Sep 092011
 

profitability

Profitability – Keep Your Eye On The Ball

Is profitability what business is all about?  Going through all the various waves and cycles of rational and irrational exuberance, you begin to wonder.

Let’s get back to the basics.  When you start a business, why do you do it?  Is it because you want something to do with your spare time?  That may be part of what you’re looking for, but if that were the whole story, it would be called a hobby, not a business.  Is it because you want to help people?  That too may be part of the story, but if that were the only motivation, it would be a non-profit organization, not a business.  Is it because you want fame?  That may be some of what you’re looking for, but if that were all you wanted, there’d be more direct routes.  Is it because you want to “do what you love”?  Again, that could (and should) be part of the picture, but if it were all you were trying to do, again, we’d just be talking about a hobby, not a business.  I think you’re starting to get the point.  When you start a business, the vast majority of the time, the motivation is (and should be) to make a profit.

I will grant you that there are some great businesses that are started by founders who know that the company will likely never “see a profit” while they are still in control of it. The businesses are started with the main objective being to grow (in revenue terms) to a size where big competitors can no longer ignore them and rather than have to compete against them, just acquire the company, hopefully at a “handsome profit” to the founders and investors.  Granted, this strategy exists and it has worked spectacularly in certain cases.  For most entrepreneurs and most businesses though, this strategy is very risky and makes almost no sense.

Even for those companies that aren’t built to be acquired, there may be a logical reason why they need to go through the early stages of their lifecycle “bleeding red ink,” and only reach profitability several years down the road.  In certain cases, this makes a lot of sense.  There may be a great deal of necessary early investment in building a market presence and reaching a scale where profitability is possible.  This is true in some cases, but even when it is, it is not an excuse to lose money without any sense of when profitability will arrive.

It is important as an entrepreneur that you don’t deceive yourself into thinking, “sure it’s a lousy business now, but we’ll make it up in volume”.  As absurd as that sounds, you’d be shocked how many times I’ve heard and seen variations on that theme during my career.  Don’t fall into that trap.  Understand your break-even point.  Understand your cost structure and whether your gross margins at the outset and certainly at some foreseeable point in the future, will be sufficiently high to justify the risk you are taking by starting and running your business.  If you have investors who have any common sense and experience, they will require such analysis and forecasts from you.  If you don’t have investors, do yourself a favor and be very realistic about the business you’re in or you’re thinking about entering.  Don’t rationalize.  Make sure your assumptions about costs and revenues are realistic and don’t deceive yourself into thinking that if the business model is lousy in the beginning that it will somehow magically get better with time.  Typically, it won’t.

Time is precious.  Make sure you are spending it on business opportunities and potential deals that have a realistic chance for a level of success that justifies the risk involved.  Remember that, in the end, if a business is not profitable, unless you’re working some financial alchemy, there’s no way it can provide you with the economic benefits that justify the risks you are taking and the time you are investing.  Make sure the fundamentals of the business look good from the beginning, or that you can at least reasonably project a point on the horizon where it all “comes together”.  If not, you are likely to dump a bunch of money and time, among other resources, into a venture that had no chance from the get-go.

I look forward to your thoughts and questions.  Please leave a comment (“response”) below or in the upper right corner of this post.

Paul Morin

paul@companyfounder.com

www.companyfounder.com

 

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  8 Responses to “Profitability – Keep Your Eye On The Ball”

  1. Hi Paul,
    Yes, it’s so true. I see a general lack of understanding about profitability in business, too. I love what you said about the type of entrepreneur that grows their business in the hopes of making a profit during the sale of a company. That IS risky and is not for the faint of heart. It’s right up there with big stakes gambling.
    Sherrie
    Sherrie Koretke recently posted..What Makes a Person Charismatic?My Profile

  2. Agreed, Sherrie. Entrepreneurship can be challenging enough. When one starts with an unprofitable business model in hopes that is will “somehow” get better or another company will come along and acquire the business, one really is fighting an uphill battle.

  3. Paul, don’t you think the first objective of a new entrepreneur is to evaluate the potential revenues first ?

    Lets take the example of a new massage therapist in town, He needs to know WHO is his target first : women? men? profiles? number of people living in the area with these profiles. WHAT he can offer that other salons or therapists don’t, HOW MUCH people are willing to pay? if it is a one-to-one service how many hours can he possibly work to generate a revenue that first cover the costs, WHEN is he going to reach that break even point?

    What would be your avises to that guy to gather all the information above and how to calculate the potential profits he can make before even starting his business?
    Anne Egros recently posted..Resilience During Disasters: Are Expats Better Prepared ?My Profile

  4. Hi Anne,

    Yes, revenues are absolutely an important part of the equation … after all, you can’t calculate (or forecast) profits or even break-even without some assumptions about the price charged and the quantity sold.

    Your point about market research is also well-taken. It’s also difficult to make reasonable assumptions about price and quantity sold without first having done some primary and secondary market research. Otherwise, you’ll be pulling numbers out of the sky and as you know, that’s a very dangerous game.

    I lay all of this out in a fairly step-by-step fashion in the following article, which is linked to other articles that go into more details on keys steps: How To Start A Business.

    Specifically to your question on break-even analysis, the following article covers that in detail: How To Do A Simple Break-even Analysis.

    Thanks for your questions, Anne. If there are any that I did not answer fully, let me know.

    Paul

  5. Your insight and advice on this topic Paul is one to take notice. I think there are far too many folks out there that hop online, spend tons of money on websites, logos and such and then expect money to roll in. I appreciate you sharing the difference between loving what you do, helping people or wanting to be famous. An entrepreneur is in it for profit and that means sticking your neck out there to attain your goals.

    Initially I believe if you know the direction you want to take, do some research first before jumping in. Especially when it comes to having an online business. But of course, having that passion for success will also be key, because if you don’t have that, you won’t have the drive to reach your goals.
    Lynn Brown recently posted..LinkedIn Marketing Tips for Creating a Successful GroupMy Profile

  6. Thanks, Lynn. Sounds like we’re on the same page. Many people jump into businesses without putting much, if any, thought into it. They don’t do market research, they don’t do a simple break-even analysis, and they don’t give even basic thought to whether the business truly has a chance to succeed at a profitability level that will justify the risk they are taking. I also agree with your point about passion and drive; they are critical to success in most cases. The only case where they work against you is when you are applying them to a business that has no real chance for meaningful success. That was one of the main points of this article. I’m glad it resonated with you. Paul

  7. [...] This one appeals to me a bit more, because entrepreneurship is all about taking initiative, and the motivation for taking that initiative and assuming the related risks, is usually to make profits. [...]

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