Profit as a Residual

The owner determines the amount of profit that they wish to make. The owner needs enough internally generated information to have control of his profit. Most business owners do not even know that they can control their profit. Your accountant has done you no favors. They have beaten into the heads of business owners an accounting format in which profit is treated as a residual. Pull out your financial statements. They are arranged as follows: on the top line is revenues followed by the cost of goods sold. These numbers are subtracted and the result is your gross profit. Then you subtract overhead and what is left over is profit. Right? Wrong. This is tax accounting. This is the basis of the letter written to the CPA for the purposes of paying (or hopefully avoiding) taxes. This is not managerial accounting. If you use your tax accounting to compute your break even you will divide your fixed overhead by your gross profit percentage resulting in the company revenues needed to pay your bills. But we are not in business just to pay our bills. It is the owner’s job to generate a pre-determined profit and the owner’s job to determine how much. If you take what is left over, that is what you will get.

On your financial statement go to the space between gross profit and overhead. Insert the amount of profit that your Strategic Plan shows that you need to make. Now add that to your overhead and divide the result by your gross profit percentage. That is the sales volume required to really “break even.” Now you can develop a sales plan designed to “win the game” and not to merely “lose by a touchdown.” Unfortunately this is so backwards from what most people practice that they never are able to overcome the mistakes ingrained in them by their accountant.

Engineering Profit

Making money is so simple that most people don’t understand it. If you want to make 10% profit, simply spend only 90 cents of every dollar that comes in. Anyone can figure that out. So why do so few people have a plan to do it? In producing a profit there are only two variables. First is the relationship between what you charge (price) and what it actually costs you to produce your product. Second is the relationship between overhead and gross revenues. You want to make money? Establish your plan to determine the required relationship between price and cost (gross profit), identify ALL of the variables that control this relationship, pick out the key ones and monitor the crap out of them. Then take out your desired net profit from the gross profit and establish the amount of overhead that the company can afford. Implement controls so that the overhead cannot exceed that level and you end up with your profit. Simple isn’t it? Unfortunately 99 out of every 100 small business owners spend virtually no time focusing upon making money because they are “too busy” (doing other people’s jobs). It is also overwhelming to them because their accountant and software have provided tools that are inadequate and overly complex. Those really making money are doing it despite these inadequacies and with a lot of luck. Reliance upon luck can be significantly reduced if the proper information is generated and USED.