Today, I had a class on COSTS and the relationship of cost and volume. Starting a business means that you won’t be escaping this concept anytime soon. In order to manage and sustain a business, we need to monitor and control costs, because ultimately, to increase profits, you need to increase revenue and decrease costs while maintaining the value of your service.
Now one of the things we need to look at is the behavior of costs. Here are the three behaviors:
VARIABLE – These are the costs that are directly proportional to the volume (level of activity).
FIXED – These are costs that you incur whether there is volume or not.
MIXED OR SEMI VARIABLE – These are costs that have a variable component and a fixed component. A classic example of this are utilities and manpower (when employees who receive pay but sometimes go overtime).
To be able to make profit, we need to increase volume to be sold to increase sales.
So how do we increase volume and sales?
1. Look for the customers who find value in availing your product.
2. Deliver great service so that your customers will be brand believers. This will be FREE advertising for your company.
3. Pray for sales!
Now there is this term, Full Cost which is Unit Variable Cost + Unit Fixed Cost.
Total Variable Cost increases as volume goes up but Unit Variable Cost is constant on a per unit basis.
Total Fixed Cost remains constant as the volume goes up, but Unit Fixed cost decreases on a per unit basis. With this, you are trying to achieve what you call Economies of Scale. This is the reason why we can give discounts when people order in bulk or in huge volume. Check different tiers so that you would know at what volume you will start to earn a margin.
The next term that I learned is Contribution Margin. Contribution Margin is the difference between sales and total variable costs or the difference between selling price and unit variable cost. This margin covers (or supposed to cover) for your fixed cost. Contribution Margin Ratio is Contribution Margin divided by Sales.
You need to find out where the biggest margin is. If you find out that the segments that you are tapping all bring in the same margin, look for the segment that will bring in the most volume.
I wanted to share these things. I just thought of sharing it, since I think it will be useful for startups and entrepreneurs to understand. Hope this helps!