By Neil Portus, CFA, CMA
Neil Portus is a freelance CFO & Advisor for growth companies at Tailored Partners and a former Vice President & Equity Analyst at Goldman Sachs in New York where he covered car rental and mobility stocks.
* Visit our store to download a free copy of the CONTRIBUTION MARGIN spreadsheet.
This is Neil Portus from Tailored Partners. I work as a freelance CFO for growth companies.
As government’s make plans to reopen businesses following Covid-19 closures, capacity levels at many brick-and-mortar businesses may be limited by law or by new consumer habits or both. Hotels, restaurants, coffee shops, retail stores and music venues may operate at limited capacity to allow for social distancing.
So, I want to show an analysis that can help brick-and-mortar business owners understand the percent capacity at which they can operate profitably. It’s a unit contribution margin analysis. Let’s go ahead and dive in.
Two points to start. First, this is a unit economics analysis because we want to know the number of units or in this case the number of customers that we need to be profitable. Second, we’ll need separate our variable costs from our fixed costs. Variable costs are those driven by volume while fixed cost will be incurred no matter how many people are in our store. Rent is a good example of a fixed cost. This is why I want to show a unit contribution margin analysis.
Contribution margin is simply revenues generated from a sale or order minus the variable cost of a fulfilling that order: materials, wages, etc. Here’s a simple, made up calculation shown on a per unit or per customer basis. This business makes $11 in revenue per customer on average with $5 of variable costs, leaving a $6 unit contribution margin.
Now, let’s put this into an analysis for a business owner to use. Pick a time period that you’re considering reopening – let’s say June. Now, I think you’ll want have an understanding of the number of customers that you serve when operating at full capacity. Perhaps we had 1,000 customers in June last year but this June we may only operate at 35% capacity. That means we’re only expecting 350 customers. If we use the $6 unit contribution margin that we calculated before times 350 expected customers our gross contribution margin is going to be $2,100. Next we need to subtract our fixed costs which we estimate to total $3,000. So, here we see that at 35% capacity we’ll operate at a loss of $(900). But if we move the percent occupancy up to 50% we see that means we are now expecting 500 customers and our gross contribution margin increases to $3,000 which equals our fixed cost and means that we’ll break even. Once we move the occupancy above 50%, we see that we start to turn a profit. So, at 50% capacity we break even and above that we start to turn a profit.
Now one final thing – even if you don’t have exact numbers on a per-unit basis, I think that even a rough picture will still be a helpful guide. Even with perfect numbers an analysis like this won’t be the only reason to reopen at a certain time. Just one of the many factors supporting a decision of when to open.
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