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Business Profit

Reference Book

  • Profit First, Mike Michalowicz
  • Let’s Talk Money, Monika Halan

Youtube Videos

1.0 What is Business

A human definition – Business is a Miracle. An individual creates a business out of thin air with nothing but a great idea, unique talent, and whatever few resources one has to start with. 

  1. A business takes a customer problem that is hard to solve and provides a unique solution. 
  2. The customer is willing to pay a perceived value (figured out experimentally).
  3. Then, you find a large number of customers facing the same problem, and your business rolls.

A robot’s definition – Business is an economic machine. This works with cash as input and cash as output. Positive cash comes as output only if your machine’s product or service matches anticipated customer satisfaction.

Before further reading, let’s decide from which angle we want to proceed with our businesses.

2.0 What is Profit?

Profit is the money a business makes (different from the money a business keeps). 

Business profit is used for the following reasons:

  1. A metric to assess business health – Accounting or Robotic Profit
  2. Financially reward the owners – Human Profit
  3. Investment for future growth – Human Profit
  4. Save cash for future rainy days – Human Profit

However, profit generally differs from the money you make as a business owner. The owner might often get surprised by seeing the ‘accounting’ profit on paper but still with no cash at the owner’s disposal.

2.1 What is Accounting Profit?

This is very straightforward.

Profit equals Total Revenue – Total Expenses.

Let’s break it down even further:

  1. Total Revenue (Cash in) – This comes from doing your business,
    • By selling manufactured products
    • Re-selling purchased products.
  2. Total Expenses – This is direct (doing the business) and indirect (running the business)
    • Direct
      • Cost of Goods sold (COGS) – This increases in direct proportion to the sales. 
      • Materials, Packaging, Labour (without which making or selling the product is not possible)
    • Indirect or Operating Expenses (OpEX)
      • Staff cost
      • Rent
      • Administrative expenses
      • Selling and Promotional expenses
      • Professional fees
      • Utility expenses
        • Electricity
        • Telephone
        • Internet
        • Water
  3. Now, some profit categories
    • Gross Profit (GP) = [Total Revenue – COGS]
    • Operational Profit (OP) = [GP – OpEX]
    • Net Profit (NP) = [OP – Taxes – Depreciation]

2.2 What is Human Profit?

This is the kind of profit an owner is interested in. The one which they can use to make important decisions & buys you freedom.The main difference between Accouting Profit and Human Profit is that former is an event while the latter is a habit.

Maximizing Accounting profit means ‘More Sales’ and a hope that it will trickle down to ‘More Profit’. Business owners can tell that this is seldom true. Cyclically, the owner sells more > gets more short term cash > spends that short term cash > panics > sells more and the cycle goes on and on. This is known as the Survival Trap. Majority of small or big businesses are in this trap. 

Ironically, the owner started their business for financial freedom. But the accounting profit method keeps them in a financial blackhole. Out of which, only the lucky ones survive. This fallacy is explained with a simple logic.

  • The COGS increases proportionately with sales. As the owner tries to frantically increase the revenue, the direct costs to sell also increase.
  • With more revenue at hand, the indirect cost of sustaining higher sales i.e. more staff, equipment and software increases
  • Sales are cyclical. Every business going with above approach is one bad season away from frantically adding more variety and more product offerings (in the name of growth, obviously).

You take on toxic clients

You take on unfit projects

Run last minute promotions

Change terms last minute

Make haphazard collection calls, breaking client’s trust

Do the work yourselves

This does 2 damages

  1. It gives you momentary ‘high cash’
  2. It takes you further away from your vision of starting the business altogether.

      No matter how much income we make, we will always find a justified way to spend it. An accounting profit will robotically indicate you to a good season. But this perpetually comes at a cost of burnt out, frustrated robotic owners who have come far away from the Miracle of the business they envisioned.

      Human entrepreneurs making human profit are like heart surgeons. 

      1. They excel uniquely at repeatedly doing heart surgeries. 
      2. They do one thing really really well. 
      3. They attract the best customers in this process. 
      4. They learn to deliver it efficiently and perfecty
      5. hey get world renowned in that thing. 
      6. Subsequently, they dictate their premium.
      7. They take home the profit, Cold Hard Cash for freedom, celebration and food.

      3.0 How does Human Profit happen?

      Believe in the old saying: Revenue is vanity > Profit is Sanity > Cash is king. For this to happen, start with a new accounting formula:

      Sales – Profit = Expenses

      Yes, this is Profit First. Simply, take out the profit first. If one is amused by the simplicity, then there is more to believe in it because simple things have better chances of working. 

      Setting up the ‘Profit First’ for your business

      3.1 Use smaller plates

      When money comes into your main income account, periodically disperse it into 4 sub accounts in pre-determined percentages. Your income account should serve as a serving tray for all the other accounts.

      • INCOME
      • PROFIT
        • Plowing the profit back into the business is just another way of saying that I am not able to run my current operations with allocated OPEX budget. It is just another expense and not heroics.
      • ONWER’S COMP – This is the owner’s compensation. This is the freedom. This is what you work for.
      • TAX – Setup TAX HOLD to make it difficult to ‘steal’ from government
      • OPEX

      3.2 Serve Seuqentially

      Always allocate the money based upon the percentages to the accounts first. Never ever pay bills first. Pay the bills only from the money transferred to OPEX account. Not enough money in the OPEX account will tell you that the business is not able to afford such expenses.

      3.3 Remove Temptations

      Make it really hard to take out money from the PROFIT and TAXES. Use an accountability mechanism to check those transactions.

      3.4 Enforce a Rhythm

      Do your allocations and payables twice a month.

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      Her language contains elements from Aeolic vernacular and poetic tradition, with traces of epic vocabulary familiar to readers of Homer. She has the ability to judge critically her own ecstasies and grief, and her emotions lose nothing of their force by being recollected in tranquillity.

      Marble statue of Sappho on side profile.

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