Small Business Profit Management
Money in the Bank Finances Growth, Employee Incentives and Survival
Aug 18, 2008
Profit is not just about big houses, yachts and holidays abroad. In fact, it's not necessarily about those things at all.
Profit for Security
Hewlett Packard, the computer and electronics giant that is one of the most successful corporations in the world, instructs its managers to plan for one bad year in every five. Experience has shown it is better to plan for two bad years in every 10, because bad years can come consecutively.
Many industries in the U.S.A., and in countries which export to the U.S., experienced a downturn in sales for four years after 9/11, 2001. The only way to cope with down years is to have money in the bank.
That's the first function of profit for a small business: to build up cash reserves to pay fixed costs and keep the business solvent when sales are down.
As entrepreneur and business educator Dr. Tony Fattal says, "When you're out of money, you're simultaneously out of business."
Money for Small Business Growth
Few businesses survive without growing. Either a business grows or it contracts. The small business owner has to plan for a turnover of customers of, on average, 20% per year. Just as with bad years, that 20% can accumulate; customers can be stable for several years and then plummet. This also happened to businesses after 2001.
The small business owner needs growth to counteract the inevitable loss of business.
As it grows, the business incurs new fixed costs. Dr. Fattal says that fixed costs, rather than being a straight line on a graph of costs against time, should be plotted as a staircase. They tend to rise sharply as growth occurs.
For example, when a new employee is hired, the fixed costs of salary, accommodation, furniture and equipment will increase before the employee is fully contributing to revenue. The same might be true of a capital purchase of machinery necessary for growth.
It is important to take a proportion of profit and earmark it for growth. Some business gurus, such as the Self Management Group, say the growth fund should be calculated separately from profit.
This growth fund should be banked separately from the rest of the profit. It should not be touched for any purpose other than for any purchase or hiring necessary for growth.
Small Business Success Story
Steve Coleman, who operates his own consulting firm BusinessManagementBasics.Com, says that for the first five years of his business he split all the profits as:
- 50% to cash reserves
- 25% to capital expenditure
- 25% to dividends/profit sharing
"At the end of that period, with enough money in the bank, we split all profits 50% capex/cash reserves and 50% dividends," he says. "We grew and prospered despite two bad periods, the money in the bank saving us."
Profits to Aid in Getting Bank Loans
If the growth fund, with or without profit, proves inadequate for whatever is needed for growth -- new people, premises or machiney, for example -- the small business owner will have to seek a bank loan, or seek an investor or investors.
Banks and investors will judge the business on its profit rather than revenue. They will need to be convinced of the future prospects of the business on the basis of its business plan. Profit history is vital to assurance that the business can meet its plan.
Banks will not be interested in unpaid invoices as evidence of money to flow in. Unpaid invoices are just that -- unpaid. They're not paid until the cheques have cleared.
Profits to Win Clients
Clients and customers will be more likely to purchase from a company that can demonstrate, by profit performance, that it will be around in years to come when repeat purchases, more products, spare parts, repairs or servicing are needed.
This is particularly so for business clients, whose businesses depend on their suppliers’ ability to service needs for the long term.
It is also useful in marketing to consumers buying major appliances and other capital items. At least one vacuum cleaner manufacturer has gone bankrupt leaving customers unable to get repairs; others will want to assure potential customers of longevity.
Profits for Employee Incentives
A small business can have a more difficult time offering a career path for employees, particularly highly-educated and skilled people, than can major corporations. By sharing profits, the small business owner can increase the incentive of these people to stay.
Small Business Success
Profit means survival. It enables growth, helps employee motivation, eases negotiations with banks, attracts investors, and gives clients and customers confidence. All that adds up to success. After that can come the mansion and yacht.
See also: Small Business Success Factors
