You enjoy flexibility in relation to business objectives. We know that many of you have gone into business for yourself to achieve some independence and the ability to do your own thing. We understand that for many, it is not about profit maximisation but achieving some balance between lifestyle choices and financial rewards.
However you may not be getting an acceptable return for the time worked or the capital invested in the business. In fact, if a commercial wage and a risk adjusted return on capital invested were computed, many entrepreneurial owner managed businesses would not be profitable.
What are the consequences of inadequate profits?
You can only work on sweat equity for so long. In the long run a business must have adequate profits or it will fail.
Sustainable cash flows can only come from profits. Poor cash flow and continued operating losses will certainly take you on a path to finanical difficulty.
There are other significant consequences of poor profitability to consider. For a start, most businesses are valued on some multiple of sustainable profits, so poor profits mean your investment in the business is not appreciating but in fact may be declining. This is detrimental to your succession plans, particularly if you have an early exit in mind.
Another problem to emerge is that the lack of profits will restrict your ability to invest back into your business. This is critical as all businesses need renewal over time. Renewal means investing in new products such as: product development, new plant and machinery, new IT, new people, web sites and so on. These items are either paid for in cash or financed through debt. With restricted cash from trading, that option is not available and getting finance will also be difficult without good numbers.
What are the warning signs?
Reliable and timely management accounts should tell you there is a profitability issue. In the absence of reliable management accounts lack of profitability can be detected if cash flow is tight, and could be caused by declining sales or overheads (like headcount) increase rapidly.
What should you do?
Ensure your monthly management reporting is reliable and take notice of any warning signs that things are not right.
You need to know that your business is profitable overall, but the real secret to increasing profits is to know where you are making good returns and where you are not. This allows you to focus energy and resources on the more profitable parts of your business and stop wasting time and effort on areas that are not so good for you