How long will it take for my business to become profitable? It’s one of 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 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 that 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 is barely making enough to earn a small salary and pay living expenses, but is making a profit. 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 is the type of profitability this article is about.
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. So the best answer to this question is 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. 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.
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, 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. A pro forma income statement contains four components:
- 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. 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. Total 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 will be able to clearly see when your business will become profitable.