5 Reasons Why Knowing Your Profit Is Crucial for Your Company's Success
Profit is the most straightforward metric that will bring financial transparency to your business and allow you to uncover long-hidden underperformance.
Do you know how much profit your company made last month? If you do not know the amount or are unsure, read on.
Many entrepreneurs see their company's profit only once a year when their accountant prepares their taxes for the IRS (Internal Revenue Service). Every year, like a big reveal at an annual ritual, they go through their tax return with their accountant and are often surprised at how much or how little they have earned. If their company's profit was surprisingly low, there is not much they can do about it now. Any course correction should have been implemented a year ago.
Why Basing Decisions Solely on the Amount of Cash in Your Checking Account Can Be Fatal
When small businesses make decisions, they usually base them on the amount of cash in their business checking account. If their available cash has grown since the last time they looked, they assume that the company has made a profit and everything is fine. It's like flying an airplane without instruments just by looking out the cockpit window. It works until it doesn't. Many don't realize the seriousness of the situation until their cash is down to the point where paying bills, credit cards, and staff or repaying debt becomes impossible.
Businesses that track their monthly profit are in a different position. They fully understand the reasons why their cash has increased or decreased compared to the last month and have enough time to react to any issues. It is like flying an airplane, but this time you are aware of your exact altitude, speed, position, and how much fuel is left.
Why You Should Know Your Company's Monthly Profit
There are many good reasons why you should invest some time, money, and effort in gathering the necessary data to calculate your company's monthly profit. Here are five worth considering.
Only profitable companies are sustainable. If you want to be in business for a long time, your company has to earn more than it spends, thus turning a profit. A profit allows you to self-fund your operations, not relying on outside funding sources, such as loans from banks, credit cards, or equity contributions from investors and friends, to prop up your venture and keep it alive. Profit is the most straightforward metric to gauge whether your company provides the necessary cash to fund all aspects of its operation.
Sole proprietors can use the profit metric to determine how much cash they can safely withdraw to pay themselves. Solopreneurs often face the dilemma that their business is seasonal. The holiday season, for example, might be the strongest month of the year, while August might be the weakest. If you were to pay yourself at the level of your strongest month, you would quickly run out of cash. Conversely, if you were to pay yourself at the level of your weakest month, you would probably not have enough money to provide for your family. You could solve your seasonally fluctuating payouts by looking at your past monthly profits and calculating an amount that is neither too high nor too low and stays constant month to month. That way, your family can better plan their expenses, knowing that the same amount of money will come in next month and the month after.
Profit is an excellent metric to set goals. It is in the nature of entrepreneurship to innovate and expand the business. But how would you know if your great new idea will live up to your expectations and turn a profit? Without tracking your company's monthly profit, you would not, at least not factually. However, if you knew your past profits, you could take that as a baseline. You could attribute any profits above that baseline to the impact of your great new idea.
Financial transparency will show your problem areas. Charles Kettering famously said, "A problem well stated is half solved." Knowing what your company's issues are, requires a substantial amount of transparency. Profit is a great metric for creating such financial transparency in your company because of its two components: receipts (revenues) and expenses. If you analyze the reasons for the monthly changes in your receipts (revenues) and expenses, you will understand the change in your profit.
Your decisions will be more factual. Once you start analyzing your profit and loss statement every month and using it to justify important decisions, you probably won't look back to when you didn't have one. After you have learned how to read it, it will forever change how you run your company. You will become a better, more conscious decision-maker because you will want to understand the impact on your financials first before you move forward with a new idea, a project, or a new business opportunity. You can weed out all those ideas with lower profit potential and, instead, promote the one idea that looks the most promising.
► Focus! The Secret of Successful Companies
There Is No Place to Hide
I am a fan of financial transparency. It creates irrefutable facts that provide a basis for many discussions, internally with your employees and externally with third parties, such as vendors and banks.
Instead of guessing, your company's financials will often lead you to the correct answers.
When you expand tracking your financial metrics to all areas of your company, you will see that one issue may not be as isolated as you might think but may affect different departments.
This interconnectedness often is a blessing in disguise as it can uncover long-hidden underperformance. There is no place to hide.
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