Split every cost into two piles: costs that grow when you sell more, and costs that arrive whether or not you sell anything. Almost every important decision gets easier once you have done this.
The two piles
- Variable: materials, shipping, contractors on projects, payment processing, usage-based tools.
- Fixed: rent, salaried staff, insurance, most software seats, your accountant.
Contribution is the money each additional sale leaves behind after its own variable costs. That is the money available to cover the fixed pile — and once fixed costs are covered, contribution is profit.
Fixed costs are a bet on volume
Every fixed cost you add raises the amount you must sell before you make anything. That is fine when demand is proven and dangerous when it is not, which is why hiring ahead of demand is the most common way small businesses get into trouble.
The same logic runs in reverse in a downturn: businesses with mostly variable costs shrink gracefully, while businesses with heavy fixed costs face layoffs almost immediately.
Try it
Export last quarter’s expenses and tag every line fixed or variable. Total the fixed pile and divide by your contribution per sale — that is how many sales a month you need before anything is yours.