October 8, 2014 Financial Management en_US https://quickbooks.intuit.com/cas/dam/IMAGE/A0IbtYUof/d8fb0d0b4d8100e5faa42e913c8f6330.jpg https://quickbooks.intuit.com/r/financial-management/long-business-profitable How Long Before Your Business Is Profitable?
Financial Management

How Long Before Your Business Is Profitable?

By Suzanne Kearns October 8, 2014

How long will it take for my business to become profitable? It’s quite possibly the most common question new business owners ask. After all, many leave well-paying jobs to set out on their own, and it only makes sense that they want to know when their risk will pay off. But, unfortunately, the answer isn’t always cut and dried.

The short answer is that profitability depends on the business. For example, online businesses will likely become profitable faster than bricks-and-mortar stores because they have fewer operating expenses. The long answer is a bit more complicated. But in the end, it is a question that you should be able to answer for your own business.

Let’s Define Profitability

Before we talk about becoming profitable, let’s get on the same page about the meaning of the word. Technically, when your revenues exceed your expenses, you’re making a profit. But there’s profit and then there’s profit. The phrase “ramen profitable” describes a business owner who is barely making enough to earn a small salary and pay living expenses. Obviously, this shouldn’t be your goal. Instead, you’ll want to pass that point to get to what’s called corporate profitability, which is when you have remaining capital after all expenses and salaries have been paid. Those are the type of profits referred to in this article.

When and How do I Achieve Corporate Profitability?

There’s a reason no lender or investor will grant a small-business loan until the borrower submits financial projections that estimate the future profitability of the business. The best answer to your question will be found in these documents. Here’s how to use them to get your answer.

Get a Baseline with a Break-Even Analysis

Once your business begins to break even every month, you can stop infusing it with personal cash because the business has begun to pay for itself. This is the first step on the road to profitability, and it’s important because, after reaching this milestone, every dollar earned will be considered profit. To calculate your break-even point, you need to know the gross profit after sales costs for your products or services and the fixed and variable costs for your business. Then, figure your break-even point by dividing the gross profit of your products or services by the sales price. That’s your gross profit percentage. Take that number and divide it into your fixed costs to determine when your business will break even.

For example, if your fixed costs are $3,000 per month and you make a 25 percent gross profit percentage, you’ll divide $3,000 by 0.25 and come up with $12,000, which is what you have to generate in sales in order to break even. You can also use a free online break-even calculator from Harvard Business School to help you out.

Determine Future Profitability with a Pro Forma Income Statement

Now that you know when your business will break even, let’s talk about determining profitability. A pro forma income statement contains four components:

  1. Sales projections: You’ll need to make an educated guess about how much sales your business will do every month for at least the next one to three years. You will use the research and knowledge that you have about your industry to create an estimate of your expected sales. Check out this three-part  instructional video on the topic courtesy of the Small business Administration.
  2. Cost of goods sold or value of services: If you manufacture a product and sell it, you’ll need to create a cost of goods sold budget report. If you are a service business, simply place a value on your services and use that figure.
  3. Other expenses: Now you’ll need to determine the cost of your other expenses, such as rent, phone, internet, accounting and bookkeeping fees, website maintenance, marketing and advertising, insurance premiums, utilities, salaries, and debt repayments. Total them up to arrive at your monthly fixed expenses.
  4. Gross profit estimate: Now that you have all the information you need, you should be able to determine exactly when your business will become profitable. Use your sales projections to determine how many sales you’ll make in a given time period, and then deduct your expenses to get an estimate of your gross profit. By preparing a month-by-month report for each of these areas and charting the results, you will be able to clearly see when your business will become profitable.