It’s time to close the books on 2019 and soon your financial statements will be ready to give you valuable information about your results. For many, the inevitable realization will soon occur. “We exceeded our sales goal and made a profit, but is that enough?” How much profit do you need?
Many people in business think that having something left to pay taxes and perhaps a bonus to the owner is enough. While owner distribution is one way that profit is used, profit is also needed to buy more assets (like inventory or equipment) and to pay back debt. In fact, a business can be profitable, but have a hard time paying bills and restocking the store. That’s why estimating the profit you’ll need to sustain or even grow the business is so critically important to your 2020 business plan.
Important, but simple. Let’s break it down:
- First, determine how much you’ll need to reinvest in assets, such as inventory, cash reserves, and new equipment (if equipment is financed, only cash down payments go here). Think about new product lines that you may want to carry, and the incremental inventory investments needed to launch them.
- The next step is to add up all of your monthly debt payments (one year’s worth of payments on principal of existing loans). If you’re going to finance new equipment, estimate the principal payments on the new loans and include them as well. Do you want to accelerate debt repayment? If so, include additional amounts here.
- How much do you want to distribute to owners beyond a reasonable paycheck for working in the business? If the business is new, it is typical that little or no additional distributions are paid to the owners. But as the business matures, owners expect and deserve a return on their investment.
- Add it up. The total of these three is your targeted profit.
- The final step is to use breakeven analysis to determine the sales needed to achieve your targeted profit.
Profit is not optional. It’s not a nice to have, it’s a need to have. You absolutely must generate enough profit to reinvest in assets, pay back debt, and make distributions to owners.
If you need a refresher on how to use breakeven analysis to determine the sales needed to generate a profit, check out our interactive eLearning series, Breakeven Plus: Your Profit Planning Power Tool . This short, four course series helps you plan for profit and set goals for sales and expense control. And most importantly, by taking the course you’ll build financial intuition that enables you to make brilliant everyday business decisions, quickly and confidently.