The Profit Equation

In 1971, the Boston Consulting Group promoted their very handy analysis tool for understanding a company's profit and its drivers.  They named this tool “The Profit Equation”.

The equation lists the key drivers of revenue growth and profitability. Once you have identified and quantified these items you can analyze them and focus in on improvements where they will add the most value. In addition, you can do very simple but valuable simulations to determine which items will have the greatest effect on profitability.

The equation is presented in a vertical format as follows:

                Existing # of Customers at Beginning of Period
                Plus: Customers Gained
                Less: Customers Lost
                Equals: Total Customers at End of the Period

                Times: Transactions per Customer
                Times: Average Sale Amount Per Transaction
                Equals: Total Revenue

                Less:  Cost of Sales

                Equals: Gross Profit
                Less  Selling and Administrative Expenses

                Equals: Net Operating Income

Take the time to calculate your company's profit equation. Build a simple model on an Excel spreadsheet and give it a try.  You will be surprised at the value of these simple management decision making tools, when you start to use them.