When you go into business for yourself, you have to strike a
balance between the risks that you assume and the return you
expect to receive if you succeed. Obviously, no one likes to
take big risks to obtain a small return. A business plan can be
used as a modeling tool to look at a variety of scenarios.
How do you strike a balance between price and
sales volume? If increasing the price reduces
sales volume, at what point do you achieve
maximum profit? Is it better to make a lot of
money on fewer units, or a little money on more
sales? The answer may surprise you.
Assume that it cost $75 to produce and sell
one unit of a product. Look at the following
table. It projects how many units of a product
can be sold at different price levels.
This type of projection would commonly be based on market
research into price elasticity (the extent to which demand
for your goods or services is affected by price). Knowing that
your cost to produce and sell each unit is $75, you can also
project the overall profit you'll attain at various pricing
levels. The profit is determined by subtracting the cost ($75)
of each unit from the selling price and multiplying the result
by the projected sales volume. Take a look:
As you can see, in this example, the profit remains
relatively constant over a rather broad range of sales volume. A
sales price of about $90 maximizes profit on sales of about 95
units. In this case, however, any sales price from $85 to
$105 is projected to generate at least a $1,200 profit.
So if $1,200 profit is acceptable, the unit sales could be as
high as 120 units and as low as 30 units. This means that other
factors, primarily operational, will be important considerations
in setting a price. Merely maximizing net profit won't
necessarily yield the best long-term result. Consider how
different your business's needs would be if you produced 30
units versus 120 to produce the same net profit.
This is the type of modeling that you can do if you have a
business plan to serve as an organized framework for considering
all the interrelated issues. Suppose you decide to accept a
somewhat lower overall profit in exchange for greater sales
volume. Will you have enough production capacity? Will you need
additional help? Have you got enough space to store that many
units? Can your suppliers provide the raw materials you need?
Answers to these and other questions are much more readily
available if you have a written plan as a modeling tool.