Posted by You’ve probably ever wondered why companies like HP, IBM or Google have huge finance departments, with hundreds or thousands of employees handling the company’s finances. So, is the way money circulates so complicated that so many employees are needed accounting, invoicing, calculating budgets, assessing cost intensity and so on? Yes, that’s exactly right – the world of money in large companies is very complicated, and everything but the treasury requirements go towards giving an answer as to whether something we do pays off.
In a small company, things are a bit simpler. First, there are fewer products or services, or they are more homogeneous. Then the calculations are much simpler, and the assumptions we have to make to be able to understand how money circulates and whether something pays or doesn’t pay is a bit simpler.
In this post I’ll show you how to count this issue using one product as an example, and in the next post we’ll do an example based on numbers, such as prices, costs and number of pieces. To count whether it is profitable to sell a product, you need to define the most important variables of this calculus.
First – revenue.
The company’s revenue (based on a single product) is the product of the price of that product multiplied by the number of units of that product that we intend to sell in the future or are selling now.
P = C * n
Where:
P – company revenue
C – the price of the product
n – the number of pieces of the product
Second – costs.
The cost of a company (based on one product) is the sum of (1) the fixed cost of running the company and (2) the product of the variable cost of producing that product multiplied by the number of units of that product that we intend to sell in the future or are selling now.
K = Ks + Kj * n
Where:
K – costs of the company
Ks – fixed cost of running the company
Kj – variable cost of producing one product
n – number of units of the product
Third – profit.
The company’s profit (based on one product) is the difference between the company’s revenue and the company’s costs. Let’s assume that profit in the case of one product can be called more profitable or profitable, but in our example it does not matter.
Z = P – K
Where:
Z – profit of the company
P – revenue of the company
K – costs of the company
Summarizing these three definitions and formulas, if the company’s revenue (P) is higher than the company’s costs (K), then the company makes a profit (Z). In the case of a single product, if the profit (Z) is positive, it pays to sell it (produce it, if the company is a manufacturing company, or provide a service).
The formulas described above are linear functions, that is, they can be illustrated in Figure 1.
Figure 1. Revenue, costs and profit of a company
In further posts I will give a concrete numerical example illustrating the profitability of a product, and show how things start to get complicated when we sell two different products, and then three, four….