Why profit matters to a small business

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I am writing a daily blog series on how to start a business.  If you’d like to review previous posts on this series, you can find them here:

So You Want to Start a Business
Revenues, Direct Costs and Expenses… Oh My!
Hourly Rates
How Can You Earn More Revenue without Spending More Time
Direct Costs and Gross Margin
Keep Expenses LOW!

If you have been with me through the series of how to start a small business thus far, I congratulate you.  It isn’t easy talking about a bunch of math without understanding the end goal.  My post today will be on the topic of Profit.  Profit is the money you have left from your Revenue once you pay your Direct Costs, and your Expenses.

What does Profit Mean to You?

Profit means different things to different people.  Of all of the things that affect small business owner’s success, I believe a business owner’s relationship with money is probably the one thing that can impact their success the most.  When I start discussing profit with a small business owner, I get some of the strangest reactions.

The Ideologue

The Ideologue will say something like, “It’s not about the money, man.”.   Of course businesses are not all about the money.  However, profits to a business are like oxygen to humans.  If you don’t have profit, you simply cease to exist.  Some people start “non-profit” businesses thinking they are exempt from the idea of profit.  This thought could not be further from the truth.  All businesses and entities are either making money (profit); or they are losing money (loss).

The Penny-Pincher

Other clients will hoard money as if they let it go it will never come back again.  Being too frugal with money can stifle a small business and prevent growth from happening.  You have heard the old saying, “It takes money to make money.”  This saying should be, “You need to spend money, to make money.”  Simply having money that is not put to use, is no different than not having money at all.

The Spend-Thrift

Opposite of the Penny-Pincher is the Spend-Thrift.  Spend-Thrifts will blow through money spending it on all sorts of things that do not directly relate to the business.  They either make purchases the company cannot afford and eliminate profits; or they will stifle growth of the company by not spending money on profitable investments in the company.  You will typically see such expenditures on the ‘expenses’ ledger rather than the ‘direct cost’ ledger.

What Should Profit Mean to You?

I could go on and on about the different money personalities, but that isn’t helpful.  So, as a small business owner, what should profit mean to you?  Profit is the life-blood of any company.  For a small business owner just starting out, it will determine if your company will survive or fail.  If you have a boot-strap company, you cannot make it even a year without making a profit.

As you can imagine, not all companies make a profit at first.  In fact, many companies will lose money in their start-up phase.  This is why the financial forecast we have been talking about in this series is so important. When you first start a company, many people do not know about your company.  They may or may not like the products and services your company has to offer.   It is common in the first few months or year of a company’s life, you will invest money in advertising, networking, marketing, and sales without sufficient revenues to pay the bills.  That means that you will need to either borrow money or invest your savings in this startup phase.

Let’s say that when you put together your financial forecast, you plan to lose $40,000 in the first few months before you break-even.  In business vernacular, this $40,000 is often called an investment.  This is the amount of money will need to either provide from your savings, or borrow from a bank.  I am not an advocate of borrowing for small business ventures; and most banks will not loan you the money anyway.  If you don’t have this money, I can offer some ideas in the future on where you can get money to start a business in future blog posts.

How are Profits Used?

During the operation of your company, you will find that you will either make more or less money than you had anticipated.  If your company makes money, it is a profitable company and something you ought to be proud of.  Creation of profits by a business indicates that you are offering society a product or service they feel is worth more than the money they are giving you for that product or service.  So, what should you do with these profits? You can: 1) pay back investors (even if the investor is you); 2) keep profits in the company and increase costs to grow your company; 3) pay off debt needed to start the company;  or 4) improve your personal income.  All of these uses should be outlined in your financial forecast.

On my next blog post, I will put all of the things we have talked about thus far in a ten year financial forecast so that you can see an actual forecast that you can use for your own company.