How Much Profit Should My Business Make?
There are three strategies frequently discussed with business owners: growth, tax minimization, and selling.
Profit. It’s obviously important for every business owner and is a necessary goal in order to start, build, and grow a business. But every business makes a different profit depending on size, location, industry, customers, and other factors. So how much profit should your business make? When the holidays are over, and you begin a New Year- it’s important to reflect on your business strategies and consider your company’s profit. Below we will discuss the topic further and go over how much profit your business should be making in order to be successful in 2020 and beyond.
How much profit should my business make?
There is not a straightforward answer to this question. Viking has access to several databases used in our business valuation models that have average profit by industry and by revenue size. These databases also have gross profit, payroll expenses, rent, and other metrics. Viking can provide these statistics as part of a comprehensive business valuation we will perform of your company at no cost or obligation.
However, the best answer to this question is defined by your strategy and your objectives. There are three strategies I frequently discuss with business owners: growth, tax minimization, and selling.
- Growth – If your strategy is growth, you may not achieve the average net profit numbers for your industry because you are investing in the growth of your business. Examples are hiring new salespeople, increased marketing and advertising, introducing new products or services or new business lines.
- Minimize income taxes – If your strategy is to reduce income taxes you should be taking advantage of the tax code to reduce taxable income such as expensing capital purchases, electing accelerated depreciation, expensing research and development and software development, or consider electing the cash basis of accounting for tax purposes if you qualify.
- Selling the business – If your strategy is to sell the business in the near term, your business should show some growth and maximize cash flow and EBITDA (earnings before interest, taxes, depreciation, and amortization). Companies that show growth and generate higher cash flow achieve greater valuations and generally sell faster.
Whatever your strategy or objective, it is important that you regularly measure and report the actual results against your objectives to evaluate the success of your decisions and the investments you make. Taking this approach will show how successful you and your management team are at managing the company and making and executing investment decisions that contribute to the growth, profitability, cash flow and ultimately increase the value of your company.
A different way to approach the annual budget
Most companies begin the annual budget process by starting with last year’s actual revenue and expenses and make changes to reflect expectations for the next year. The result of this process, budgeted revenue minus budgeted expenses is the profit. As a general rule, everyone knows a company that does not make a profit is not a good investment for the owners, nor is it a good place to work for the employees. There are exceptions to this rule for startup companies and high revenue growth technology companies that have access to capital but for a small or medium-size company where access to capital is limited a company should make a profit. But how much should that profit be? As discussed above that depends on your strategy and objectives.
Some companies approach the annual budget differently. After the budgeted revenue number is determined they decide how much profit they want to make. In other words, revenue minus profits equal expenses. So, the objective of the method is to concentrate on the amount of profit to be achieved. Once this is determined you can decide on how to allocate the profit. Do you want to invest in growth, new equipment, paying off debt or retain the funds for the future? This approach will force you and your management team to be more creative by looking at all the expenses to determine if they are truly necessary to meet your customers’ requirements and create value for the company. Another name for this approach is zero-based budgeting This method forces everyone involved with the budget process to start at zero and justify every expense. This is a much more rigorous process and takes more time but it is generally worth the effort. In my view, the objective should be to set a profit objective rather than an expense objective.
Below I have listed some things to consider in your annual budgeting cycle to achieve higher profits.
Customers and products
- Customers – Get a report of gross margin by customer and raise prices or drop accounts that do not meet the company’s profit objectives.
- Products and services – Drop unprofitable products or services that are not strategic to the company’s long-term objectives.
- New product lines – Add new products or services that are more profitable.
- Pricing – Get information on competitors’ prices and increase prices if possible.
- Innovation and technology – Is there a new process, technology or new equipment that can do a task currently being done manually more efficiently? If so, what does the investment cost and what is the payback?
Examples of expenses reductions
- Compensation – Reduce annual compensation increase and adopt a bonus plan based on company performance.
- Materials – Work with your vendors to reduce costs.
- Freight – Get quotes from other freight companies
- Energy – Hire an energy consultant to review your operations and how electricity and natural gas costs can be reduced.
- Insurance – Obtain general insurance proposals from two or three companies at least every three years.
- Health care insurance – This is a fast-growing expense for most companies, and this should be reviewed annually. Use a consultant because this can be complicated and time-consuming and start the process early.
- Consider outsourcing
- Administrative positions that are expensive and hard to find replacements like HR and IT.
- Accounting and financial reporting
- Accounts payable
- Credit card fees – Obtain proposals from other credit card companies if you accept a lot of payments by credit cards, this could result in a significant saving.
If you’re interested in learning more about the services Viking can provide, or if you are interested in getting a free valuation of your business, please feel free to contact me. At Viking, we are dedicated to securing entrepreneurs’ futures through professional representation.