Is your small business profitable, and is the business consistently and sufficiently profitable?

And if you’ve not started your business yet, when do you plan to be profitable?

On a previous episode of The How of Business podcast, episode 532, Henry Lopez addresses higher-level question: Is Your Business Model Broken? How can you tell, and how do you fix it?

A strong and healthy business model supports a business that is consistently profitable, can scale and remains competitive.

On this episode Henry Lopez shares additional thoughts on Profitability. Because generating a consistent and sufficient profit is the primary reason we are in a for-profit business!

Resources:

FREE DOWNLOAD: Business Model Health Checklist

Other Podcast Episodes:

Episode 532: Is Your Business Model Broken?

Episode 397: Profit & Loss Statement

You can find other episodes of The How of Business podcast, the best small business podcast, on our Archives page.

Transcript:

The following is a full transcript of this episode. This transcript was produced by an automated system and may contain some typos.

Henry Lopez (00:10):

Welcome to the How of Business podcast. This is Henry Lopez and on this episode I’m going to focus on profitability. Is your business profitable? And if you’ve not started your business yet, then when do you plan to be profitable? On a previous episode of the How a Business Podcast, episode 5 32, I asked the higher level question and provided some insights on the question, is your business model broken? How can you tell if it is and how do you fix it? Because a strong and healthy business model is what supports a business that is consistently profitable. We’re going to chat about that today. Also, that can scale and that remains competitive. And so on this episode, I’m going to share some additional thoughts on profitability because generating a consistent and sufficient profit is the primary reason we are in a for-profit business.

(01:05):

I also invite you to consider supporting this podcast on Patreon and please subscribe wherever you might be listening so you don’t miss any new episodes. I also encourage you to download the Business Model Health checklist, the Business Model health checklist, which you can find on the show notes page for this episode at the how of business.com is a summary. It encapsulates what I’m going to talk about in part here. This checklist covers the broader topic of is your business model healthy? Do you have a valid and solid business model? So I encourage you to download that checklist to help you think through and analyze if your business model is healthy. So again, a business model, the way I define it is that if we contrast it to the business idea, the business idea is the what of the business, while the business model is the how your business model is, how your business is operating, how it monetizes and how it’s sustainable.

(01:57):

The business model explains also if you’re planning the practical aspects of bringing the ideal to life, how you’ll generate revenue and ensure profitability. So understanding if you have a viable business model, again, whether you’re planning or you have an existing business, this is critical because if you do, then you have a plan for or already consistently and sufficiently generating a profit and your business can also scale and remain competitive, which is critical. So again, on this episode, I will focus on the profitability part of it, and so what is a profit? Let’s just level set there. So simply speaking, a profit, which is also referred to as net operating income is the money that’s left over let’s say over a period of a year after you’ve subtracted all of the expenses, all of the business expenses from your sales or your revenues, all of the money that came into the business.

(02:48):

So the net of that, the income minus the expenses is what we call the profit. Now, that’s a simple definition. It can get much more complicated than that, but it doesn’t need to. For most of us as very small business owners, I think the thing that does get tricky is do we include in that calculation, which you may or may not be paying yourself. So if you’re paying yourself an owner’s salary or you’re planning to pay yourself an owner’s salary, does that get taken out as an expense before you calculate profit? That’s a tricky one. I mean, technically speaking the answer should be yes, meaning that it gets taken out unless you’re paying yourself but you’re not actively part of the business. So if you’re acting like the manager or a key principle in the business, you’re actively involved in the business, which most of us are as small business owners, then yes, that salary that you’re paying yourself, that’s reasonable for what you might pay someone else to do what you’re doing, then that probably should be deducted as well before you calculate a net profit.

(03:49):

The challenge is that for very small businesses, if I do that, I may not have any or well, hopefully I have some, but I may not have much profit left, and so that’s where it gets a little tricky, but it is a truer indication as to how healthy my business model is if I do include at least the equivalent of what I would have to pay someone to perform my function. So if you are paying yourself a reasonable salary that you would otherwise have to pay someone else to perform the functions that you perform that are critical to the ongoing operations of the business, then that gets included in the expenses and then that leaves whatever profit there is and hopefully there is a profit in addition to the salary. Now, again, I’ll come back to the reasonable part. If for example, you could reasonably be replaced by a manager that you might pay let’s say $50,000 a year, but you’re paying yourself $250,000 a year, well, you may want to adjust that so that you can more fairly or accurately calculate how much profit the business model is generating, and that’s great if your business is paying you that and there’s nothing wrong with that if you can afford that obviously, but what we’re trying to understand is how profitable is the operations of the business.

(04:58):

The other thing that’s tricky is whether we do or don’t bring in any debt service, any no payments or loan payments that you’re making, technically those are not operating expenses. The way that I like to explain it is it’s not the business’s fault how much of a loan you have or how much interest you have. That’s not really an indicator of the health of the business model, although of course it has to be covered. So it impacts what you can take home in the way of profits, but what I’m talking about here is operating profits. So let’s keep it to just the sales and revenues that come in in a year, let’s say, and the normal operating expenses, including of course your cost of goods sold, your overhead and again, a reasonable salary that you may be paying yourself and that then results in the net operating income or net operating profit.

(05:48):

Now not to belabor the paying yourself part of it, but if you’re not paying yourself anything and you’re just living off the profits, whatever those may be, well therein and probably is an initial indicator that there might be a flaw in your business model as it relates to profitability. The business should be able to, the business model should be able to carry a reasonable salary for those tasks that you perform for that role that you play, be it CEO or a manager or the cookie maker or whatever it is that you do or the chief electrician or the chief driver, whatever your role is that in order for that business to continue to generate that revenue, someone else would have to do it and you’d have to pay them obviously a market rate salary for that position. Then the business model should be able to cover that and still generate a profit.

(06:37):

Now, there are some exceptions here in the world of single person businesses, solo entrepreneurship for example, let’s say you’re a one person plumber, let’s say, then maybe that’s not the case. You have enough business so that you at the end of the month or whatever your period of time, you have enough money left over that that’s what you make, then great if that’s working for you. What I would suggest to you though is that can border on, and this is what we have to be very careful that can border on a lower paying job than you might have if you went to work for someone. That’s a question you have to answer for yourself. So the question is, are you making a profit? If you’re planning to launch your small business, then it’s all about your financial projections. You must plan for when you will break even first, consistently break even, and when you will start to make a consistent profit, you want to calculate a return on investment.

(07:27):

Also, how much or how long will it take rather for my initial investment for me to make that back out of the business and then determine if you are going to based on your projections, make enough of a profit. And in reality happens right after we launch our businesses and after our best planning efforts, the reality takes over. The market dictates and we start our business and the market dictates how much we make despite our inaccurate projections as it might be and or desires or fanciful dreams, the reality sets in. So after your startup stage, the question is are you consistently making the profit that you projected or that is typical for your industry or segment in your industry? So I said a lot there in that sentence after your startup stage. Typically for most small businesses that I’ve been a part of or have helped others start, that can be anywhere from several months to a little bit over a year.

(08:22):

If after that initial period of time you are not consistently generating profits, something’s probably wrong with the business model. I’m generalizing, but that’s usually the case. Now, larger investments, larger businesses very well may take longer to generate a profit, but for most of us starting businesses, that’s a good rule of thumb. Anywhere between that initial six months to a year is more realistic. Then I also said in that sentence that consistently making a profit so it’s not just one month we make a profit and the next month again, we’re broke, we’re not making any money, there’s money, there’s no money left in the bank account, or I had to make a big inventory purchase and now we have no money this month or it’s a very seasonal business, and so I make a lot of money during the summer months and nothing during the winter months.

(09:07):

Those are difficult businesses, and you might argue that that’s just a nature of my business. I would have you think about that. The business model is got a problem. So after your startup stage, are you consistently making the profit that you projected or that it’s typical for your industry or segment? It is imperative that you as a business owner have hopefully done the research, initially gotten some help, gotten some input, or hopefully as you’re in the business, connected with other peers, other people that own the same or similar businesses maybe in different markets. You’re part of an industry organization, there’s various sources for this type of data, the internet, and hopefully you have an understanding of what is typical, what is expected from my type of business, my scale of business as well as far as a range. For net operating profit margin, when we add the word margin is simply a percentage, so it’s that net operating profit that’s a dollar amount that gets divided by the total income and that’s expressed as a percentage and that’s what we call the profit margin.

(10:10):

And the reason that’s so valuable is we can set goals for that first of all, but it’s also easier to have others share what range they’re in without them having to share specifically what their financial numbers are and a lot more likely that you’ll get that type of data for your industry so that you can compare, so that you can baseline how are you performing. Otherwise, it’s pretty hard to say because if you ask me, is 10% net operating margin good on an annual basis or is 50% good? It depends. Every business is different and in different industries it can span from 5%, 50%. So what else impacts making a profit? Well, your cost structure might be too high. Perhaps you can’t raise prices, and often that is where the problem might be is that you haven’t raised prices for all kinds of different reasons.

(10:59):

Some of them might be valid, some of them are just a confidence issue I suspect, but there’s not enough there in what you are able to charge or you’re currently charging for your product or service compared to how much it costs you to make and deliver and offer that product or service. So there’s not enough margin there. It could be that you’re not able to maintain enough volume at your profit margins, for example, in the grocery store industry or the convenience store industry or even in a food distribution, that’s a business with typically very slim margins, and so the only way you can make that work as a business model is to have enough volume. It’s the Walmart approach where they’re making slim margins, but on billions of dollars. As small business owners, that’s hard to do. That’s why you’ve probably heard me mentioned many times on this podcast that if your differentiator in the market is price, that’s going to be hard to be successful with because you’re at a disadvantage.

(11:55):

You simply don’t have the deep pockets, the leverage to probably be able to continue to compete for very long on price alone. So other things to look for is are you continuously having to put cash into the business or borrow money or maybe you keep having to tap into that line of credit. Now, that’s not always a bad indicator. In some businesses where you really do have very distinct seasons or large inventory purchases, and that is very common and acceptable that you might tap into an established line of credit, but if it’s because you just simply never have enough cash and that line of credit keeps growing, then you probably have a problem. So for most of us as small business owners, we don’t have the luxury of operating at a loss for very long. Again, past that initial startup phase, and hopefully we funded that with enough working capital.

(12:47):

We’re not like a high tech startup that operates at a negative purposely perhaps for years because they’re living off of additional rounds of investment, additional rounds of venture capital for you and I, that’s not typically how we’re able to start a business. We’re starting it with our own money alone, maybe friends and family, and there’s only so much of that there when that runs out and if we don’t have enough cash, that’s what’ll kill a small business. So I’ve mentioned substantial and sufficient a couple of times, a substantial and sufficient profit. Lemme define that a little bit more in my opinion, viewer toiling away for little to no profit and barely paying yourself anything. We can only do that for so long. Now, understandably, most of us have to do that in our startup stage. I think that’s one of the bigger fallacies that somehow our business model is going to start paying us a salary from day one, and often that’s just not possible.

(13:41):

Maybe it is for your business model, that’s great. However, you do have to be able to start making considerable money. I’d say again, within that one year to two year mark of starting your business. If not, then something is broken with the business model and continuing to do the same thing, continuing to just hope that maybe next year it’ll get better, or if we can get the economy to turn around or if we can just get people to buy more. All of those things are likely not going to change things significantly for the better, but I get it. I get how hard it is to admit or acknowledge that your business model might be broken. One of the hardest things that I’ve had to do as a business owner is to shut down a business because it just wasn’t working, and I’m not saying you have to necessarily shut down your business, but you may have to pivot significantly.

(14:28):

You may have to completely change up how you’re doing things to hopefully generate a sufficient and consistent profit. The bottom line is this, after your startup stage, your business should be consistently profitable. That means month over month, unless you have again a significantly seasonal business, then you are profitable consistently and that profit as a percentage of revenue called your net operating profit margin should be in line with your industry segment and should be enough to justify your risks, your efforts, and your investment. I think it may be obvious, but I think it’s worth emphasizing. Being profitable consistently and sufficiently is what results in our opportunity to achieve financial freedom and security through our business. It’s what translates into the money that we can make from the business that we can diversify into investments perhaps for the future and what allows us to benefit from that effort and risk that we have taken initially and ongoing.

(15:26):

It’s about survival and growth. Profitability isn’t just about making money, it’s about survival. As a business, a consistently profitable business can sustain. Downturns allows us to invest in growth so we can scale to the point that we want to, allows us to adapt to changes in the market which are inevitable, and so that reinvestment in the business, sufficient profits is what allows us to not just be on compensating yourself and your team, but to invest in the business, whether it’s improving your products or services or increasing your market share or attracting more customers or expanding your operation. This reinvestment is key to staying competitive and growing your business but impossible without some infusion of cash, which ideally is some profits and it also might be other investments like loans or additional investors. Being profitable is the sign of success of a business, and that’s what’s going to allow you in part to have a positive environment.

(16:22):

A positive culture that is profitable is of course better positioned to attract and retain the top talent that you’re going to need to continue growing. Strategic decision making in your business is impacted by profitability. Being consistently profitable gives you the flexibility to make strategic decisions rather than just being reactive and being in survival mode all of the time. You can plan for long-term growth. You can take calculated risks and seize opportunities that might come your way at the right time because you’re in a position financially to be able to do so. And then of course this business ideally becomes an asset and it’s only an asset if it produces income. A profitable business is inherently of course, more valuable. If you need help with any of this, whether in getting started with your business or you’ve got an existing business that you need to help turn around or make more profitable, I encourage you to consider engaging me as a business coach.

(17:18):

And the first step to doing that is to schedule a free no obligation consultation with me. The How of Business website. At the very top of the homepage, you’ll see a button to schedule a free consultation. What we’ll do on that call is we’ll spend about 30 minutes getting to know each other. I’ll ask you a bunch of questions about either of the business idea or your current business and then we’ll determine if it might be a fit for me to engage as your coach and help you with your business. So if you’re looking for help either to start your business or to grow your existing business, consider scheduling a free coaching consultation with me. Again, just visit TheHowOfBusiness.com and click on the button at the top of the screen to schedule a free coaching consultation. So let’s talk just a little bit more about what makes a business profitable.

(18:03):

Of course, you have to have enough addressable market that’s partly in initial planning and then ongoing because markets change. So are there enough people out there that are ready, willing and able to buy what it is that I have to offer? That’s key and foremost. Is there enough demands then from those people? Are you marketing your product? Are you putting yourself out there such that people who are interested or need or want your product or service know about you? And then does your sales process convert those people who are interested from somebody who’s interested to somebody who buys? Of course, pricing comes into play there. Are we pricing at such that we’re competitive enough in the marketplace and that we have enough margin in that pricing to be able to make a profit that’s related of course to our cost of goods sold in line.

(18:47):

The raw materials that might go into building a product or the direct expenses that go into a service, for example, are the expenses there in alignment relative to pricing that gives us enough of a gross margin that then covers all of our overhead expenses. I’ve seen businesses where all of the above is in order, but then they’ve got an elaborate office, let’s say, or a lot of expenses and overhead that don’t deliver revenue, but that are eating up all of that gross profit. So that has to be in alignment, and of course you’ve got to manage the business well, you’ve got to execute. So in a very short summary, that’s what makes for a profitable business. Now, there’s a lot there that can be broken down, but that’s the way I look at it in summary. And then how do we measure profitability? Again, we’re looking at this number.

(19:31):

Generally it’s the annually we’re looking at a minimum annually, but probably ideally monthly and quarterly. Certainly if you’re struggling, you should be looking at this monthly, but what is that net operating profit? Now, the financial statement that comes into play here is the profit and loss statement or the p and l statement, and I’ve done a specific episode as well as an online workshop to help you learn how to better interpret and use your p and l statement. The episode is episode 3 97, on profit and loss statements for small business owners, and you can also go of course to the how business.com and check to see when is the next date for my next online workshop for the profit and loss statement. Alright, so I’ll summarize here now on this topic of profitability as one of the key three components of a solid and healthy business model.

(20:21):

The other two being scalability and competitiveness. I encourage you again to download the Business model health checklist. You can find that at the show notes page for this episode at the how a business.com. That brings all of this together, this whole concept of is my business model healthy and then also related the episode 5 32 is your business model Broken where I take that higher level view of understanding your business model. If you are planning to start a business, it’s imperative that you forecast your financials and plan for consistent and sufficient profitability. If you’re an existing business owner and you’re past your startup stage, then you should be consistently and sufficiently profitable. If not, it’s time now to honestly assess if your business model is broken, what needs to be adjusted and make the necessary changes, perhaps significant or extreme to changes. Now, don’t keep toiling away of this if it’s not making a profit.

(21:19):

Something is broken and don’t keep waiting for it to just turn around on its own. After that startup stage, your business model should be consistently profitable and should be enough, definitely enough to justify your risks, your efforts, and your investment of money and time. This is Henry Lopez and thanks for joining me for this episode of the How of Business. I wish you the best as you start and grow your profitable and scalable small business. I release new episodes every Monday morning and you can find a show anywhere you listen to podcasts, including the How of Business YouTube channel, and at my website, TheHowOfBusiness.com. Thanks for listening.