In my years of experience working in corporate finance and with small businesses, I’ve noticed that while the two environments have many differences, there's one key metric that every growing business, regardless of size, should track. This metric is crucial for ensuring that as your business grows and your revenue increases, a significant portion of that growth translates into pure profit. After all, the goal isn’t just to boost your sales numbers—it's to increase your profit as well.
So, what’s this magic metric? It’s called "drop through." While the name might not be particularly exciting, the concept behind it is incredibly powerful. Drop through refers to the percentage of your sales growth that directly contributes to your bottom line as profit.
Why Drop Through Matters
There are two primary reasons why drop through is so important. First, if you’re putting effort into increasing your sales, you naturally want to see your profit rising too. But more than that, as your business grows—from a micro business to a small or medium-sized enterprise—you should aim to achieve economies of scale. This means that ideally, your profit should be increasing at a faster rate than your sales. Why? Because as your business grows, you already have the necessary infrastructure in place, such as equipment, technology, and personnel. This allows you to take on more work without necessarily having to invest heavily in additional resources.
How to Calculate Drop Through
Calculating drop through is straightforward. You simply divide the increase in your profit by the increase in your turnover, which will give you a percentage. For instance, if your turnover has increased by £100,000 and your profit has gone up by £20,000, your drop through is 20%. This means that for every additional £1 in sales, you’re making an extra 20 pence in profit.
Using Drop Through for Strategic Growth
When I work with businesses looking to grow, we always perform a drop through calculation beforehand and set a target for what we expect to achieve. This helps us assess the viability of different growth opportunities. For example, if a business is currently making a 40% profit margin, it might not make sense to introduce a new product line or service that only delivers a 10% profit margin. Drop through, therefore, serves as a valuable tool for planning and assessing which growth opportunities will be most profitable.
An Alternate Take on Drop Through
Another useful way to view drop through is by considering it as a proportion of your gross margin instead of your sales. You can perform the same calculation, but use gross profit instead of turnover. This variation gives you insight into how much you’re spending on overhead resources—like staff, systems, and equipment—to achieve that extra gross margin. By looking at drop through from this angle, you can better understand how efficiently your business is using its resources to convert gross margin into net profit.
Why Drop Through Should Be Part of Your KPIs
Incorporating drop through into your monthly key performance indicators (KPIs) is critical, yet many small businesses overlook it. This metric reveals whether your profitability is keeping pace with your sales growth—a vital insight for any growing business.
At Profit Cash Growth, we specialize in working with six- and seven-figure business owners. We understand the information you need to drive your business forward and turn your ambitious plans into reality. Tracking drop through is just one of the ways we help our clients increase their profits, improve cash flow, and grow their businesses effectively.
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