 in fixed costs. The shop loses $1,000 in its biggest sales month.
A 20% discount halved each sale’s contribution, so the shop would have needed to double its sales just to earn the same profit as before.
Other ways growth can squeeze profit
Discounts aren’t the only cause.
Variable costs can rise with growth. Expedited shipping to keep up with demand, overtime, or buying materials in a hurry can all eat into each sale’s contribution.
Fixed costs tend to rise in steps. A business may handle 600 orders a month with its current team, but 900 might require a new hire or a bigger space. The month that cost arrives, profit can fall even as sales rise.
Some customers cost more to serve. Large clients may demand bigger discounts, longer payment terms or more support, so their sales contribute less than they appear to.
Growth can also strain cash before it hurts profit. A business that buys inventory up front and gets paid by customers 30 or 60 days later can run short of cash while growing quickly, even if each sale is profitable.
The numbers to watch
Revenue tells you how much you’re selling. A few other numbers tell you whether it’s working.
Gross margin is the share of revenue left after the direct cost of what you sell. If it falls as sales rise, each sale is contributing less.
Contribution per unit, or per order, shows exactly how much each sale adds toward fixed costs. Knowing it lets you work out how many sales a discount needs to pay for itself.
Your break-even point is the number of sales needed to cover fixed costs. When fixed costs step up, it moves too.
And cash on hand, against monthly spending, shows how long you can keep going while growth pays off.
Working through your own
The profit margin calculator shows margin and markup from cost and price. The break-even calculator shows how many sales cover your fixed costs, and how a change in price moves that number. The business runway calculator shows how long your cash would last at your current pace.
The takeaway
Revenue growth is only good news when each sale still contributes enough to cover costs and leave something over. Before a promotion or an expansion, it’s worth working out what each sale will contribute afterward. The answer can turn a promising idea into a clearly profitable one, or reveal a costly one before it happens.
Keep reading
This article is general education about US personal finance, based on the assumptions and sources described in it. It isn’t financial, tax or legal advice, and examples use hypothetical people and figures.