Understanding Profit: The Heartbeat of Every Successful Business
The main goal of any business is straightforward: to make a profit for its owners. Yet, this simple idea is often overlooked when we venture into starting businesses. Let's break it down so it’s clear and practical.
Profit, at its core, is the difference between what you earn (revenue) and what you spend (costs). Revenue is the money you get from selling your products or services to customers. For each unit you sell, there’s a cost to produce it, called the Cost of Goods Sold (COGS). Subtracting COGS from your revenue gives you gross profit.
Now, there’s something called the gross profit margin, which is the ratio of your gross profit to your revenue. Think of it like a snapshot of how much you’re actually keeping after covering the cost of making your products. The higher this margin, the better. To achieve this, you must price your products or services well, ensuring you’re not losing money from the start.
From the gross profit, you still have to cover other expenses like employee salaries, marketing, rent, and administrative costs. Once you subtract these, what remains is your operating profit, often referred to as EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization). This figure must also be positive. If it’s not, the business could be heading into serious trouble.
After EBITDA, you deduct taxes, loan interest, and depreciation on fixed assets to arrive at your net profit. This is the final measure of how well your business is doing. To make sense of this, we look at the net profit margin—the ratio of net profit to revenue. Ideally, this margin should be at least 10%. Why? Because even a basic investment in a unit trust would typically earn you about that much.
Another important measure is the return on equity—the ratio of profit to net assets or equity. This figure should be competitive with long-term treasury bonds, which usually yield at least 15%.
The problem many small business owners face is a lack of proper record-keeping and financial analysis. Without these, it’s like driving a car blindfolded—you won’t know if you’re making money or bleeding losses. I’ve seen so many hardworking entrepreneurs unknowingly running their businesses into the ground because they don’t have a clear picture of their finances.
If you’re running a business, hiring a professional accountant can make a world of difference. They’ll help you maintain accurate records and provide financial insights that keep your business on track. This way, you can ensure your venture isn’t just surviving but thriving, building something profitable and sustainable for the long run.