I said I would, from time to time, share the issues that arise with the growth firm I am advising.  And, here is one of the biggest issues- what will it cost us to expand?

The first issue is to determine what are the fixed expenses of the firm.  Our policy has always been to consider employees as a fixed expense.  Because we are not going to let go of our administrative staff, our warehouse personnel, etc. or change their hours.  Our truck drivers, however, are a variable expense, because they are paid based upon how many hours/miles/deliveries they provide.

This firm also has other fixed expenses- rent (which will increase if we expand the business),  phone service, health insurance (for the staff), office supplies (actually a very small number), a leased vehicle for the owner, and insurances (worker’s comp, liability, auto insurance).  Oh, and my services.  Those all come to a grand total of $ 88.75 K a month.

I have also adjusted the cost of goods that are involved in this operation to include inbound freight (0.075% of product costs) and outbound freight to customers (0.275) because freight is not charged for orders over $ 250.  And, our average order exceeds that value.

If you are still paying attention, you figured out that a 35% markup would be a disaster.   (Markup= Price to customers/product costs.  So, [Product costs (1+0.075+0.2750/Product costs=1.35] that means a 35% markup is the bare minimum to get the product in and out the door- but not the costs of those doors (and warehouse, and other bare operations.)   You can’t run a company that only covers the cost of goods, inbound freight and delivery to the customers.

Now, given these facts, one has to determine what the price to the customer has to pay for us to make a profit.  And, that will be volume dependent.  2 years ago, this company barely hit $ 250K in sales.  (Of course, its costs were much lower).  Last year (when I was not there), their gross revenue was $ 1 million.   They expected to clear more $ 2.5 million this year- a volume that would necessitate a 55% markup to break even.

When you look at these graphs, it should be clear you want your gross revenue to exceed the sum of your fixed and variable costs.  Or else, you will be losing money hand over fist.  That is the problem with a 45% markup (which, when you add in the in-bound and out-bound freight, means you are only obtaining a 7% margin over your true costs).  Our situation looks a lot better at 55%.

I’ve already said we expect to gross more than $2.5 million this year.   That means that the markup we have chosen will cover the cost of additional rent- and the salesperson we are contemplating to hire.   Given that the volume would increase by some $ 2 million with the addition of the salesperson (he has that many customers already), we can also let him keep a significant portion of the markup on those sales, since it will lower our breakeven dramatically.

Things are looking up round here…

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