What to do and not to do with the profits in your business
Profit is good. Profit is fun. Profit makes us smile.
Business coaches like me will tell you that a business must make profit or it’s a hobby instead of a business.
Just to be crystal clear about what profit is:
- Don’t confuse profit with the owner’s wages. Profit is the money left over after all wages and other costs have been paid, including the wage of the owner.
- Don’t confuse profit with what’s in the bank. That’s cash. Cash has very little direct relationship with profit (More about cash here).
- Don’t confuse profit with the Purpose of your business. Profit is what you need to fulfil the purpose of your business instead (More about purpose here).
The reasons a business must make profit are these:
- Profit provides the means to invest in the development and growth of the business and keep the business safe.
- Profit is the most direct and simple measurement of the effectiveness of the business model.
- Profit provides the means for the business to pay its investors (often the owners) a return on their investment.
So let’s just agree that profit is a good thing and I’ll proceed on the assumption that you have a business, not a hobby. What do you do with the profit?
It’s no use in someone else’s bank account
The first thing you have to do with it, is to collect it. Profit is no good to you if it’s not in your bank account, but in the those of your clients. This may seem an obvious point, but you’d be surprised how many small business owners I work with make profit, and yet can’t pay their bills.
And once it’s in your bank account, what then? After all, as I cautioned before, you’re already being paid a regular wage, enough to pay your bills and appropriate for someone with your role, so you don’t specifically need it yourself (unless you really need a bigger toy of some sort).
Assuming you’ve realised that bigger toys don’t make you happier and given your nice car is already leased through the business anyway, what do you do with your growing bank balance?
Investing in the future
Invest in the business future, that’s what. Investing in the business means the business increases in value and makes the business future proof.
Let’s say you’ve made $100k net profit before tax last year. The tax department is going to want a piece of it, let’s say 30%, and that leaves $70K to do with as you see fit. In all likelihood, if you are the sole owner of the business, it makes a lot of sense to pay yourself a piece of that, either direct or into your superfund. Let’s say you decide to give yourself a $20K dividend and that leaves you with $50K to invest.
What happens next is of course entirely dependent on your circumstances. Maybe your business plan calls for opening a second store or office elsewhere. You may need to sign a lease for the new office and pay a rental bond. You also may need to invest in a new website or a marketing campaign to get the new store moving, or maybe you will be traveling a lot for the new store in the coming year. What you don’t want to do is cannibalise the finances of the current business, so you set half of the profits aside to finance the expansion. This is a great way to invest your profits.
Keeping the doors open for 6 months
Another great way to invest your profits is to open a separate savings or investment account to build up a cash buffer in your business. I’ve often helped my clients build up cash reserves in a separate account equal to 6 months of their overheads, so that if the market takes a turn or there is a gap between contracts, you don’t have to “buy” contracts just to keep the doors open (“buying contracts” is always a bad idea).
So here’s what you gotto do:
- Pay yourself a wage or equivalent.
- Make profit.
- Collect the profit.
- Pay yourself a dividend.
- Open a separate savings account.
- Transfer as much money as you can into the savings account, every month ideally, and build up real value in the business to give yourself options down the track.
You’ll be glad you did… I promise you
Purpose, Profit and the 7 Big Questions of Small Business
Business owners frequently ask 7 Big Questions about how to Build a Beautiful Business and Life.
The second of the 7 Big Questions is: How do I make more money in my business?
To answer the second question, I have identified 7 Rules for making more Profit in business.
The first of the 7 rules states that Profit is not the Purpose of business. This is one of many more articles on this site that explain how Purpose, and Profit hang together, in some depth.