Essential profit knowledge

Profit knowledgeLet’s touch on one of the basics that many small business owners, particularly solopreneurs and freelancers, can become confused about: profit.

There is gross profit, net profit, and the enigmatic EBITDA. I'll talk about gross and net profit and leave EBITDA for CPAs and for the folks at the business news organizations.

Gross Profit

Gross profit is a company’s residual profit after selling a product or service and deducting the costs directly associated with its production and sale. Directly is key here; if you did not have these costs, you would have no sales. A baker sells no cakes without buying flour and a cabinet maker sells no cabinets without buying wood. Direct costs are less tangible in a service industry but can be identified nevertheless. Arrangements for a specific speaking event might require room rental or lunch catering or paper handouts, for example.

So to calculate a company's gross profit, subtract the total direct expenses from the total income. This should be a positive number. (If not, stop reading now and contact to your local small business development center; you need help!)

Assuming positive gross profit, monitoring them gives visibility to which cakes, which cabinets, and which speaking events have the best gross margin, that is, the biggest difference between income and direct costs. If you don't have a positive margin on any one product or service, it gives you nothing to put towards rent, utilities, or salaries.

Net Profit

Once you understand gross profit, the next step is net profit. Gross profit minus pretty much all other costs leaves a net profit. Those other costs include such expenses as rent, utilities, office supplies, legal and other professional fees, bank charges, advertising, and insurance. Collectively these can be thought of as overhead expenses, since they must be paid whether you have income or not.

Net profit is also referred to as the “bottom line” and, obviously, a positive bottom line is good! But if you are just starting out and the net profit is low, don't panic. Do, however, keep a close eye on your expenditures and make sure they are planned and reasonable.

Know your costs

As touched on in the examples above, knowing all the costs that must be covered is key to truly making a profit. A typical mistake small business owners make is that they focus on the revenue. Yes, you have to generate revenue and you'll know where the money is coming from. But equally, or perhaps even more importantly, you have to know where the money is going. If you don't know, you cannot maximize profits.

Need help understanding where your profits lie? Let's talk. Let's make sure your business is as successful as it can be.

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