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This article is for educational purposes and does not constitute legal, financial, or tax advice. For specific advice applicable to your business, please contact a professional.
Operating your business at a profit is a business goal for many small business owners. You can take your first steps toward this goal by charting a path toward profitability.
While there is no tried-and-true measurement of how long it takes to be profitable for a business, on average it takes a few years for small businesses to reach that point. Factors like the type of business you’re running, where you are located and the types of goods or services you provide can affect how long it could take for the business to meet this goal.
By building a foundation that leads to operating your business at a profit, you’ll be empowered to better control your own financial future without the need for unexpected cash infusions to help buoy day-to-day operation costs.
What does it mean to be profitable?
When it comes to building a business it can be hard to distinguish between making money, making a profit, and being profitable. You might start making money as soon as you open your business, but it is good to keep track of your cash flow to see that you’re not losing money on the sale of each good and service when you take into account all the costs associated with the final product. You can make a profit on various items or services if the cost to produce it is less than the revenue from the sale.
Finally, there’s profitability. You could be making a profit on the sale of each of your products, but still not cover all the costs in running your business as a whole when you include labor or rent, for example. The moment where your total business income is greater than your total business costs is when it is considered profitable.
How is making a profit different from profitability?
The difference between profitable and profit is that profit is an absolute amount — it measures the financial gain you make on the sale of a good or service. A profit takes into account the money you earn after factoring the amount spent in buying, operating, or producing that good or service. On a fundamental level, this is how you calculate your profit:
Profit = Total Revenue – Total Expenses
If you are looking to manage profit, a good place to start is a profit and loss, or income, statement. This is one of the basic accounting statements you can use to get a good gauge of your business’s cash flow.
Your business might be making profits on your goods and services sold, but you might not be profitable. Profitability is the measurement of profit itself. You use this profitability measurement to help forecast if your business has enough profit to continue growing. This measurement, unlike profit, is not relative.
“The difference between profit and profit margin when it’s at its most basic, profit is your total revenues minus your total expenses. The difference between the two is your profit.” said Stash Wealth CEO Priya Malani. “Profit margin, on the other hand, is a measure of essentially how profitable you are and is usually expressed as a percentage.”
Malani says that it’s important to distinguish between your profit and profit margin as your business grows. If your revenues are doubling, it could be tempting to assume your profit margin is also doubling, but if you don’t make any changes it will likely be the same ratio as you scale.
How do you calculate profitability?
A commonly used formula for calculating profitability is a break-even formula. The break-even point of your business is when your business has grown to the stage where revenues are equal to costs. What this means is this is the point for your business where you are not making a profit yet but you are also not losing any money. You can calculate your break-even point a couple of different ways by using units or sales dollars, for example.
Using a break-even analysis can help you forecast financial decisions for your business that will help manage your cash flow and not go beyond that break-even point. Some examples of areas of your business this could impact might be keeping an eye on changing cost of goods sold so that you know which materials may impact your pricing and overall costs of production. If, for example, your cost of goods shifts heavily and you have to sell a larger amount of your product to cover your other costs, you’ll be better prepared to identify those shifts and the impact to your business by regularly calculating your profitability.
Ultimately, a break-even point analysis can’t predict the future, but it can help you gain more control over your finances and determine the amount you need to cover your fixed and variable costs of production.