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How to Earn More From Your Business
By: Michael Gallagher
North Dakota District Office
This is the first in a series of articles covering essential tools for putting cash in your pocket and profit on the bottom line. You will learn ways to increase your profits and to develop an attitude of profit maximization and increased cash flow. Each of these articles will cover a separate idea on how the business owner can increase profits. Each idea is a step in the process of profit maximization. Together the concepts, if implemented, should yield a business that demonstrates management discipline resulting in increased profits and stronger cash flow.
Profit maximization includes two basic concepts:
- Increase revenues (sales), or
- Reduce expenses
Many businesses try these approaches, but they increase costs to achieve increased sales or lose sales as they decrease expenditures. A good example of this is advertising. Business owners invest money in advertising and sales are increased, but in the end profit may actually be reduced. We want you to look at both areas - increasing sales while controlling expenses - and understand how your business operates within these parameters.
I'm not going to belabor the point, but . . .
- You have to have records.
- Your records have to be timely.
- Your records have to be accurate.
You have to be able to track the changes and see how these changes have affected your business. You have to be able to do this daily and you have to be assured that the information you use will result in the correct action step.
Profit - How Much Does Your Business Owe You?
Before taking up the methods and systems that help achieve a profit, we must understand what the word "profit" really means.
"Profit" is an obligation of a business to its owners. "Profit" is the amount of money a business owes to the individuals who, at considerable financial risk, started and continue to support the business through the money they invest in it. The amount of profit owed to these investors is dependent on how much money is invested in the business and the type of business activity the money is invested in.
Profit is the amount of money a business must earn to compensate its owners and/or investors for their assumption of financial risk in the enterprise. Owner's wages and business profits are different water from the same well. To demonstrate this point let me offer an example of two different business owners.
First, let's look at a "profitable" business. Mike Hardworker operates a restaurant as a sole proprietor. Even though he has worked 14 hours a day, six days a week (without ever really getting everything done) for the past two years, Mike is happy. After all, he's the owner of a profitable business! On $150,000 in sales last year, he made $30,000 profit.
Now let's look at our second example. Mike Savingsome considers himself a real entrepreneur. After saving $150,000, he opened two garden centers - one downtown and one in the mall location. Mike immediately hired managers to run each store and an accountant to keep an eye on things. Things went pretty well. So well, in fact, that Mike was able to pay himself a $75,000 salary, lease a new high-end luxury SUV and take several "business trips" to Las Vegas. Then the books were closed for the first year and Mike fumed. Between the two stores, the company only made $20,000 profit. Now Mike is sure he's got a couple of lousy managers on his hands.
Don't confuse the issue. Profit is a return of invested capital - what your business pays for the use of your money. Wages are what owners and officers are paid for the work they do. If owners and officer's salaries are less or more than an outsider would be paid for doing the same job, operating profit is being over or understated.
Let's do a quick calculation on Mr. Hardworker. If Mr. Hardworker had invested the $70,000 he put into the business at 4% interest, he would have received a return of at least $2,800 - but what is the risk factor?
Should his investment have received at least a 12% return? If so, his return should have been $8,400 on the $70,000 initial investment. If we reduce his profit by the amount attributable to the investment function of the business, he really eared $21,600 as "wages." Working 14 hours a day, six days a week for 51 weeks a year, he is "earning" $5.04 per hour - or less than minimum wage.
We could do a similar calculation for Mr. Savingsome and probably find a more favorable result. There are many factors to consider. Could Mr. Hardworker find a job that would pay him $10 an hour for his talents and skills? If so, could he then have invested the $70,000 with less risk and received a reasonable return on his investment? Would Mr. Hardworker be better off in that situation? Would he enjoy it more? Mr. Hardworker, who is presently 30 year old, may question if he will still be able and willing to put in 84 hours a week, 10 or 15 years from now. Even if he works that hard, is there ever the opportunity to increase the profit or raise sales in the community he is in? After all, you can only sell so many hamburgers, bowls of soup and cups of coffee in a community of 1,200 people.
We need to review these attitudes about our "profit" before we develop a strategy to increase the profit. Are we really making a profit or just trading our time? How long are we willing to do this? Is there really an opportunity to increase the profit in our present market? We really need to know "what is our bottom line" before we start working on the bottom line.
Mike Gallagher joined the U.S. Small Business Administration in 1984 as a Business Development Specialist. He was chosen as the Deputy District Director in 2005 and the District Director in November 2013. A graduate of the University of North Dakota, Mike is a Certified Public Accountant and a former business owner. He can be reached at firstname.lastname@example.org.