Do businesses make first year profit – how to measure your own profitability
Do businesses make first year profit? Find what you need to know in this article about what to expect in your first years of trading.
4 min read
How long will it take for my business to become profitable? Will I see profit in the first year? These are some of the most common questions new business owners ask. After all, many leave well-paid 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 probably become profitable faster than bricks-and-mortar stores because they have fewer operating expenses. The long answer is a bit more complicated.
But it is a question you should be able to answer for your own business.
Before we talk about becoming profitable, let’s clarify what it means. 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’s having to live off soup, but whose business is technically profitable.
Obviously, this shouldn’t be your goal. Instead, you’ll want to attain corporate profitability, which is when you have remaining capital after all expenses and salaries have been paid. That’s the type of profitability this article is about, whether first year profit or further down the line.
Corporate profitability – when and how?
There’s a reason no lender or investor will grant a small business loan until the borrower submits financial projections estimating the future profitability of the business. So the best answer to this question is found in these documents. Here’s how to use them to get your answer.
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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. It’s important because, after reaching this milestone, every pound 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, calculate 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.
Here’s an example.
Your fixed costs are £3,000 per month.
You make 25% gross profit.
Divide £3,000 by 0.25, which is £12,000.
This is what you have to generate in sales in order to break even. There are plenty of free online break-even calculators 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. You can do this with a pro forma income statement, which has four components:
Sales projections: You’ll need to make an educated guess at your monthly sales figures for at least the next one to three years. Use the research and knowledge that you have about your industry to create an estimate of your expected sales. Salesforce has a handy guide on accurate sales forecasting for SMEs.
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 report. If you are a service business, simply place a value on your services and use that figure.
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. Add them up to arrive at your monthly fixed expenses.
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’ll be able to clearly see when your business will become profitable.
If your business makes first year profit, that’s great news. If it doesn’t, don’t worry - this may be down to the nature of your business, which could take longer to become profitable. Either way, QuickBooks online accounting software will help you track and forecast the growth of your business.
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