RUN · Business Foundations / Module 2 of 5Free
M02
How the Business Makes Money
Revenue is visible. The drivers behind profit – volume, price, mix, cost and capacity – usually are not.
Revenue is the most visible number in any business, which is precisely why it misleads. It is reported every month, discussed in every meeting and celebrated when it rises. Profit is built from several forces working underneath it, and most owners can describe those forces only loosely. This module makes them explicit.
You will
- Break profit into its drivers: volume, price, mix, variable cost and fixed cost
- Distinguish fixed from variable costs and why the difference matters
- Calculate contribution and break-even for the business
- Identify which driver has the largest effect on profit
By the end you will have
- Contribution and margin for each of your main products, services or channels
- Your break-even revenue and margin of safety
- A sensitivity test showing which driver moves profit most
- The decision you face tested against contribution, fixed cost and capacity
Time to apply: about three hours with last month's figures
The case · Bakery and café group, 3 outlets
The supermarket order that fills the ovens
Crust & Co. runs three cafés in Kampala and a central bakery that supplies them. Four years ago the founder, Ruth, started supplying sliced bread to a supermarket chain to use spare oven capacity at night. Wholesale now produces 42% of revenue and the bakery runs at 92% of its oven hours.
The supermarket's buyer has offered a bigger deal: 40% more volume across all its stores, at a price 5% lower than today. Ruth's production manager is enthusiastic; the order would make Crust & Co. the largest bread supplier to the chain. Ruth's instinct says yes. More volume has always felt like progress.
But the business made a profit of only UGX 24.5 million last month on revenue of UGX 360 million, and the cafés have been asking for more oven time for catering orders that they currently turn away.
- Monthly revenue
- UGX 360 million
- Wholesale share
- 42% (UGX 150 million)
- Monthly fixed costs
- UGX 160 million
- Monthly profit
- UGX 24.5 million (6.8%)
- Oven capacity used
- 92%
- Offer
- +40% wholesale volume at −5% price
Should Ruth take the bigger wholesale order, renegotiate the wholesale terms, or use her ovens for something else?
Before you read on: form your own view
- 1.Which part of the business do you think makes most of the profit: the cafés or wholesale?
- 2.Will 40% more volume at 5% less price increase profit? What else would you need to know?
- 3.Which would add more to profit: a 5% price increase or a 5% volume increase?
Write your answer down. We return to this case after the worked example.
Step 01 / 13
The business problem
Most founders know their revenue and have a rough sense of what is left at the end of the year. Far fewer can say which lever moves profit most: a five per cent change in price, a better mix of products, fewer returns, or more output from the same people. Without that knowledge, decisions are made on instinct.
Instinct is not worthless, but it has a characteristic bias. It directs effort towards whatever feels urgent, which is usually volume, because more sales are visible and exciting. The levers that matter more, often price, discounting and variable cost, receive less attention because their effect is harder to see.
Ruth's situation shows the cost of not knowing the drivers. She can see revenue by channel, but not what each channel contributes after its own variable costs, how close the business is to break-even, or which lever would move profit most. So the large order is judged on the number that is easiest to see, volume, instead of the number that matters, contribution per oven hour.
Every business has a small number of profit drivers: how much it sells (volume), what it charges (price), what it sells (mix), what each sale costs (variable cost) and what it costs to keep the doors open (fixed cost), all within the limits of its capacity. Until the owner can put numbers on each, every decision about discounts, hires, branches and big customers is a guess.
Why it matters
When the owner understands how profit is built, the consequence of a decision can be estimated before the decision is taken. A discount, a new hire, a second location and a large new customer each change one or more of the drivers, and each can be tested against the model in advance.
This changes the character of management. Instead of reacting to results after they arrive, the owner begins to make choices with a view of their effect.
That shift from reaction to choice is the foundation of everything that follows in the Manage and Grow Sections.
What it costs when it is left alone
- Discounts are granted to win volume without knowing how much extra volume is needed to pay for them.
- Scarce capacity is filled with the lowest-margin work, so higher-margin work is turned away.
- Fixed costs are added for growth that does not produce enough contribution to cover them.
- The business does not know its break-even point, so a bad month comes as a surprise rather than a warning.
- Effort goes into the most visible lever, volume, while price and cost, which usually matter more, are neglected.
Step 02 / 13
The decision
Which profit driver should you work on first, and does the decision in front of you improve or weaken it?
Volume is visible and exciting; contribution is invisible unless someone calculates it. A big order feels like success and refusing it feels like losing. The analysis forces the question to be asked differently: not 'will this increase sales?' but 'what will this do to contribution, to fixed costs and to the use of our scarcest capacity?'
Grow volume
Right when contribution per unit is healthy and there is spare capacity.
Raise price or reduce discounts
Usually the most powerful lever; right when customers value what you deliver more than you charge.
Change the mix
Shift capacity towards the products or channels with the highest contribution per unit of scarce resource.
Reduce variable or fixed cost
Right when cost has drifted, or when volume cannot grow without new fixed cost.
Step 03 / 13
The concept
Profit is not a single number that goes up when sales go up. It is the result of a simple equation: for each unit sold, the price minus the variable cost of that unit is its contribution. Add up contribution across everything sold, subtract fixed costs, and what is left is profit. Each term in that equation is a driver the owner can manage.
Variable costs rise and fall with each sale: ingredients, packaging, card fees, delivery, sales commission. Fixed costs stay the same whatever you sell in a month: rent, salaries, loan repayments, the bakery's lease. The distinction matters because a sale only helps profit if its contribution is positive, and growth only helps profit if the extra contribution is greater than any extra fixed cost it requires.
Break-even is the revenue at which total contribution exactly covers fixed costs. Below it the business loses money; above it, every additional unit adds its full contribution to profit. The distance between current revenue and break-even, the margin of safety, tells the owner how much revenue can fall before the business makes a loss.
- Contribution per unit
- Price minus the variable cost of one unit. What each sale adds towards fixed costs and profit.
- Contribution margin
- Contribution as a percentage of price or revenue.
- Fixed costs
- Costs that do not change with monthly sales: rent, salaries, leases, insurance, loan interest.
- Break-even revenue
- Fixed costs ÷ contribution margin. The revenue needed to make zero profit.
- Margin of safety
- (Current revenue − break-even revenue) ÷ current revenue.
- Mix
- The proportion of sales coming from each product or channel, each with its own contribution margin.
- Constraint
- The scarcest resource (oven hours, machine time, skilled staff, shelf space) that limits how much you can sell.
Step 04 / 13
The framework
The tree breaks profit into the five drivers and capacity. The break-even model shows how close the business runs to loss. The sensitivity test shows which driver matters most.
The profit driver tree and break-even model
01
Volume
Units sold, by product or channel
02
× (Price − variable cost)
= Contribution per unit
03
Mix
Weighted across products and channels
04
= Total contribution
05
− Fixed costs
= Profit
Profit
Σ (units × (price − variable cost per unit)) − fixed costs
Break-even revenue
Fixed costs ÷ (total contribution ÷ total revenue)
Contribution per unit of constraint
Contribution per unit ÷ units of scarce resource used per unit
When capacity is full, rank products by this, not by contribution margin.
| Driver | Typical question | Warning sign |
|---|---|---|
| Volume | Can we sell more without new fixed cost? | Volume grows, profit does not |
| Price | Do we charge for the value we deliver? How much do we give away in discounts? | Prices unchanged for over a year; discounts granted on request |
| Mix | Which products or channels carry the most contribution? | Fastest-growing line has the lowest margin |
| Variable cost | What does each unit really cost, including waste, returns and delivery? | Waste or returns not measured |
| Fixed cost | Which fixed costs support revenue, and which have simply accumulated? | Fixed costs rise in steps with each expansion |
| Capacity | What is our constraint, and what earns the most per unit of it? | Turning away high-margin work because capacity is full of low-margin work |
The sensitivity test asks what a 5% improvement in each driver would do to profit, all else equal. It almost always shows that price is the strongest lever, because a price increase goes straight to profit, while extra volume brings extra variable cost with it. That does not mean you should always raise prices; it means you should never discount without calculating how much extra volume the discount needs.
Extra volume needed to pay for a discount
Current contribution margin ÷ (current contribution margin − discount) − 1
At a 33% margin, a 5% discount needs 18% more volume just to stand still.
The rule that matters most
When capacity is full, the question is never 'is this order profitable?' but 'is it the most profitable use of the capacity it will take?'
Step 05 / 13
Diagnostic questions
These questions reveal how well you know your own economics. Answer from evidence where you can, and note where you cannot.
The questions this module must answer for your business
- 01What is our contribution margin, and how many sales do we need to break even?
- 02Which costs rise with each sale, and which do not?
- 03If price rose 5% and volume fell 5%, would we be better or worse off?
- 04Which driver are we managing least well today?
What you know today
- What was your profit last month, and how soon after month-end did you know it?
- What is the contribution margin of your three most important products or channels?
- What revenue do you need each month to break even? How did you work it out?
How decisions are made
- When you last gave a discount or accepted a lower price, did anyone calculate the extra volume needed to pay for it?
- When did you last raise prices? What happened to volume?
- When you added your last significant fixed cost (a hire, a lease, a branch), how much extra contribution did you expect it to generate? Did it?
Capacity and change
- What is your scarcest resource: people, machine time, space, cash or management attention?
- What work do you turn away because capacity is full? What would it have earned?
- How has your mix changed over the last 12 months, and has profit followed revenue?
- If revenue fell 15% next quarter, would you make a loss?
Step 06 / 13
Worked example
Ruth's accountant split last month's figures by line. All amounts in UGX; unit prices in shillings, totals in millions.
Crust & Co.: building the driver tree before answering the supermarket
1.Calculate contribution by line
Line Units Avg price Variable cost/unit Revenue (m) Contribution (m) Margin Café bakery items 60,000 1,500 600 90.0 54.0 60.0% Café drinks and meals 30,000 4,000 1,300 120.0 81.0 67.5% Wholesale bread 100,000 1,500 1,005 150.0 49.5 33.0% Total 360.0 184.5 51.3% Wholesale brings 42% of revenue but only 27% of contribution. Its variable cost includes ingredients, delivery to 14 stores and returns of unsold bread, which run at 8% of deliveries.
2.Find break-even and the margin of safety
Break-even revenue
160 ÷ (184.5 ÷ 360) = UGX 312 million per month
The margin of safety is (360 − 312) ÷ 360 = 13%. A 13% fall in revenue would wipe out the profit. That is thin for a business with a single large wholesale customer.
3.Run the sensitivity test
Change (all else equal) New profit (m) Change in profit (m) Today 24.5 – Price +5% across the business 42.5 +18.0 Volume +5% 33.7 +9.2 Variable cost −5% 33.3 +8.8 Fixed cost −5% 32.5 +8.0 Price +5% and volume −5% 32.4 +7.9 Price is twice as powerful as volume. Even if a 5% price increase lost 5% of volume, profit would still rise by about a third.
4.Test the supermarket's offer
The offer: 140,000 loaves a month at UGX 1,425 (5% less). Variable cost per loaf stays at 1,005. But the ovens are at 92%, so the extra volume needs a night shift and a second oven on lease, adding UGX 14 million a month in fixed cost.
Today Supermarket offer Change Wholesale revenue 150.0 199.5 +49.5 Wholesale contribution 49.5 58.8 +9.3 Extra fixed cost – 14.0 +14.0 Effect on monthly profit −4.7 Revenue would rise by 14%, and profit would fall by 19%. The order would also consume all remaining oven capacity, ruling out the catering work the cafés turn away at 60%+ margins.
5.Build the alternatives
Option Monthly effect on contribution What it needs Renegotiate: +6% price (UGX 1,590), returns capped at 5% (cost per loaf to 960) Wholesale contribution 63.0 (+13.5) A firm conversation, backed by the numbers; risk the buyer cuts volume If the buyer cuts volume by 30% at the new terms Wholesale contribution 44.1 (−5.4) Frees about 16% of oven hours Use freed oven hours for café catering (about UGX 25m revenue at 60%) +15.0 A catering menu and order process Even in the worst case, where the supermarket cuts volume, renegotiation plus catering leaves Ruth about UGX 9.6 million a month better off than today, and less dependent on one customer.
The lesson
The bigger order looked like growth and was a step backwards: more revenue, more fixed cost, less profit and no spare capacity. The driver tree showed that the cafés carried the business, that price was the strongest lever, and that the scarce resource, oven hours, should go to the work that earned most per hour.
Back to the case: The supermarket order that fills the ovens
Ruth declined the 40% expansion and went back to the buyer with a counter-offer: current volume at UGX 1,590 a loaf, returns capped at 5%, and a 12-month agreement. After two weeks the chain accepted the price for 80% of the volume.
The freed oven hours went to a catering menu for offices and events, launched through the cafés. Within three months catering was producing UGX 18 million a month at a 61% margin. Profit rose from UGX 24.5 million to about UGX 36 million a month, on slightly lower total revenue (about UGX 355 million).
If your first instinct was to accept the order because it was larger, notice what changed the decision: contribution by line, the cost of the extra capacity, and the sensitivity test.
Compare this with the view you wrote down at the start. What changed, and why?
Step 07 / 13
Apply it to your business
Now do the same for your business. Allow about three hours with last month's figures.
Gather this first
- Revenue for the last full month (or average of the last three), by product line or channel
- Units sold by line, or a reasonable proxy (orders, jobs, hours billed)
- Variable costs per unit by line: materials, packaging, delivery, commission, card fees, waste or returns
- Total monthly fixed costs from your management accounts or bank statements
- Your capacity: what limits output, and how much of it is used
- 1
List your lines
Choose three to eight lines that together make up most of revenue: products, services or channels whose economics differ.
- 2
Enter units, price and variable cost
Use average actual price after discounts. Include every cost that rises with each unit, including waste, returns and delivery.
- 3
Enter fixed costs
Include salaries that do not vary with volume, rent, leases, insurance and loan interest.
- 4
Read contribution, break-even and margin of safety
The worksheet calculates them. Note which line has the lowest margin and its share of revenue.
- 5
Run the sensitivity test
In part B, enter your base revenue, variable cost and fixed cost and test a 5% change in each driver. Then test the specific decision you face.
- 6
Check capacity
If capacity is above 85%, work out contribution per unit of your constraint for each line.
- 7
Choose the driver to work on
Decide which one driver will move profit most in the next quarter, and what you will do about it.
Step 08 / 13
Worksheet
Use one month of figures (or a monthly average). All amounts in the same currency. Your entries are saved in this browser.
Profit driver tree and break-even calculation
AContribution by line and break-even
| Product, service or channel | Units per month | Average price per unit | Variable cost per unit | Revenue | Contribution | Margin | Share of revenue | Share of contribution | Rank | Remove |
|---|---|---|---|---|---|---|---|---|---|---|
| Total | – |
- Total revenue
- –
- Total contribution
- –
- Weighted contribution margin
- –
- Profit
- –
- Break-even revenue
- –
- Margin of safety
- –
BSensitivity and decision test
Enter your base month. Each row tests a change in one or more drivers. Type changes as percentages (for example 5 or −5). Use the last rows for the decision you face.
| Scenario | Price change (%) | Volume change (%) | Variable cost change (%) | Fixed cost change (%) | New revenue | New profit | Change in profit | Remove |
|---|---|---|---|---|---|---|---|---|
CWhat the numbers say
Step 09 / 13
Interpret your results
A completed worksheet is evidence, not a conclusion. Read it before you decide.
- 1.Which line has the biggest gap between its share of revenue and its share of contribution?
- 2.How large is your margin of safety? How many months like your worst month last year could you absorb?
- 3.Which driver produced the largest change in the sensitivity test? Is it the one you spend most time managing?
- 4.Did the decision you tested increase or reduce profit once extra fixed costs and capacity were counted?
- 5.What surprised you? Which line did you think was more profitable than it is?
- 6.How confident are you in your variable cost figures? Which missing cost (waste, returns, delivery) might change the picture?
| If you find… | It usually means… |
|---|---|
| The fastest-growing line has the lowest margin | Growth is diluting profit. Price it properly or limit the capacity it takes. |
| Margin of safety below 10% | A modest fall in sales means a loss. Prioritise price and fixed cost before any growth that adds fixed cost. |
| Price is by far the strongest lever | Typical. Review discounts and pricing before chasing volume (see M50). |
| Capacity is full and low-margin work occupies most of it | Rank work by contribution per unit of constraint and reallocate. |
| A growth option increases revenue but reduces profit | The extra contribution does not cover the extra fixed cost. Renegotiate or decline. |
| You could not estimate variable cost for a line | You do not yet know whether that line makes money. Fix the data first (see M04). |
Step 10 / 13
Make the decision
Choose the driver you will work on first and record the decision you are making about the specific opportunity or problem you tested.
Raise price
Choose this whenPrice is the strongest lever and customers value what you deliver.
What followsPlan a price change with notice, or remove automatic discounts. See M50.
Change the mix
Choose this whenCapacity is full and low-margin lines take a large share of it.
What followsReallocate capacity to the lines with the most contribution per unit of constraint.
Renegotiate a channel
Choose this whenOne channel or customer has a much lower margin than the rest.
What followsPrepare terms that bring its margin up; know your walk-away point.
Cut variable cost
Choose this whenWaste, returns or delivery costs are high or unmeasured.
What followsMeasure them weekly and set a reduction target.
Grow volume
Choose this whenContribution per unit is healthy and capacity is available without new fixed cost.
What followsSet a volume target and a sales plan for the highest-margin lines.
Decline the opportunity
Choose this whenIt raises revenue but lowers profit once fixed cost and capacity are counted.
What followsSay no with reasons, or come back with terms that work.
Your decision record
Step 11 / 13
Action plan
Driver work is fast to analyse and slower to change. Edit the suggested actions to suit your decision.
Implementation cycle: 30 / 60 / 90 days
| Action | Owner | Deadline | Expected result | Resources needed | Measure of success | Review date | Remove |
|---|---|---|---|---|---|---|---|
| Days 1–30: Know the drivers | |||||||
| Days 31–60: Act on the strongest driver | |||||||
| Days 61–90: Make it a habit | |||||||
Step 12 / 13
Management routine
The driver tree is not a one-off. These routines keep the numbers in front of the people who make decisions.
Monthly
Contribution by line, break-even and margin of safety
- Which line's margin moved most?
- Is the margin of safety improving?
Before every major decision
Run the decision test
- What does this do to contribution, fixed cost and capacity?
- Is this the best use of the constraint?
Quarterly
Price and discount review
- How much did we give away in discounts?
- Which prices have not moved in a year?
Annually
Rebuild the tree in the budget
- Which driver will we work on next year?
- What fixed costs will growth require?
Step 13 / 13
Final output
By the end of this module you should have
- Contribution and margin for each of your main products, services or channels
- Your break-even revenue and margin of safety
- A sensitivity test showing which driver moves profit most
- The decision you face tested against contribution, fixed cost and capacity
- A recorded decision on the driver to work on first, with a target
- A 90-day plan and a monthly routine to track the drivers
When the problem is bigger than this module
The driver tree answers 'where does profit come from?' quickly. Acting on it can be harder: repricing a major channel, renegotiating with a dominant customer, or redesigning operations around a constraint. If those changes are in front of you, a Growth Partnership works them through with you, together with unit economics (M04), pricing (M50) and growth economics (M53).