So, we have looked at why variable costs are not truly variable and why they will in fact change with changes in sales and not always be a flat percentage. Why is this important? Well, it’s good to understand that you might see some cost advantages to growth, but it is also important to see that you may have to make changes to your cost structure to support that growth. Will you need to increase the number of production employees you have and then, if so, will you be able to have the sales going forward to keep them busy all the time? Remember, they don’t just come in for your busy week and then stop working when you get slow again. If you are expecting a slow period coming up, should you assume that COGS might increase as well? It is important to truly understand your variable costs and therefore gross margin when planning for the future so that you know exactly how much you can expect to be leftover to cover fixed costs and to provide a profit for the business.
Most people will look at a P&L and argue that profits (or losses) are the most important line. In fact, by name the statement is called the Profit & Loss statement so it must be the most important! It’s not. The bottom line is simply an output- it is not something that can be measured or changed without influencing the other items in the statement, so while it is important, it is not the most important. So which line is? The top line- revenues, and here’s why: the amount of money you bring in from sales determines the amount of money that can flow through the rest of the P&L (the business).