By Jana Matthews
Many entrepreneurs have asked me, “Which is more important, revenue or profit?”
Increasing revenue signals that your customers are buying more. That’s good, as long as you’re making a profit on what you are selling. As the old saying goes, if you are selling pants for $1 but are losing 25¢ on each pair sold, the more you sell the more unprofitable you become, and eventually, you go bankrupt.
An increase in profit, on the other hand, signals that you are finding more efficient ways to manufacture and deliver products—and that’s good. But if you want to win at the game of business, you need both a good offense (sales) and a good defence (profitability).
Here are some myths about revenue, profitability and business growth:
Myth 1: I should worry about the business, my accountant can worry about profit
Many chief executive officers (CEOs) have no idea how profitable their business is until their accountant tells them—sometimes weeks after the close of the month or the year. This is worrying: CEOs are responsible for managing resources effectively, and that includes setting a yearly budget, and regularly measuring revenue and expenses. Not knowing if the bottom line is growing or shrinking, is like flying blind.
Myth 2: Since profit goes into my pocket, I’m the only one affected if we aren’t profitable
Some entrepreneurs do not understand that profit is what funds the development of new products, enables you to hire additional people, expand into new markets. Your company needs to be profitable in order to grow.
Myth 3: Profitability is not important because I pay myself a salary
Profits are the way to compensate the founding entrepreneur/investors for the risks taken to start and grow a company. Think about the profit you expect to get from investing in stocks, superfunds, or property. You should expect to receive at least that much profit at the end of the year from your company because you are investing both your money and your time. The opportunity cost of getting a lower return from your company than you’d get if you invested the equivalent amount of money in an alternative asset is worth thinking about.
Myth 4: Being ‘profitable’ means we are ‘ripping off’ customers
I encourage entrepreneurs to identify the “value” they are delivering and then price their product or service accordingly. If a company is competing on price, then it’s a race to the bottom. The trick is to find out what customers are willing to pay for the “value” being delivered, and then offer it to them, e.g., last minute flights to football games (higher airfares), fast turn-around (surcharge for 1 hour dry cleaning), reliability (extra charge for late child care pick-up), brand (emotional response to a Tiffany diamond). If customers are willing to pay for the value you are delivering, don’t worry that you are “ripping them off”.
Myth 5: You’re operating at industry norms
I recently spoke to a CEO in the home improvement sector who had used “cost plus 5%” to price his goods and services for the last 20 years. He was astonished to find that similar companies within his industry were generating 20-30% profit, and that customers were willing to pay those higher prices. While those other companies had the funds to expand, he was struggling to stay in business.
Another CEO in the automobile industry struggled with cashflow because his customers would not pay until 30 days after the product was delivered. The interest paid on loans to keep his company afloat was severely affecting his profitability. When he began selling to the defence industry, he didn’t realise they operated on a different business model and were willing to make progress payments. This one change had an immediate impact on his profitability.
Myth 6: Believing that there’s one “silver bullet” to profitability
In fact, small changes in the price and number of sales, coupled with small changes in the cost of goods sold and in operating costs can impact your bottom line 10-30%. Encourage your employees to come up with suggestions about small marginal changes in the development or delivery of your products or services, then give a “shout out” to the ones who help you become more profitable.
Myth 7: You can’t grow your company and be profitable
For entrepreneurs who have passed the startup phase, one of the top issues that keeps them awake at night is profitability. Raising prices and selling more is not that difficult, but doing what’s needed to be more profitable requires that you have a plan, a budget, and then measure and communicate where you are and what lies ahead.
It’s true that growth is a hungry beast, but profit is one way to feed growth.
Professor Jana Matthews is the ANZ chair in business growth and director of the Australian Centre for Business Growth at UniSA.
This article was first published by Entrepreneur.com