In the “Seven Simple Numbers for Business Success” series, we’re talking about each of the Seven Key Numbers that really matter to sustainable, profitable businesses. Based on the principles in Simple Numbers, Straight Talk, Big Profits!, these insights will show you how to use the Simple Numbers Profit Tool to run a long-term, wealth-generating business.
Our first key number is Profitability. Monitoring profit is key because profit is not something that “just happens;” it has to be a target that you aim for. As a wise person once said,
“A man who aims at nothing hits it with amazing accuracy.”
In my original book “Simple Numbers, Straight Talk, Big Profits,” I shared the following fruits of my business data research:
At 5% profit you are on life support,
At 10% you are a “good” business,
And 15% or better is a “great” business.
This blog is about dispelling the myth that you do not need to worry about profits.
Rare and few are the business success stories that involve plenty of invested capital, allowing them to not worry about profits. Such a situation may occasionally work in the technology space, but the real world of normal business requires profits for growth. Believe it or not, you can actually grow a business while being profitable!
Just a Job or Building Wealth?
My central premise for helping businesses relies on the assumption that you want to build wealth from your endeavors. If you look at your business as your job and maintain that whatever meager leftover profits are yours to consume, stop right here and go back to work. If you want to be highly compensated for the job you are doing in the business you own AND use the profits that the business makes over and above your salary for building wealth at a return on investment of 50% to 100% per year, then keep reading.
I have rarely seen a business that could not be profitable if effort and capital are applied correctly to overcome the challenges that are holding it back. You must first start with validating whether your business has true profit potential. In our research, most business models can produce 10%+ profits on revenue. Those businesses where the industry standard is less than 10% are not “true revenue” businesses.
In my book, “Simple Numbers Straight Talk, Big Profits,” I show an example of a construction business that is only doing 2.63% profit. In reality, they are doing 18% profit because their $20 million in revenue is not “true revenue;” it is over inflated by “pass-through” costs of materials and subcontractors. These are considered a pass-through because the Construction Company takes a draw against the job to pay for the materials (no cash out of pocket) and they typically do not pay subcontractors until they get paid. After you filter out these costs from revenue, they are at “true revenue” of 18% against gross margin.
If you are a business that has these types of cost arrangements with a low margin, you need to target your profit measure against gross margin and then work backwards to what a reasonable profit percentage against revenue would be. Our Simple Numbers Profit Tool reports on both of these percentages to make it convenient to track.
Profit is the Biggest Driver of Cash Flow
You will read endless articles about improving cash flow by getting better terms. It sounds great, but there is a big hook in that bait if you are not careful! I am not a fan of giving significant discounts for anything above my cost of borrowing unless I am in desperate cash mode. But if you are a skeptic, here are the numbers and you decide.
For a business that collects its accounts receivable in an average of 45 days (a good general average for most businesses), the following table shows you how many months it takes for you to be cash flow positive:
At 5% profit 66 months (5 ½ years for the math challenged)
At 10% profit 33 months
At 15% profit 21 months
So you tell me, which business model do you want? It really is not a question of your model as much as it is for your commitment to “Aim at Profit.”
Key Steps to Aim at Profit
Once you decide that you are ready to commit to profitability, here are the steps:
- Eliminate distortions primarily caused by owner’s compensation. For a complete discussion on this, refer to Chapter 1 of my book or check out my website for past blogs and articles.
- Determine if you need to base profit on Revenue or Gross Margin. I will discuss these in more detail on the next installment and you can also refer to my book as well as Verne Harnish’s book “Scaling Up” where I contributed a chapter in the Cash section on profitable business models.
- Determine the monthly amount of gross margin to hit your profit target and start tracking on a weekly basis. If you have trouble getting data weekly, refer to my previous blog on how to create a “Weekly Accounting Rhythm.” I dispel all of the myths that keep every business from having “live” accounting data.
- Track and adapt. The number one key to not getting profitable is how you manage labor productivity. You can read about it in my book or also in Scaling Up. The blog post for labor efficiency is coming up in a couple of weeks so stay tuned!
Best of Both Worlds
If you have a profitable business, you have the best of both worlds. It is fine to keep it, or you could be growing to sell. Both are good. A business that’s all revenue and no profit may end up “riding the pig off a cliff” before finding a fool with more money than brains to buy it.