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5 Oct 2017

Financial Intelligence: Replace your Financial Statements with Contribution Margin Statements

(Watch our short video at here)

Having looked at financial intelligence for an individual, today we look at financial intelligence for businesses. I will tell you to throw away your financial statements as they are not useful!

Traditional financial statements will show you the profit and loss statement as follows:
Sales
Less cost of sales
= Gross Profit
Less expenses
= Net Profit

The question I want to throw to you is: is this your real profit?  How do you make decisions based on this information?

We know that businessmen do not rely on the above financial statements to make decisions because they lack an important information.  They do not give you information on your costs.

There are two types of costs: fixed and variable. Fixed costs do not vary with operations level, like your rental or staff salaries, they are the same regardless of your sales.  Variable costs vary with your operations level, like your selling costs and cost of purchase. 

You need to break down your costs into fixed and variable in order to have meaningful information. For example, when sales are down, what can you do to maintain your profit level?

When you know your costs as fixed and variable, you can compute your Contribution Margin as follows:

Sales
Less Variable Cost of Sales
Less Variable Expenses
= Contribution Margin
Less Fixed Expenses
= Net Profit

You have simply converted your traditional profit and loss statement into contribution margin format. With this Statement, you have a new term: Contribution Margin.

To maximise your profits, you maximise your Contribution Margin. You do not reduce your fixed expenses, because they are fixed in the short term and reducing them will reduce your quality and lead to lower sales and contribution margin!

With Contribution Margin statement, you are able to know which product to focus on. Naturally, you will focus on products that have the highest contribution margin,

With Contribution Margin, you can also compute your Operating Leverage, which is simply how much are you leveraged on based on our fixed cost.

To know more about Financial Intelligence for businesses, come for our last public run of Financial Intelligence course on 16 October 2017 Monday 9 am to 5 pm. To know more, text to Andy at 65-8201-4347 now!