How much profit should your business be making?

How much profit should your business be making?

How much profit should you be making?

How much should you be paying yourself?

The Business Owner’s Guide To Finding Out – Introduction

How much profit should we be making, and how much should we be paying ourselves as business owners are two of the most internally pressing questions we tend to ask ourselves. In this post, we’re going to look at (and answer) both of those questions.

We rarely verbalise it, but we want to know the answers – as business owners and human beings there are a couple of traits that we carry with us…albeit subconsciously most of the time:

We’re curious: after all, you wanted to know what answers you would find in this blog post based on the title of the blog post

We’re competitive: we want to know how we are doing compared to our friends, acquaintances, business peers, our contemporaries and our competitors – in fact, just about business benchmark that we can find to compare our own performance to

We’re compassionate: we fundamentally know that our business (product or service based) has a need to serve its audience with a solution to their problem – essentially – we want to help (and make bank, of course 😉)

Idea to develop {We forget however, to be compassionate with ourselves – we don’t pay ourselves enough for the time and effort – mental and physical – that we put into our businesses. Often, we’re too worried about looking after everyone else, and we tend to put ourselves last}

So what does all this mean then when it comes to finding out whether or not we are in fact paying ourselves enough, or making enough profit? How do we know if we’re leading the pack?

We go back to measuring two of the most primal indicators: profit and pay – how do they compare?

Make sure that you access the worksheet here to make it nice and easy to work out your answer.

Question 1: How much profit should we be making?

As is so often the case with such questions, the answer is…it depends…

However, the good news is that there is an answer for you and your business – it just depends upon the ‘size’ of your business. All that we need to answer the question more accurately is a suitable benchmark that will allow us to compare the relative performance of businesses of different ‘sizes’.

The benchmark that we use when we apply the Profit First method within a business is ‘Real Revenue’.

So what is ‘Real Revenue’? It is a term that we use in the Profit First system to show that ‘top line revenue’ is not truly representative of the ‘size’ of a business.

Your ‘Real Revenue’ is the revenue your firm generates when Materials and third party Sub-Contractors are excluded. This number is used to represent the ‘true’ income of a company, and the cash flow it actually manages and controls – Real Revenue is the real money that your business makes, therefore.

Real Revenue gives us a quick way to get all companies onto a level playing field so that we can make sensible comparisons between them.

Real Revenue – The Calculation

Here’s how we work out Real Revenue:

Total Income

Less: Materials Costs

Less: Sub-Contractor Costs

= Real Revenue

 

Idea to develop {Is Real Revenue the same as Gross Profit?}

When it comes to materials and sub-contractors, whilst you may make a margin, it isn’t the core driver of profitability (because you don’t really control it).

If you run a service based company, then it is quite possible that your Total Revenue figure is the same (or very close to) your Real Revenue figure. Note: when applying the Profit First system in a business, if Materials plus Sub-Contractors come to less than 20% of the Total Revenue of the business, then we normally class these costs as ‘Operating Expenses’ as they don’t make up a significant proportion of the costs of the business overall.

Real Revenue – An Example

Let’s start with an example of a building contractor firm, and assume that they have a $3,000,000 top line revenue (Total Income). They spend $1,000,000 on materials and a further $500,000 on sub-contracted labour in order to complete the projects that they are working on.

Taking the calculation above, that means that they are in fact a $1,500,000 Real Revenue firm according to the Profit First method ($3,000,000 – $1,000,000 – $500,000 = $1,500,000).

All that is really happening here is that there is $1,500,000 being moved around for other people and businesses – the building firm is just a conduit for moving money from the customer directly to the purchase of materials and the cost of sub-contractors.

So, before we can make a sensible judgement about what the profit level for your business should be, we need to know what the ‘Real Revenue’ of your business is first…

Jot down the numbers for your business in the table below: (or access the worksheet here)

Total Revenue $ / £ / €
Materials Costs $ / £ / €
Sub-Contractor Costs $ / £ / €
REAL REVENUE = $ / £ / €

 

You should be able to find these numbers fairly easily from your own records (spreadsheets, or accounting/bookkeeping platform if you do your own bookkeeeping etc – if you are looking at your accounting system, you should find these numbers towards the top between the ‘Sales’ line and the ‘Gross Profit’ line), or you can ask your bookkeeper / accountant for them.

Remember, deduct only materials and sub-contractor costs from your ‘top line revenue’ number – if the materials and sub-contractor costs come to less than 20% of your top-line revenue (you may instinctively know this, ie you don’t use any ‘raw materials or third-party sub-contractors), then we’ll assume that your top line revenue is the same as your Real Revenue number (nice and easy!)

We’ll need your ‘Real Revenue’ number for later on…

You will also need your ‘Net Profit’ number later, so whilst you’re digging into your Profit & Loss Account, note this number down for later too (you should find this number right at the bottom of your Profit & Loss Account, or again, ask whoever does your bookkeeping / accounting for this number if you are unsure).

We need to know the ‘actual’ amount (number) for your Net Profit, and we need to calculate what that is as a percentage of your Real Revenue (Net Profit divided by Real Revenue).

 

Net Profit $ / £ / €
Real Revenue (number calculated above) $ / £ / €

Net Profit as a % of Real Revenue

(divide Net Profit by Real Revenue)

%

 

 

Question 2: How much should you be paying yourself?

As a business grows, how a business owner ‘earns’ their money tends to change. Typically, the aim is to work less ‘in’ the business, and more ‘on’ the business.

As a result, the way in which a business owner is financially rewarded will also change through an increase in profit payments (dividends / distributions), and a relative decrease in the wages component.

So we need to work out what your Total Owner’s Pay is…

Jot down the following numbers in the table below: (or enter into the worksheet if you have already downloaded that – if not, you can access it here).

Gross Salary $ / £ / €
Dividend / Distribution $ / £ / € +
Total Owner’s Pay $ / £ / € =

 Add your Gross Salary to the additional Dividends / Distributions you take to work out your ‘Total Owner’s Pay’

Now we need to work out what ‘Total Owner’s Pay’ is as a percentage of our ‘Real Revenue’ number (Total Owners Pay divided by Real Revenue)

Total Owner’s Pay as a % of Real Revenue

(divide Total Owner’s Pay by Real Revenue)

%

 So now we have 2 percentage figures noted down – one for our Net Profit, and one for our Owner’s Pay.

In order to complete the picture, there are 2 other components that Real Revenue must cater for:

Tax

Operating Expenses

They will make up the balance of the 100% allocation of Real Revenue in the tables below.

The tables below show the typical Real Revenue bandings – applied initially as Target Allocation Percentages according to the Real Revenue level of a business.

These percentages have been compiled over an extensive period of time, and are as a result of comprehensive research and analysis by Profit First, and have been found to be representative of companies that exhibit ‘healthy numbers’ at the various levels of Real Revenue range.

Let’s start with businesses that have a Real Revenue of below $1,000,000 (c£750-800,000):

Real Revenue Range $0 – $250k $250 – $500K $500k – $1M
Real Revenue % 100% 100% 100%
Profit 5% 10% 15%
Owner’s Pay 50% 35% 20%
Tax + Operating Expenses 45% 55% 65%

Example:

For instance, let’s take a business that has a Real Revenue of $300,000 (so we will use the percentages from the middle column from the table above):

Our Profit should be: $300,000 x 10% = $30,000

Our Owner’s Pay should be $300,000 x 35% = $105,000

 

Let’s move onto businesses that have a Real Revenue of more than $1,000,000 (c£750-800,000):

Real Revenue Range $1 – $5M $5 – $10M $10 – $50M
Real Revenue % 100% 100% 100%
Profit 10% 15% 17%
Owner’s Pay 10% 5% 3%
Tax + Operating Expenses 80% 80% 80%

 

Example:

For instance, let’s take a business that has a Real Revenue of $1,000,000 (so we will use the percentages from the left hand column above):

Our Profit should be: $1,000,000 x 10% = $100,000

Our Owner’s Pay should be $1,000,000 x 10% = $100,000

Bringing It All Together – Your Answers

Consequently, now that we have found out the answers to the questions above, we need to bring all that information together so that you can find out whether or not you business is making enough profit and whether or not you are paying yourself enough as the business owner relative to the Real Revenue size of your business.

Real Revenue Range (for your business) $/£/€
ACTUAL Real Revenue (for your business) $/£/€

 

ACTUAL Net Profit (for your business) $/£/€ %
ACTUAL Total Owner’s Pay (for your business) $/£/€ %

 

Now we need to enter the Profit % and Owner’s Pay % numbers from the table above into the second column in the table below,

AND

We need to add in the 2 percentage figures for Profit and Owner’s Pay from the Real Revenue Range Tables above (whichever range applies to your business) into the first column for the Target Real Revenue Range:

 

Target Real Revenue Range % Your Actual % + / – %
Real Revenue 100% 100%
Profit
Owner’s Pay

In conclusion:

How did your business measure up to the benchmark levels?

How far above (or below) the Target Real Revenue levels were you?

Let me know in the comments below!

This is normally the moment that people need to check in with their emotional state!

Feelings can range from elated, through ‘breathing sigh of relief’ to disappointed…

If you have beaten the benchmark figures and are feeling elated as a result of your answers – congratulations! – keep doing what you’re doing, but remember to keep a keen eye on those expenses though! Come and celebrate with me – schedule a call here to let me know!

If you are breathing a sigh of relief, then chances are you realise that your positive answer is more by luck than judgement – which is fine at this point (you are where you are, after all), but this is probably not going to sustain as the business grows further without a system in place that intentionally creates an environment for your business to generate the right levels of profit, and one that is capable of paying you your just reward as a business owner…so let’s build on the solid platform you have built – schedule a call with me here so that we can plan out how to sustain and improve upon your current position.

If you are feeling disappointed, then now is the time to take action and plot a new course when it comes to how money is managed and allocated within your business. As hard as it may seem at this point, we definitely need to talk about the situation in which you find yourself right now…take the action step that you need right now and book a call with me here and we can work out a plan to get you to where you want to be.

Hi there, I'm Jason!

As a Certified Profit First Professional Coach, I specialise in driving profit growth in ambitious entrepreneurial and owner managed businesses.

Profit is the commercial non-negotiable. I want to help you to create a more profitable business so that you have the freedom to make the choices that you want to make, to create the impact that you want your business to make - be that within the business, in terms of your own personal life satisfaction (and that of your management team & staff), and socially.

As a profit growth strategist and mentor, I help business owners get clarity over their finances - specifically as it affects their profitability. That means that we focus on getting intentional about improving business profitability with simple strategies.

Together we make sure that the business is baking profit into every sale, that business owners and stakeholders are able to receive a commensurate reward, that money is set aside for taxes (corporate and personal as appropriate) - and we create a buisness model that fits around those three priorities.

Learn more about the great work that we can do together here on the website

Or you can book a call here 

 25+ years of commercial experience are blended into a hybrid mix of business growth coach, consultant and CFO, bring strategic and tactical support to businesses looking to transform their profitability.

I graduated with an Accounting & Finance degree, have been the Bookkeeper, Financial Controller, Financial Director, CFO & Commercial Director, Financial Strategist, Consultant, Coach and Business Mentor. That has covered business turnarounds, corporate SME/SMB growth, and external roles including being a registered business finance growth coach on the UK Government's 'Growth Accelerator' scheme.

What does that all mean for you?

Knowhow. And absolute dedication to the transformation of the profitability of your buisness.

So, make the decision to invest in your profitability and book your call here.

Profit First – Top 10 Mistakes To Avoid When Implementing On Your Own

Profit First – Top 10 Mistakes To Avoid When Implementing On Your Own

So you have read the book “Profit First by Mike Michalowicz” and it all rings true to you as an entrepreneur.

Maybe you completed the Profit First Instant Assessment as you progressed through the book, or maybe you avoided that part, anticipating that your allocation percentages wouldn’t match up to the target levels outlined in Profit First.

What you have realised though, is that the concept behind Profit First is as straightforward as it gets when it comes to managing your money as an entrepreneur or business owner. And you would be right – it is, even for those amongst us who think of themselves as not being ‘numbers people’. The Profit First system is designed for you!

The implementation of the Profit First method is essentially straightforward. However, once you have taken the leap and committed to implementing Profit First into your business, sticking to the Profit First system is the hard part – after all, you have (probably) decided to fundamentally change how you interact with your money – and more than likely, that is going to turn out to be a great decision that you have made.

Profit First – Sticking With It

As a Certified Profit First Professional, part of my job is to make sure you stick with the Profit First system in your business, hold you accountable to your goals of running a more profitable business and paying yourself more – and to help you navigate the unique challenges (and temptations!) that inevitably present themselves – and that is what I’m covering here for you.

In this post, I’m going to help you by giving you a ‘heads up’ on some of the mistakes and common pitfalls that tend to crop up when people are implementing Profit First into their business without the help of a Certified Profit First Professional – if not initially, over the course of time – and then give you some hints and tips about how to avoid making the same mistakes, or falling into the various traps that may appear along the way…

 

Top 10 Profit First Mistakes

Mistake #1 – The Instant Assessment

The Instant Assessment (diagram below) is where the practical journey begins with the Profit First system – it is typically the tangible beginning of the process of feeling like you are taking action (the first real step is actually a mindset based issue – recognising that your business is not as profitable as you want it to be, and that you aren’t paying yourself enough…and you never seem to have that all important tax money set aside in time…).

So what could possibly go wrong with the Instant Assessment?

It all seems straightforward enough, but there are two elements that tend to catch people out:

  • Mis-calculating ‘Real Revenue’ – this is more common with product based or ‘brick and mortar’ style businesses. The mistake normally arises as a result of including employed ‘direct labour’, whereas it should only be third-party sub-contractors that are included within the ‘Materials & Sub-contractors’ section. The ‘Materials element is typically easier to identify, and this tends to cause less of a problem in the calculation.
  • Making sure that it adds up. This mistake is more common than people would ever believe, and tends to arise as a result of forgetting to include the ‘direct labour’ in ‘Operating Expenses’ having removed it from the ‘Materials and Sub-contractors’ section. Another common issue is ‘double counting’ Owner’s Pay within both the ‘Owner’s Pay’ section and then not deducting it from ‘Operating Expenses’.

So make sure to remember that:

  • Top Line Revenue – Materials – Sub-Contractors = Real Revenue
  • Real Revenue = 100%
  • Profit + Owner’s Pay + Tax + Operating Expenses = 100%
  • Test by: Real Revenue – Profit – Owner’s Pay – Tax – Operating Expenses = 0 (zero)

Mistake #2 – Using The Wrong Real Revenue Benchmark

We use the Real Revenue number as the benchmark number that allows us to compare businesses of different sizes and assess the appropriate levels for Profit, Owner’s Pay, Tax and Operating Expenses. Those levels are different for different levels of Real Revenue attributed to a business as it grows, and as a consequence of what ‘Profit’ and ‘Owner’s Pay’ represents (as a business grows, it is typical for a business owner to work more ‘on’ than ‘in’ the business – Owner’s Pay therefore decreases as a business grows proportionately, but this is replaced by an increasing allocation of Profit by way of dividend / distribution).

It is therefore important that we select the correct Real Revenue range when assessing where our business currently stands compared to where we need to get to in terms of matching up to the Target Allocation Percentages.

Make sure therefore that you are using the Real Revenue number when assessing which category your business falls into rather than the Top Line Revenue number (although for many online entrepreneurs and service based businesses, it is quite possible that these two numbers will either be the same, or very close to each other, which is absolutely normal and fine).

Mistake #3 – Too Much Too Soon

An underlying principle of the Profit First system is that you must allocate Profit and not touch it – this means that you need to be sure that your business can handle that. To increase your Profit allocation over successive quarters, we will become more efficient and deliver the same or better results at a lower cost. Using the Profit First method means that we work from the goal backwards.

We start with small percentages to build the profit habit (remember that Profit First is a behavioural system), and then gradually increase the Profit allocation every quarter to move closer to your goal. Start slowly and increase slowly – this will deliberately still force you to look for ways to become more efficient. Adjust the percentages until your reach your Target Allocation Percentages (as defined by the ‘Real Revenue’ range for your business in the diagram above). The power of reverse engineering profit is that you identify the elements that support the profit – you can remove everything that doesn’t.

Mistake #4 – Grow First (and Profit Later)

Too many entrepreneurs believe (incorrectly) that you can only have either Profit or Growth. It is not a trade-off.

The healthiest companies figure out how to consistently be profitable first, and then do everything to grow that.

Implementing the Profit First system in your business will automatically show you the path to efficient growth when you put profit first.

Mistake #5 – Cutting The Wrong Costs

It is often the case when people complete the Profit First Instant Assessment that they discover that a large proportion of their Real Revenue is allocated to Operating Expenses. In order to be able to increase the Profit, Owner’s Pay and Tax elements we will need to inevitably restructure and reduce our Operating Expenses.

If an expense incurred is going to help contribute to the growth of your profit and create significant efficiency, then find ways to cut costs elsewhere and consider different or discounted equipment, services or resources rather than sacrifice efficiency for what you think are savings. Almost all businesses have expenses which do not contribute to the generation of profit – we need to make sure that we cut those out, not the ones that do have a positive effect on profit growth.

Mistake #6 – “Plowing Back” & “Reinvesting”

‘Real Talk’ time – “Plowing Back” and “Reinvesting” are ‘fancy’ terms to justify ‘borrowing’ from our dedicated accounts to cover expenses. Using a credit card to cover what you can’t afford should be a ‘red flag’ that your expenses are too high – we need to deal with the problem and cut the expenses, not use the credit card more.

The Profit First system is designed to help us establish the parameters of how we allocate our money – and helps to show us the path to greater profitability and higher pay for the business owner. Make sure that you remain disciplined and guided to achieve your goal of reaching those Target Allocation Percentages.

If you think that you need to ‘plow back’ profits into the business, you should reassess the situation – inevitably, there is a more sustainable way to maintain the health of your business. Reinvest thought, not money.

Mistake #7 – Raiding The Tax Account

The Profit First method is designed to counter one of the most common entrepreneur and business owner issues – having enough money to pay taxes when they are due. The temptation to ‘borrow’ from the Tax account arises due to the timing differences between when the money is set aside and when you actually need to pay it to your local tax collection agency. The temptation comes with the belief that we will have time to replace the borrowed funds by the time they are required, but that rarely happens…#justsaying

Paying more taxes is an indicator that your business health is improving – as your profit grows, so will your taxes. By all means consult with your tax advisor to mitigate taxes wherever possible (apart from splurging on additional costs for things that you don’t need and won’t improve your profitability in the long run), but don’t ‘borrow’ from your Tax Account – that money does not belong to you, it belongs to your Government and you need to make sure that you have it available when they need it. If you get left with a surplus in this Account at any point, it will be reallocated to your Profit Account, not your OpEx Account!

Mistake #8 – Adding Complexity

The Profit First system is a cash based system (none of that ‘fancy’ / ‘incomprehensible’ accountant talk and terminology).

Cash is cash – you either have it or you don’t. That is why Profit First does not need to be more complex than people think.

The system is easy and is designed to work with your natural behaviours. It doesn’t need to be overthought, or be more complex. It doesn’t need to be outsmarted. It is simple for a reason.

Mistake #9 – Skipping The Bank Accounts

This is one of the most tempting pitfalls, but is central to the Profit First method. Attempting to ‘simplify’ the Profit First system by not setting up the bank accounts is a recipe for failure – using a spreadsheet to emulate the various accounts inevitably ‘falls  over’ at some point, and the immediate reaction tends to be that Profit First ‘didn’t work’, ie the system takes the blame – the problem however is that the system wasn’t used properly in the first place…

Profit First is a behavioural system – the act of actually transferring money from your Income account to an account with a dedicated purpose will focus your mind without a shadow of a doubt – it will teach you to amplify the behaviours and activities that create the greatest benefit to the profitability of your company (ie your Profit account has more real cash allocated to it), and to your own Pay (more real cash will be allocated to your Owner’s Pay account).

Open the Bank Accounts – don’t be tempted to miss out this step or think you can ‘shortcut’ the process at this point. The Profit First system works when you follow the methodology.

Mistake #10 – Going It Alone

Avoid this mistake by working with an accountability partner – the benefits are numerous:

  • Your sticktoitiveness skyrockets because someone else depends on you
  • When you go through a painful process with others, the pain is diminished
  • Enforcing or implementing a plan with someone else ensures you are more likely to do your part
  • When you meet regularly, you get into a rhythm that makes it easier to stay on course and achieve your goal – big aspirational goals get broken down into smaller achievable milestones

The Best Remedy To Counter Mistakes #1 to #10

Profit First and The Importance Of Accountability

 

The Profit First system provides stability and freedom, and importantly, a plan to help you meet your goal(s). The Profit First system is simple, but it requires discipline to implement it consistently – and that’s the most common reason that the people who try and implement Profit First alone fall short – they go it alone. Sad but true – the worst enemy of Profit First is (probably) you.

The Profit First method works, and being held accountable whilst implementing the system will help you to succeed. Working with a Certified Profit First Professional Coach who has been expertly trained to help you drive profitability in your business will make the process easier. And we all like ‘easier’. You want to work with someone who has seen and understands the pitfalls before you discover them for yourself. Working with a Certified Profit First Professional Coach will get you to profit faster and with fewer problems.

Working with a Certified Profit First Professional Coach means:

  • We will make sure that you Initial Profit Assessment is correctly analysed, and that it adds up!
  • We will make sure that your Target Allocation Percentages are appropriate to the Real Revenue range that your business fits within (and that as your business grows that appropriate allocations are applied to your business)
  • We will stop you from taking too much too soon – we help you grow into the changes that may need to be made
  • We will focus on making sure that you have a profitable business model that is primed to grow. Profit will show us the way.
  • We will help you review and assess your cost base and help you to decide on which costs are the right ones to cut
  • We will balance your desire to reinvest and plowback profit into your business – we will reassess the cost base, and we will think harder about a more healthy and sustainable way to achieve the growth that you desire for your business
  • We will stop you from raiding your tax account – we will however help you reallocate any unrequired Tax Account surplus to your Profit Account. With pleasure.
  • We will make sure that we keep the system as simple as possible, but also relevant to your business
  • We will make sure that you don’t try and ‘cheat the system’ – the system works, and we are there to keep you accountable to it. That means following the system, and that means a greater chance of success for you, and that’s what we are all working towards
  • You will not be ‘going it alone’, but you will be held accountable – we want you to achieve your goal(s)

Hi there, I'm Jason!

As a Certified Profit First Professional Coach, I specialise in driving profit growth in ambitious entrepreneurial and owner managed businesses.

Profit is the commercial non-negotiable. I want to help you to create a more profitable business so that you have the freedom to make the choices that you want to make, to create the impact that you want your business to make - be that within the business, in terms of your own personal life satisfaction (and that of your management team & staff), and socially.

As a profit growth strategist and mentor, I help business owners get clarity over their finances - specifically as it affects their profitability. That means that we focus on getting intentional about improving business profitability with simple strategies.

Together we make sure that the business is baking profit into every sale, that business owners and stakeholders are able to receive a commensurate reward, that money is set aside for taxes (corporate and personal as appropriate) - and we create a buisness model that fits around those three priorities.

Learn more about the great work that we can do together here on the website

Or you can book a call here 

 25+ years of commercial experience are blended into a hybrid mix of business growth coach, consultant and CFO, bring strategic and tactical support to businesses looking to transform their profitability.

I graduated with an Accounting & Finance degree, have been the Bookkeeper, Financial Controller, Financial Director, CFO & Commercial Director, Financial Strategist, Consultant, Coach and Business Mentor. That has covered business turnarounds, corporate SME/SMB growth, and external roles including being a registered business finance growth coach on the UK Government's 'Growth Accelerator' scheme.

What does that all mean for you?

Knowhow. And absolute dedication to the transformation of the profitability of your buisness.

So, make the decision to invest in your profitability and book your call here.