What will topple your business? It’s probably not what you think. In fact, putting profit last is what sinks most business owners.
They spend all of the money they've earned, and they have little or nothing left over for profit. Too many business owners are running their enterprises with hardly any savings. And it can ruin a company.
"In a situation like COVID, revenue drops off sharply, but expenses don't drop at the same rate," he says. "So for quite a while, people will continue to spend and spend and spend at the rates that they've always been spending at. That's what causes them to topple."
On the latest episode of the CFO Weekly podcast, Andrew Royer, a CPA, a certified general accountant, and a bookkeeper, discusses why we should be putting profit first.
Accounting vs Bookkeeping: What's the Difference?
Accountants ask: What ideas can help you save money in the future? Bookkeepers ask: How can I implement those ideas on a day-to-day basis?
Of course, there's overlap between the two. But primarily the accountant looks at your books once a year, sees what you did over the previous 12 months, and makes recommendations for the future. Bookkeepers bring those recommendations to life day in and day out throughout the year.
It takes both accounting and bookkeeping to derive profit for a business. You need that day-to-day, month-to-month data entry because your books need to be solid and reliable. That's important. Super important.
But so is being able to offer advice. When you're working with your clients, it's good to ask those big questions:
What are your goals?
How do you provide value to your clients or customers?
Do you understand these numbers we're providing you? (Pro Tip: Most business owners don't because they care more about running their business than figuring out your spreadsheet. So don't fight them. Engage them. Help them. Educate them.)
That is actually a great profit strategy.
What Is Profit? Why Is It Important?
In business school, we all learned that sales minus expenses equals your profit. True enough. But Parkinson's Law also states that work (or demand) expands to meet the time (or supply) available.
Consider the toothpaste example. Lots of toothpaste, lots of waste. Little toothpaste, lots of saving. So profit depends on the attitude around the supply that's available.
When we don't have any profit left over because we're spending it all, we try to fix the problem with revenue. That's a trap. As revenue starts to grow, so do expenses. Consequently, the profit numbers never move.
Ramping up revenue won't fix your profit problem.
“In an ideal world, we would want all business owners to be able to read their financial statement on a regular basis, understand it, follow a budget, and follow a cash plan. But in reality, most business owners are busy doing what they do best, which is running their business.” Andrew Royer
How to Use Profit-first to Survive a Crisis Like COVID
If we were to take an example of an external challenge — let's say COVID-19 — as an example, how can these external events topple companies that are more focused on revenue than profit?
Companies focused on revenue only survive as their revenue grows. But the problem is that as revenue grows, expenses increase in direct proportion or close to it. Then a situation such as COVID happens. Revenues drop or disappear altogether. But expenses don't fall at the same rate.
So business owners keep spending like they always have but without the revenue to offset those expenses. They can't sustain that kind of income/expense ratio. They don't have money set aside. (They were barely making payroll and paying rent anyway.) And they're just unable to cope. So they shutter their company and go work for someone else.
How Focusing on Profit-first Can Save the Business
Does a business owner just decide what percentage of a dollar's worth of sales they are going to sock away for a rainy day?
It depends on the revenue level the company is at. As the company grows, you need less and less of an owner's draw, and you can start to put away more and more of your income. With growth, you take less of an owner's cut and start increasing operating expenses.
There are guidelines set out in the book Profit First. Just to give you an example of one: up to the first $250,000, 5% is profit, 30% is for expenses, and 50% is an owner's draw. For most businesses, getting down to that 30% is tough.
Since we can't reproduce the whole book on the blog, we suggest buying a copy for yourself. You can also get help from a profit-first professional firm such as Andrew's company.
“People will continue to spend and spend and spend at the rates that they've always been spending at. And that's what causes them to topple.” Andrew Royer
How to Put Profit First in Your Business
Set up a savings account. Even if you can only put in 1% of the revenue you earn right now, that's more money than most businesses are saving.
If you can run the business on 100%, you can definitely run it on 99%. At the end of the quarter, just seeing even a small amount of money sitting in that savings account, will make you feel a lot better about operating your business into the future.
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