Defining ‘Profit’ for the Entrepreneur
January 11th, 2013 // 2:03 pm @ Million Dollar Methods
This is the first edition of my ‘Profit Report’, a weekly newsletter for members of Million Dollar Methods focused on the math and science behind getting rich as an entrepreneur.
Note: this is not an accounting lesson, nor an attempt to provide any accounting or financial advice. It IS however a marketing lesson based on numbers.
You might find a great deal of contradiction to these lessons within accounting guidelines, that’s because my interest is not to prepare SEC compliant financial statements. What I want to achieve, is to provide you a set of parameters in order more accurately identify opportunities to increase your personal income.
It seems fitting to start the ‘Profit Report’ series with defining exactly what ‘profit’ is from the stand point of an entrepreneur. Of course there are very technical definitions, loose interpretations, and more corporate-guided uses of the word ‘profit’.
The broadest definition of profit is:
Profit = Revenue – Expenses
However, that’s far to vague to do us any good, so we’ll need to break down revenues and expenses even further.
Revenue = Units x Price
Expenses = Operating Exp + Cost of Goods Sold + Marketing Costs
Which means that:
Profit = (Units x Price) – Op Exp – Costs of Goods Sold – Marketing
That fairly simple equation actually gives us a very powerful lesson…
While most entrepreneurs focus on generating more sales, there are actually FIVE ways to increase profit.
1. INCREASE the number of units sold
2. INCREASE the average price of those units
3. DECREASE the expense related to running the business
4. DECREASE the expense in delivery the product/service
5. INCREASE our marketing’s effectiveness
Doing any one, or a combination, of those five will boost our profit, and ultimately increase our personal income. Throughout this series, we’ll examine each more closely.
I should stress that a textbook might recommend reducing marketing expenses, whereas the correct approach is to increase the effectiveness of our marketing. Unfortunately, some entrepreneurs’ first reaction is to cut the marketing budget in an effort to quickly boost profits. This only negatively impacts the number of units sold. It might pay off in the very short term but could lead to catastrophic results in the future.
One final critical note: you might question how does your business profit relate to your personal income? (This, after all, is the primary objective I set out to achieve). Your situation might be slightly different, but generally profit will equal your personal income plus any debt payments (notes payable) plus any re-investment into the business.
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