(Read Time: 7 mins)
Here’s a simple explanation of what “profit” means (and two ways to increase it.)
Right, we’re covering this one for two reasons.
Firstly, we hate it when clients feel uncomfortable asking us a question they think they should know the answer to. Terms like revenue, profit and bottom line all come with the territory but remember, your brilliant expertise lies in your service or product. Not necessarily in the running of a business.
You’re a business owner, not an accountant, so give yourself a break.
The second issue is loads of people think profit is the cash you’ve got in the bank and…it’s really not that simple. That’s why we’re breaking it down to make it super clear because misunderstanding what profit is can be super risky.
Basically, consider this the friendly guide to business jargon you didn’t know you needed and learn how to boost your profit.
Your profit is the cash made from sales (your revenue) minus the costs your company pays.
After you’ve settled all your direct, overhead and operational costs, and all wages and expenses (including paying yourself), you’re left with your profit.
Direct costs are the expenses you incur when you make your product or deliver your service (or when you buy a wholesale product for resale). Think materials for Etsy products, coffee beans for a café or a ring light for IG content. They’re all absolutely essential to the product or service you’re selling.
Overhead and operational costs are the expenses the business incurs to stay in business, regardless of how you’re actually doing. Think rent for premises, utilities or insurance. Totally necessary but nothing to do with the product or service you’re selling.
Now, how much profit you have left over depends entirely on your profit margin. Your profit margin is the amount your revenue exceeds your costs by.
Let’s say you sell vegan cupcakes at $1 per cupcake (or unit). Today you’ve sold 100 cupcakes (units) meaning your revenue is $100. All of your direct, overhead and operational costs to make those 100 cupcakes comes to $80 (or 80¢ for every $1 spent on the cupcakes). You’ve made $20 profit and your profit margin is 20%.
If you’re wondering what the difference is between profit and profit margin, that’s a good question! It’s simply that the profit is the dollar amount and the profit margin is the percentage. It’s the same data, just presented differently.
Profit margins say a lot about how a business is doing.
When someone asks you about your profit margin, they’re likely asking:
- How efficient you are with your costs
- How sustainable your business is
- How safe their investment is
- How much money you’re making
It’s hugely insightful data. Revenue, on the other hand, despite it being seen as one of the more exciting numbers in business, doesn’t actually reveal how profitable a business is.
You could make $1,000 in sales but if each unit is $1, and you only have a 5% profit margin, you’re only actually generating $50 in profit. That’s a very small buffer should any operational costs change. An increase in rent, a drop in sales, or a change in wholesale price means you would eat through your profit margin quickly resulting in a net loss (or a negative margin).
Ultimately, a profit margin is an indicator of a business’s pricing strategy and how well it controls its costs.
If you want to boost business profit, look at driving up your sales.
The amount of profit you make is entirely dependent on the relationship between revenue generated and costs incurred. Now, if you want to grow that margin you can impact it in two important ways.
First, start by reviewing how you price things. Consider charging more, or less, for the same product or service.
A price increase can result in a surge in profit, but can send some of your customer base away. Equally, charging less could reduce your profit in the short-term but make it more affordable resulting in more sales. Do your research and always check this stuff through with your CPA.
Secondly, you can review wastage and cut your costs. Look at things like your suppliers, employee productivity and absenteeism, and changing business premises. Invest in a killer CPA who’s experienced in your industry too. They’ll ensure you’re only paying the tax you owe while also forecasting your cash flow.
An audit can also offer brilliant insight into ways to save. Your CPA will know what to look for and will identify sources of wastage. They’ll review every transaction in and out of your business and find ways to keep more cash in the business and boost your profit.
For the majority of our clients Revel targets a healthy level of profit for our clients: a 20% margin.
It’s no secret we want all creative businesses to thrive. It’s why we aim to build a 20% profit margin into each of our clients’ financial models. We know that means they’re:
- More likely to sustain changes in circumstances
- Cushioned with a good buffer
- Able to save at a quicker rate
- Able to keep more money in the business to fund future projects and initiatives
If you’re a creative business owner and yearning for that type of support, get in touch with us. Oh, and when you do, ask the “obvious” questions. We love to answer them.