What Is Profit In A Business | A Simple Guide
Some people think that profit means you have made it in business. However, it is only the beginning. What exactly is profit if it isn’t only a metric of success?
It seems a rather simple question, but there are different layers to it and nailing its definition is key to making sure there are no nasty surprises further down the line. Essentially, it is the monetary rewards for the risks you take as a business owner. There are many ways to make yourself profitable, but making money is only just the beginning.
How is profit calculated?
If we break it down into its simplest form, profit is the amount of income you take in during a certain period minus all your outgoings. So far, so good. However, at this point it is important to make a vital distinction:
This is everything that your business earns per month or per year that isn’t specifically exempt from tax. However, this figure absolutely does not include any of your outgoings, so does not count as profit. It acts as a way of showing how much your business has taken it.
This is the gross income of your business minus all of your outgoings. By outgoings, this means absolutely everything that needs to be deducted from the money that you earn, such as tax, VAT, wages, petrol, external services, loans and even food. What is left at the end of this calculation is your profit.
Adjusted taxable income (AGI)
AGI and net income are often presumed to be the same thing, but there is an important distinction to make.
Net income is ‘after tax’ and relates to business
AGI is only related to your personal income
So, once your business tax has been taken off, AGI refers to the total taxable amount of income that is liable for tax and deductions.
Also, and it is always worth reminding yourself, any errors in tax payments at this stage will result in them being due at the end of the tax year in April in one, usually large, lump sum.
What does profit do for business?
Of course, earning money and creating profit means that you are justifying the decision to set up your own business. However, once you start earning enough, you are faced with entrepreneurial decisions.
How much of your profit do you want to keep for yourself and how much will you put into the company in order to make it grow?
The latter could take the form of hiring an employee so you can take on more work or investing in better equipment.
Should you change the businesses format from self-employed to limited company?
Is it time to invest in a marketing strategy?
This is a fine line, so while profit is fantastic and represents the first hurdle, it throws up way more questions than answers.
What makes a small business profitable?
Profit, especially in your early days as a company, very much depends on the industry you are in.
For example: a mobile hairdresser will have fewer set-up costs than someone who is producing a new, physical product. However, there are some factors that we should all adhere to in order to make our profit margins stretch that little bit further.
Diversify your products
Most profitable small businesses diversify. If possible, you should look to add additional facets that do not require any extra expenditure.
If you are a self-employed language teacher, try adding proofreading services to your portfolio. Or, if you are a fitness coach, try running evening classes. This will maximize profit and keep your overheads to a minimum.
Keep low overheads
Cutting down on overheads is one of the best ways to keep your business profitable.
- Use a home office
- Be careful with equipment
- Keep a tight rein on your outgoing costs
- Use technology
- Take advantage of bartering
Improve your skills
Always be on the look-out for courses, certifications and diplomas that will help you stand out from the crowd. As well as helping with visibility, it will also improve you as a person and your business in general. The better your product, the more people will enthuse about it to others.
Evaluate your costs
Competitive pricing is crucial, but think about how you can entice people to keep coming back.
If you offer classes that are €50 per hour, think about offering a course of 10 classes for €400. Although you are charging less per hour, you will make that up by encouraging your clients to stay with you for longer. This helps with brand loyalty and keeps cash flow high.
Do your own bookkeeping
By not outsourcing your bookkeeping, you can save a significant amount of money and keep your profit margins healthy
Many bookkeeping firms will charge a retainer fee, while each transaction is often charged individually.
If you are tempted to try your own bookkeeping, take a look at our article describing the basics of bookkeeping.
When should a business become profitable?
Time for a little bad news: you are not going to start accumulating profit immediately. Or, if you do, please let us know the secret!
Depending on your initial costs, when you start the business you could be looking at years before you are able to look at turning a profit. It’s generally agreed that it takes two-to-three years on average for a small business to become profitable.
This doesn’t mean that you can’t make enough money to survive, but it is certainly something to factor into your business plan when you are looking at setting up.