How Do Small Businesses Make Money
Top Ten Questions Small Business Owners Ask
#8 How Do Small Business Owners Make Money
This would seem like an obvious question for ever small business owner, but many of them do not really understand how they make money (a profit) in their own company. To many of them, they just do one day.
When asked what was your profit last month or last year, they have a difficult time with the answer. They explain that they are too busy operating the business instead of working on how to make it more profitable. Without the correct metrics, you won’t be as financially successful as you could be in your company.
Where is your leverage point in making a profit? Every company has a basic profit model. It is typically based on one of the following broad models:
- Buy a product, distribute it for a higher price than you bought it for (example: luggage)
- Manufacture a product, sell it for more than it cost to produce it (example: picture frames)
- Sell a service (usually by the hour) and pay the person that performs that service less than you charge the customer (example: A bookkeeper)
- Develop a product once, and resell or license a copy of it repeatedly to many customers at little of no added cost (example: Video games)
Build a gross margin. Once you understand which model your business fits, then the goal is to make as large a gross profit as possible on each sale. It is a lot easier to make a net profit with a gross margin of 80% than it is with one that has only a 30% (there is a lot more room for overhead). Every additional dollar of gross margin will add to your net profit.
Fixed or variable costs. Fixed costs are ones that do not change based on sales units . Variable costs are directly tied to the number of units sold. As sales go up and down, it is more beneficial to your company to get as many costs variably tied to those sales. In this way, net profits will not shrink when sales go down.
Economies of scale. You must know where fixed costs do not go up when sales do. In this way, you have more sales to cover these fixed expenses. Identify which costs are affected by these economies and which are not.
Jealously guard your profit. Pay yourself first. Watch that expenses don’t go up faster than revenue. When sales go up, the first inclination is to add expensive people. Instead, invest in processes and tools that enable your team to work better and faster. Resist the “staff bloat”.
Remember that net profit is not the same as cash flow. Cash is what you have in the bank at the end of the month and this is typically different than the net profit. Make sure customers pay on time and that cash is not eaten up by an overstock in inventory or paying your bills too quickly.
Review the profit and loss statement, balance sheet and cash flow statementsthat will give you the information that identifies the key metrics you need to know to grow a profitable business.
Want to read the other top 9 questions small business owners ask?
