A successful small business is a dream come true. Business owners watch their dreams turn into reality. Hopefully, the reality is profitable. When we start a small business we invest our savings and typically take out a business loan. We watch our business expand, more and more customers buy our products and services, and it is exhilarating. This is the point at which one of two things will happen. You borrow more money to speed on business expansion or you force yourself to make smart business decisions by taking your profit first. How do you decide to take profit first and how does that work?
Despite the excitement of starting a small business, many such efforts fail. Twenty percent of small businesses last a year or less. A third last two years before closing. Fifty percent are gone by five years and by ten years, seventy percent of small businesses have failed. There are lots of reasons for business failure. But a large number of failures fall into the category of bad financial decisions or significant lack of attention to business finances.
As a business expands it is easy to be optimistic and it is easy to get credit. After all, look how fast the business is growing!Unfortunately, with excessive borrowing comes excessive risk. Business growth only works if it results in profits. Unless profit occurs, expenses eventually become overwhelming. That process is typically hastened by a business downturn,the appearance of an aggressive competitor, or saturation of your market so that further expansion is impossible.
Sometimes, a business owner will catch on in time, take a closer look at the bookkeeping reports, and start to make the hard decisions that should have been made months or years before. This does not have to happen this way.
A good way to avoid the poor profit and eventual failure scenario is to take your profit first and get used to taking a critical look at all expenses from the very beginning. Here is what can happen otherwise.
Your business is not generating good profits despite having reasonable cash flow. If this is happening to you, can you spot the problems? If you cannot, the problem may be in your bookkeeping. If your books are a mess, that may be the issue. But, your bookkeeping may be pristine, but still be misleading you into thinking you are profitable! Most bookkeeping follows what are called generally accepted accounting principles. This approach says to count up sales and subtract expenses. What is left is your profit or loss. What’s missing in this picture is an appreciation of how humans (business owners) behave.
Apple is the first company to pass a trillion dollar market cap. They have well in excess of two hundred billion in cash reserves. And, Apple was once a small business running out of a garage! Apple had a great idea with the home computer and grew rapidly. And then they ran out of money! Steve Jobs went hat in hand to Bill Gates to get an investment of one hundred fifty million dollars. As Apple recovered, Jobs made sure that he put profits in the bank so that Apple would never again need to beg to stay out of bankruptcy.
What everyone remembers is when Gates made the investment and Jobs said that Gates had “made the world a better place.” What we at Exigo Business Solutions remember is that Apple originally thought that they did not need to control costs and take profits as they went.
The human factor in a small business is that we love the work we do and we love to see the business grow. What we hate to do is pour over financial reports and then cut staff, reduce your rate of expansion, or even cut out whole business segments because they are unprofitable.
Unlike the standard bookkeeping approach, the Profit First system takes sales, subtract profit and that leaves expenses. These are all the same numbers from the same business. But, this way of looking at and dealing with your finances has to advantages. First, it forces you to put profit aside each and every bookkeeping cycle. But, the second advantage is the real reason to use Profit First. Smart cash and asset allocation are critical to the long-term success of a business. When you follow the Profit First method, you force yourself, early rather than late, to look critically at your expenses, your plans for expansion, and the debt you are taking on.
First of all, not everyone uses or is familiar with Profit First bookkeeping. At Exigo Business Solutions we are Certified Profit First Professionals. We belong to a select group of bookkeepers and accountants that are dedicated to helping businesses grow their profits. If you have a bookkeeper in-house the odds are that they do not know or understand this approach and the many tools that make it work. You probably need to outsource your bookkeeping in order to use the Profit First approach. We also use QuickBooks which is a bookkeeping application specifically designed to support a small business.
If you would like to make smart business decisions early in the game instead of waiting for a crisis, we will be pleased to explain more about how Profit First can help your business, analyze your business needs, and make concrete suggestions about howto do your bookkeeping and run your business with a more reliable profit.