It’s one thing to understand what profit is but actually achieving profit – and achieving it consistently – is quite another. Like so many financial terms, understanding the concept and being able to put it into action are a million miles apart.
I believe that being able to run businesses at a profit is a skill, and one that is learned over many years. It involves having great abilities in many different areas. For a start, you have to be good at selling your services, but also at selling them for the right price. At some point, we all make the mistake of selling ourselves too cheaply. We have talked previously about skillsets such as value articulation and models such as the three thirds or the 40-40-20 rule, which help to set a price that allows for profit.
But beyond that, you need to be able to deliver your product or service in a cost-effective way. For example, are your people productive? Are they efficient? Are you overpaying them? This is now the territory of expertise in operations, and suddenly you’re having to think about managing people well, motivating them, making sure they keep good records. Are they delivering on client work? Are they busy for the right reasons? This kind of management never ends, it’s day to day and week to week. Doing this well is the difference between being profitable or not, and it’s not easy.
A different way to think about profit
I recently read a book by Mike Michalowicz called Profit First. His premise is that you should stop looking at profit as the residual amount that comes after everything else (i.e. what’s left after you pay your costs, overheads, salaries, etc.) and instead make profit your first stop. So, as long as you have sales, every time money comes into the business, you should first take out whatever your target profit is and THEN pay your costs. If you want profit of 30%, put that immediately into another bank account – it’s the first cost of the business.
It’s a radical take on profit, but very interesting. If you’ve ever heard of Parkinson’s law, you’ll know the adage that, “work expands so as to fill the time available for its completion.” You may be starting to see why Mike’s approach could be a smart way to target profit. If the money is in your company account, the chances are expenses will turn up to absorb it, and suddenly your residual – your profit – is no longer. However, if the profit isn’t in the bank account anymore, it simply cannot be spent and your costs will look after themselves.
I’m not convinced this is the best way to focus on profitability, but I do think it’s a good way to start a conversation around profit and how you, the owner(s) of the business, look after profit and build it into your business planning. I do believe that the method of passively waiting to see “what’s left” at the end of the year is not a good way to run a business.
You CAN drive profit. You CAN influence it. Our proactive approach, based on the four cycles, means that it’s easy to target profit and make it a priority. As an example, you could create a Rapid Improvement Project (RIP) based on getting employee billables from 28 hours per week to 31 hours per week. It’s not a huge change – maybe you restructure their schedules, tweak the workflow, or allow them to work from home one day per week – but the effect on profitability can be substantial.
Having a good salary AND making a profit should be the aim, otherwise you could simply go and get a nice secure job in someone else’s firm.
Taking a more aggressive stand on profitability
I think that deep down a lot of business owners feel they don’t deserve profit. We’re a bit unsure about what a realistic level of profit is from a business. There can be the argument in our heads that we’re making a decent salary, so that should be enough. Or, if we make a profit, we shouldn’t let anyone know because it’s somehow a bit grubby. The reality is, however, that running a business is a high-risk and draining activity. There’s no pension (unless you do it yourself) or healthcare package (unless you pay for it). There’s not even any job security (unless you keep turning up to turn the lights on).
Given all these negatives, what’s the point of running a business if it isn’t profitable?! Having a good salary AND making a profit should be the aim, otherwise you could simply go and get a nice secure job in someone else’s firm. In reality, many business owners don’t even make as much money as their employees. They put themselves second when it comes to the monthly pay run, and sometimes may go months where they don’t take anything out of the business.
I believe this is fundamentally wrong and not the right way to run a business. If you’re creating value and giving people jobs, you deserve to get paid for it. If profit isn’t happening in your business, it’s because something is missing from your skillset.
The fallacy of the bad year/good year
If you are focused on profitability, there should be no such thing as a good year or bad year for the business. Let’s say the country heads into recession and demand for your goods or service halves. If your business model is right, you should be able to adjust down to half the size while not sacrificing your profitability percentage. If you have the same overheads as before but only 50% of your revenue, you’ll end up making a loss and this just isn’t smart.
A good business should always be profitable. There was a trend in past decades for startups to assume that they would make a loss or the first few years. The justification was that you had to trade making money against gaining market share until you had a strong foothold in your sector. And that did work for some well-known brands (Amazon or Facebook, for example). But the companies that make it are a tiny fraction of all the companies started.
Startups hoping to be “the next [insert name of cool tech company here]” are going through round upon round of investment funding on the promise of what is to come, but in the real world, it’s not inevitable that you will make a profit. Lots of commentators in this space have been saying for a while now that growing your business in this way is dangerous. It’s much better to make a profit from the beginning, and then grow at a profit. Balance what you spend with what you bring in every step of the way.
Profit is a good thing. It’s necessary, it’s worthy, and it should be targeted from day one. But it’s really not easy and it may take years to develop all the skills and knowledge you’ll need to drive a business profitably. My key learning from years of running and owning businesses is that – as the owner – you shouldn’t forego your own salary while you build the business. Pay yourself the market rate for the job you do, and then factor in your profit on top of that.