47. Simple Formula To Make Better Financial Decisions

SUMMARY

Simple Formula To Make Better Financial Decisions

Before making a decision do you understand the financial impact? If you increase the price of a product, how much can sales drop before you have a problem?
 

Transcription

Simple Formula To Make Better Financial Decisions

Hi, welcome. This short video, I wanna talk about a simple financial formula to make faster, smarter, and better decisions. So, as we know, the business acumen formula, we wanna be able to make faster, better and clearer decisions. So we know why we're making making the decision. We can communicate that, and then we can understand what are the ramifications before we make the decision.

So many times, business owners are making decisions, but they don't understand the actual financial impacts of the decision that they're making. So, I just wanna give ya a simple formula. This is from the break even formula, but how you can modify it to help you work out rules of thumb or to understand what are the financial impacts.

In this first case I'm gonna do, I'm gonna talk about if you decrease the cost of goods sold. So the formula we're using is the break even formula, and so it's your fixed expenses, which in most small businesses are your operating expenses. So your expenses aren't going to change that much unless it's huge jump in sales, divided by the gross profit percentage.

And the gross profit percentage is worked out by your sales minus minus your cost of goods sold, divided by your sales. So that that's getting the percentage for your gross profit. So an easy example of that is if you're selling it for $10, you're buying it for $5, so you're making a gross profit of five, so that gives you a gross profit percentage of 50%.

So in this case here, we're gonna give an example of if you decrease the cost of goods sold. So an example like this, well let's say we'll take the Cadbury's example where they used to sell a block of chocolate for 250 grams, then they dropped to 220 but they didn't reduce the price. So they're keeping the price the same, but they're increasing their gross profit because they're not using as much materials. So in this case here, we're going to use let's say the current state, so where the business currently is at.

They've got fixed expenses of 200,000, and their gross profit is 64%, or 0.64, so now if we divide the 200,000 by the 0.64, we can work out what the break even point is for this business, and it's 312,500. So the 200,000 divided by the 0.64 gets 312,500. So now if we go over to the proposed state, we know just by dropping the amount of materials that we'll be using to make the product, it's not gonna change the fixed expenses, the operating expenses, but it is going to make the product more profitable.

So we anticipate that it's going to go up to 0.66, or 66%. So now if we divide 200,000 by 0.66, we get 303,000. I think it's on 40. I can't remember. So we now know that sales can drop by roughly 3%, I think, if I've done my math right. That sales can drop by roughly 3%, and they're still better off. So this is just a really, a quick method without having to go off and do lots of financial modeling, especially if you're in a small business that you can start looking at things very quickly before you start jumping into making big decisions.

So this is one example of using a simple formula in a different way to help you make decisions. Thank you.

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