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What is Profitability? We all know what profit is: the surplus left over from
revenue after covering expenses. Profitability is the measure of profit
generated on an ongoing basis. Profit is generally measured in dollar terms;
profitability is measured as a percentage of sales. You need to focus on
both.For many small businesses, profit equals the owner's paycheck. If your
profitability from operations doesn't generate enough cash flow, you don't get
paid. The first step is to figure out how much you need to pay yourself--to
cover your basic needs and desired lifestyle, savings and retirement, and to pay
your taxes. Then, figure out how much money your business needs to bring in to
cover its expenses and pay you this amount. This is an eye-opening experience
for business owners. Your initial reaction may be dismay: "How can i ever bring
in that much revenue? Am I doomed to just scrape by? " But, given your financial
goals, you can begin looking seriously at how to restructure your business to
give you what you need financially--or else get out of it and go on to something
else. Profit is more than your pay Even if you are a sole proprietor,
learn to view "profit" as separate from what you pay yourself. Pretend that your
company is a corporation, where you earn a regular salary, and that makes a
profit beyond that. You get paid to work there, and as owner, you expect a
profit dividend. Profit is more than money Here's how small businesses
should look at profitability:
o Profit is ROI--return on investment. You
(and perhaps others) put capital into your business and you expect to get it
back someday with a suitable rate of return. For an established yet vulnerable
small business, a suitable ROI can be from 20% to 30% per annum.
o Profit
is ROE--return on effort. Many people start their businesses largely with sweat
equity, putting in thousands of hours of their own time--unpaid--to get the
business up and running. Can you ever recoup the value of your time?
A
business run by the owner should look at profit as the financial return per unit
of your effort. For example, suppose you work 2, 000 hours in a year, and your
company's profit is $250, 000. For that year, you could say that you had a
return of $125 for each hour you put in. If you want to operate with greater
ease, make sure you don't increase profit by dint of harder work and longer
hours. More on this in chapter 11 of my book "How to grow Your business without
Driving Yourself Crazy" in the section on "Leverage Your effort. "
o
Profit is a tuning fork. It tells you how well tuned your business instrument
is. When you are doing things right--working productively and cost-effectively,
selling the right things to the right people, serving your customers well,
treating your own people well--profit is the measure that amply demonstrates
that.
The opposite is also true. When your business is not tuned
properly, it sounds the discordant notes of low productivity, unhappy employees,
dwindling customer base, and mounting losses. Profit is acknowledgement that the
business is tuned properly.
o Profit is flow. Profit provides the surplus
that helps you weather the lean times. Profit allows you to be
generous.online
o Profit is energy. Many small business owners say they are
more interested in achieving their vision than in making a big profit. But
without adequate profitability, you get worn down, burnt-out and
discouraged.
An unprofitable business fails unless outside money is
continually pumped in. You cannot make the contribution you want without
bringing in a good profit.
The uses of profit
As your attitude
toward profit shifts from (a) what's left over that you use to pay yourself, to
(b) a resource you use for critical business needs, you can plan your operations
so that they regularly generate profit beyond what you pay yourself. You can
create a "profit budget" to calculate how much you need to cover such items
as:
o Fund for expansions or upgrades. How much do you need to set aside
each year for anticipated upgrades and expansion?
o Cushion to cover
downturns. How much should you set aside each month to provide an insurance
policy against short-term financial reverses?
o Fund for bonuses and
financial incentives and profit sharing. What proportion of sales revenue should
you allocate to incentives and bonuses in order to motivate top
performance?
o Retirement programs. What proportion of salaries and wages
should you set aside to fund retirement plans for you and your
employees?
o Paying taxes. How much must you set aside each month to pay
taxes on the profit you anticipate?
o Debt repayment. How much cash flow
must be available after taxes to pay down your debt--including repayment of
money you have put into the company?
Calculate all these amounts that
pertain to you and add them up. This is the amount of profit from operations you
need each year. If you divide this sum by your projected revenue, you get a
percentage that shows what proportion of each dollar of sales revenue should be
available for these uses. One of the most important uses for this percentage is
to set prices that assure the desired level of profitability. Your accountant
may gnash his or her teeth over the above paragraph, correctly pointing out that
many of these items are business expenses, not profit. I agree. However, for
small business owners who are trying to make a transition from a cover-the-costs
mentality to a generate-surplus mentality, developing this profit budget is
invaluable. These are the very items that they otherwise fail to account for in
their planning, their projections and their pricing decisions.profits
Need
help?
Several of our books, workshops, and e-tools help you boost your
profitability--and to figure out how much profit you need. These
include:
o How to Grow Your business without Driving Yourself Crazy, esp.
Chapter 13, "Build a Culture of Profitability" and Chapter 15, "Calculate the
benefit and Cost. "
o "Build a Culture of Profitability" available as
e-book and tel-online workshop.
o "Sources and Uses of Cash" template. A
crucial tool in projecting cash flow.
o "Success in 2007" plan workshop
helps you put profit in the context of all other facets of your business.
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