Finding the Correct Net Profit for Your Business
Profit - Now that's a word every owner wants to hear. That’s if the conversation isn’t about gross profit. Business leader know that when "gross" is placed in front of profit, there are still bills to pay. Once net is placed in front of profit, the actual performance can be measured.
It’s all roses unless the bottom line remaining is not enough or worse, in the red. So a business owner might ask: how much is enough? How much net profit does a business need?
This question is asked of every business owner and the answer is typically 20% or the, “I'd like to get into double-digit percentage.” Both of these answers are good, but they are not complete. As with gross profit, unexpected expenses still must be paid out of net profit. Typical expenses could be debt service, reinvestment, savings or disbursement.
Here is another question: When making a debt repayment, reinvesting in the business, and depositing or withdrawing from the bank, should you consider dollars or percentage points.
The obvious answer will always be dollars. With this in mind, why does the average company use percentage when talking about net profit? Business owners are so conditioned to think that percentage is the correct way to talk about net profit. Similar to a group of fishermen sitting around discussing the size of the fish they caught, when company leaders gather together, they share the size of profit in percentage. This is an unnecessary practice.
The amount of net profit required varies from business to business. Why does it vary?
Every business has different needs. Companies growsing a different combination of cash and debt. As such, debt to service each month is unique as well. The first step in knowing the amount of net profit dollars required each month is to find the sum of the debt installments needing to be repaid each month.
Reinvestments – Planned and ….Oops.
Reinvestment comes in two forms – the planned and unplanned. Adding a new tech or increasing marketing spending are two examples of planned reinvestment and can be arranged ahead of time. When a technician steps through a ceiling or the truck’s transmission wears out, you are required to make an unplanned - or “oops” - reinvestment. Consider how frequently these situations occur in a 12-month time period and create an average. Once the unplanned reinvestment average is generated, add this to your planned reinvestment for a summation of required profit each month. Abiding by this true break-even guarantees a business to prosper and not lack resources.
Save it or Take it
Every business should save for the proverbial “rainy day”. When considering the net profit budget, contemplate potential expansion projects, such as building new office or adding a second location. This could also include a target amount saved in the bank by a certain date. These savings should be added to the amount that is planned to disperse to the owners each month.
The quantity of dispersal or draw is based on the company’s unique or personal requirements. Savings and withdrawals should always be added to debt service and reinvestment.
Once a business acknowledges the importance of creating a net profit equal to the dollar amount of debt service, reinvestment, both planned and unplanned, and target savings and dispersal amounts, it’s time to get to work!
Profit is a phenomenal business term, especially when proceeded by “net.” This value only increases when the business required dollar minimum is recognized and generated each month, regardless of percentage. Next time you are surrounded by business owners, smile to yourself and remember percentages aren’t necessary. Or even better, share the wealth!
Visit ServiceRoundtable.com for more information on growing your bottom line.