What it Really Means to Run a Profitable Business

For those of us who have nodded through an Accounting 101 course, if nothing else we learned that sales minus expense equals profit (or loss). While this is a good way to understand the basics of financial reporting for a business, it merely scratches the surface of what it really means to be profitable. An owner of a truly profitable business has at least one dollar left over after business expenses, personal living expenses, taxes, savings, health insurance, retirement, and perhaps an investment account.

The first step to sound financial management for your business is to determine the end game. Have you started a side business, in addition to regular employment, just to make ends meet? In this case, you have no intention of running a business for the long term. Have you created a lifestyle business, whereby you sell as much as you can as an individual but have no plans to hire employees? If so, you are a solopreneur and when you are done operating the business, it will no longer exist. Or, is your intention to turn this side hustle into a formal company with employees and, perhaps, ultimately multiple locations or a national or global market? There’s no wrong answer; however, you will understand best what it means to be profitable when considering the third scenario.

The first clue that a business is functioning is its ability to cover all the expenses needed to operate sufficiently (including the cost to make or purchase products to sell, rent, supplies, equipment, labor, loan payments, insurances and taxes). If the business doesn’t yet have enough sales to cover expenses, it’s likely the owner is still investing in the business with other resources. Based on the accounting formula, if revenue from the business exceeds all necessary expenses it will result in profit. If you are fortunate enough that your net result is positive, you would think that the time has come to rest easy. Profit! Right? Not so fast. Here's the reality: even businesses that manage to breakeven or turn a profit still aren’t paying the owners a reasonable salary, if at all.

Which brings us to the next measurement of business profitability. While you may feel a level of satisfaction for having generated positive cash flow, have you paid yourself? Ideally, you will receive compensation from the business that is equal to what you would be paid in the same position at an established company. Research what a competitive salary is for the role you are playing in your business. The position may be CEO (or Principal, Director, Manager, etc.) It may take a few years before working your way up to an ideal salary. In the meantime, you must achieve at least an adequate salary that covers basic living expenses. Create a comprehensive personal budget to calculate what it costs to maintain a modest lifestyle. This is your starting salary number. You don't need to leave out money for gifts, occasional travel, movies, dining out, etc., but you do need to be reasonable. Some of these things may need to wait until you can afford to pay yourself a higher salary. You are overworked and underpaid. I bet you never imagined being your worst boss.

Presumably, you paid any tax obligations for the business under business expenses. Depending on what US state you're in and how you formed the business, there may be annual filing fees, minimum franchise fees, federal and state income tax and some others. There’s a chance, however, that your company is what’s considered a “pass-through” entity and your tax obligation is paid on a personal level. If this is the case, you will need to be diligent with setting aside money to remit tax on the net income the business is generating. There’s an obligation to pay business tax on a quarterly basis or annual basis based on how much you expect to owe. It’s not uncommon for so-called thriving businesses, or business owners, to be burdened by unmet tax debt. Take a moment to realize that there is a cost to doing business, one of which is tax. If you keep excellent financial records, you shouldn’t pay a penny more than your share, but you will pay something.

Part of the compensation as an owner/employee of your company should include health insurance. This becomes even more important once you hire employees, particularly if you want to hold on to them. Even if you are the only person working for the company, you should have a health insurance policy. It is a valid tax deduction. You should have insurance, not because you are a business owner, but because you are human. Health issues can arise unexpectedly; address these immediately and use insurance to avoid paying medical expenses directly out of pocket.

Here’s where savings also come into play. One of the main reasons for the high failure rate of businesses is undercapitalization. In other words, there’s not enough to meet every financial obligation. When emergencies happen, the bottom falls out. Beginning capital for any business should include start-up expenses (formation, supplies, equipment, etc.) and a 3 - 6 multiple of operating expenses (rent, utilities, labor, etc.), plus reserve (contingency savings). When planning for your business, factor in all three - startup, operating, and reserve, then open your doors (hang your shingle, go live, however opening is represented for you.) As the business progresses, continue to move a portion of the income, even as little as 1% of gross revenue, into a savings account. What’s important is to develop a natural habit to save.

Many business owners forget to consider retirement. Remember, you are human, and you will age, hopefully gracefully. You are the owner of the business, which means it’s your responsibility to pay self-employment tax (which is social security and Medicare), in addition to making contributions to a separate pension account if you plan to be able to take care of yourself once you've retired. (It pays to take good care of your grands too.) If you are spending every penny of income from your business, but aren't tucking away anything for retirement, you are almost there, but not quite profitable yet.

Finally, if you really want to be a profitable business owner, start investing in the stock market to help build wealth. It is a known fact that the path to wealth, outside of inheritance, is real estate, business ownership, and equity investments.

Notice the word success was never used in place of profitable. A successful business is defined differently than profitability. Success is subjective and should be fluid. Once you meet a milestone, you are indeed successful. Another milestone, another level of success. While you're building your successful business, however, keep in mind what it truly means to be profitable and you'll get there!