How Increasing Utilization Affects Profitability

We’re going to talk about increasing gross margin. One of the best ways that you as a business owner can go about figuring out how to improve profitability without increasing sales. One of the best ways to improve gross margin is by increasing throughput or increasing utilization.

It’s easiest to talk about in terms of the manufacturing sector. Products get created in a manufacturing building. They go in on one side, and come out as finished goods. If products are being manufactured at a 100% efficiency rating, that means that we’re going as fast as we possibly can. But nearly no one is going as fast as they possibly can. If a realistic efficiency rating is more like 80%, what would happen if we increased it by just 10%? What if we could go from 80% to 90% efficiency?

How it Works

What would that do? That means, on a 50% gross margin item, we’d increase our gross profit by 5%. A 5% increase to gross profit makes a big impact. Your 50% Cost of Goods Sold becomes 45% Cost of Goods Sold, which puts you at a 55% gross profit. This takes your profitability on a 35% SGNA from 15% to 20%. An increase of 33% in profitability.

Motivating Workers

What are some ways we can motivate workers to do this? If we have a 10 million dollar business and we’ve got a 5% increase in our gross margin, how many extra dollars do we have? 5% of $10 million is $500,000. What if we could somehow share that extra money with our workers to get them to improve efficiency? Using it to get them to work more effectively without paying them overtime, which would kill gross profit? Now, all of a sudden, we’re sharing the spark. If we pay workers an extra $250k, we’re sharing with them in the increased efficiencies and increased opportunities. And hopefully motivating them towards a 10% better efficiency rating.

Monthly Accounting Insights

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