By Ed Emerson
Understanding profit is one of the most important lessons anyone can learn when starting or running a business. And the best way I’ve ever heard profit described is: “What’s left.”
Unfortunately, most people really don’t understand that concept, even folks who’ve been in business for a lot of years.
So what does that mean?
First of all, profit is not the salary you pay yourself, nor is it the difference between the costs of the product you’re selling and the price being charged for it.
There’s a whole lot of other stuff in there to consider. Those additional things are called fixed costs (what you have to pay regularly, regardless) like the rent and the phone bill, the electricity and salaries, insurance and distribution.
And did you advertise or buy in supplies? Those things are called variable costs. They fluctuate with the business.
It’s only when you add fixed and variable costs together that you get the other key number called your “overheads”.
Now we have something to talk about.
Profit = Overheads and the costs of the product (or service) you’re selling, less your income from sales.
Oh, and there’s just more more thing; your tax. The tax you pay is based on a percentage of your income less your expenses.
After tax, your profit is “What’s left”.
And while the accounting can get more complex as the business grows, the reality of what profit is does not.
So let’s try that out in simplest terms:
Your business sells cupcakes.
It costs you 10p to make a cupcake…or rather, it costs you £10 for all the ingredients to make 100 cupcakes, meaning the cost to make a single unit is 10p.
Most folks stop there and say: “If I can sell a cupcake for 50p per unit, I’m making 40p per unit in profit and operating at 80% profitability: costs of goods less sales.
“Business is all about solving people’s problems – at a profit.”
― Paul Marsden
For instance, you need to buy a whisk to mix the batter and a bowl to put the batter in, and an oven to cook the batter and cupcake holders to put them in.
Then you need a place to make the cupcakes and a glass shelf to sell them from, along with light so the customers can see the cupcakes and tables for patrons to sit round.
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Then there’s the van that delivers your products to a party your client has booked and the petrol it uses to get there. And then there’s your assistant’s salary who washes the pans and bowls, and a brush and mop for her to clean the floors.
Oh, and then you have to pay yourself…
Your profit before overheads
So by the end of the month you check your figures and reckon you’ve sold about 5,000 cupcakes and made £2,500.
You then subtract your costs for the ingredients, which were £500, and now you’re left with £2,000.
Time to go to Vegas, right?
Your fixed costs were £1,740.00
Salaries £300 (assistant) £600 (you)
Distribution £150 (van lease)
Your variable costs were £300
Cupcake holders £20
Miscellaneous (mops & brushes, soap and repair bills) £190
This means your income of £2,500.00 less your “overheads” of £2,040.00 left you with a profit (before tax) of £460.00.
You pay your stamp and corporation tax (you don’t need to worry about VAT as yet because you’re not making any where near the £70,000 plus income threshold) and you’re left with about £350.00.
That’s your profit.
But you want to make more, don’t you?
Always understand the basics first.
Our next lesson is about the four ways to grow your business, which will work in any business.
Now before you go…
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