Today we’re continuing our series on key metrics that all businesses must monitor. Today’s topic is profitability. Sounds simple enough. Profit is essentially what you have left over after your revenues and you take away your expenses. That can be a positive or a negative number. It should be positive. Let’s not get caught up in modern day rhetoric where profits are bad or evil and are only for greedy people. Even not-for-profit organizations must generate a surplus in order to stay a sustainable viable organization.
Profitability, though, is very different from cash flow. Many small businesses get this confused, and they look at their bank balance to determine whether or not they’re profitable. That is a classic error. In fact, cash flow is probably more important than profitability, in the short run. Most businesses actually go out of business from lack of capitalization that they need in order to sustain the cash flow required by aggressive growth. The older organizations, over a longer term, will go out of business for not making profits, and it takes a long time. But cash flow will kill you in the short run. Profitability is your long-term goal.
Why do we need profits? We need profits to replenish our working capital, to put money back into our business cycle, so we have money for materials and payroll. Profits are necessary to recover the cost of equipment that we’ve purchased in order to to generate our product, whether it’s a laptop computer or if it’s a multi-million dollar printing press. We need to have profits so that when it comes time to replace that equipment, we have the resources to be able to do that–that’s why profits are necessary.
You cannot be a “break even” organization in the long run and be sustainable. If you’re just breaking even, then you’re just taking in money and spending it. Therefore, there’s nothing set up for the future, because assets do not last forever. People do not continue to work without salary increases or other benefits, and all costs increase over time. You must be making a profit in order to be sustainable.
If you’d like to discuss this concept further, please let us know. Harvard Grace is happy to help!