September 26, 2006

The Magic Formula

In a meeting today I was asked by a student:
"How do I know if I can afford to hire a new salesrep?"

This question is very easy to answer,
and it is similar to many other questions
but which deal with other investments.

For example, "How do I know if spending $10,000
for a new website will be a good investment?"

All of these questions are answered with
"The Magic Formula".

Sales Needed = Investment required / Gross Profit Percent

Therefore, if a new salesrep would cost a base salary
of $6,500 and the company Gross Profit Percent is 40%
then the answer is 6,500 / .40 = $16,250.

That means that $16,250 in new sales would be needed
from the sole efforts of that new sales rep,
in order for the company to cover his base salary.

If the company would pay a 10% commission on
the sales of the new sales rep, then
the Gross Profit Percent would be reduced to 30%
and now the answer is 6,500 / .30 = $21,666.

(In this example we are dealing with a company
in the throes of deciding to hire their first salesrep,
and for this reason we have to adjust the GP$ down
to take into account the commissions.)