Profitability – Keep Your Eye On The Ball

Let’s get back to the basics.  When you start a business, why do you do it?  Is it because you want something to do with your spare time?  That may be part of what you’re looking for, but if that were the whole story, it would be called a hobby, not a business.  Is it because you want to help people?  That too may be part of the story, but if that were the only motivation, it would be a non-profit organization, not a business.  Is it because you want fame?  That may be some of what you’re looking for, but if that were all you wanted, there would be more direct routes.  Is it because you want to “do what you love”?  Again, that could (and should) be part of the picture, but if that were all you were trying to do, again, we’d just be talking about a hobby, not a business.  I think you’re starting to get the point.  When you start a business, the vast majority of the time, the motivation is (and should be) to make a profit.

I will grant you that there are some great businesses that are started by founders who know that the company will likely never “see a profit” while they are still in control of it. The businesses are started with the main objective being to grow (in revenue terms) to a size where big competitors can no longer ignore them and rather than have to compete against them, just acquire the company, hopefully at a “handsome profit” to the founders and investors.  Granted, this strategy exists and it has worked spectacularly in certain cases.  For most entrepreneurs and most businesses though, this strategy is very risky and makes almost no sense.

Even for those companies that aren’t built to be acquired, there may be a logical reason why they need to go through the early stages of their lifecycle “bleeding red ink,” and only reach profitability several years down the road.  In certain cases, this makes a lot of sense.  There may be a great deal of necessary early investment in building a market presence and reaching a scale where the business generates profit.  This is true in some cases, but even when it is, it is not an excuse to lose money without any sense of when profitability will arrive.

It is important as an entrepreneur that you don’t deceive yourself into thinking, “sure it’s a lousy business now, but we’ll make it up in volume”.  As absurd as that sounds, you’d be shocked how many times I’ve heard and seen variations on that theme during my career.  Don’t fall into that trap.  Understand your break-even point.  Understand your cost structure and whether your gross profit margins at the outset and certainly at some foreseeable point in the future, will be sufficiently high to justify the risk you are taking by starting and running your business.

If you have investors who have any common sense and experience, they will require such analysis and forecasts from you. In fact, they will expect you to going into far greater analysis, at the outset and on a regular basis, the present the result to them. You will provide them with full historical, current, and pro-forma financial statements and analysis, at least quarterly, but most likely more frequently. Figures and calculations of interest based on the Income Statement will include:

• Revenues and expenses (high level look at movement in total revenue and expenses)
• Cost of goods sold (COGS)
• Operating expenses
• Net Income (aka Net Profit or “the bottom line”)
• Profitability ratios including profit margin ratios and return on equity

Even if you don’t have investors, do yourself a favor and be very realistic about the business you’re in or you’re thinking about entering.  Don’t rationalize. Make sure you keep your eye on the profitability of your current or prospective venture. The profitability of a company and its ultimate viability or failure is predicated on many factors that can and will change over time.  Make sure your assumptions about costs and revenues are realistic and don’t deceive yourself into thinking that if the business model is lousy in the beginning that it will somehow magically get better with time.  Typically, it won’t.

Time is precious.  Make sure you are spending it on business opportunities and potential deals that have a realistic chance for a level of success that justifies the risk involved.  Remember that, in the end, if a business is not profitable, unless you’re working some financial alchemy, there’s no way it can provide you with the economic benefits that justify the risks you are taking and the time you are investing.  Make sure the fundamentals of the business look good from the beginning, or that you can at least reasonably project a point on the horizon where it all “comes together”.  If not, you are likely to dump a bunch of money and time, among other resources, into a venture that had no chance from the get-go.

Image by Alexsander-777 from Pixabay