With a good understanding of your costs, margins, and sales, you can calculate exactly how long you’ll be able to stay in business. More importantly, you can use those figures to make informed decisions so you can survive longer, and get a plan in place for achieving profitability.
- Defining Profitability
- Calculating Run Rate
- Establish How Long You Can Stay in Business
- Changes You Can Make to Become Profitable
Defining Profitability
First, let’s define profitable. At the most basic level, being profitable means achieving something beneficial, usually making money. For small businesses, that means that your business is earning more money than it spends to stay in business. The excess (what you have left after paying your bills) is your net profit.
In some cases, initiatives that lose money or break even can still be considered profitable – Most often, it will refer to beneficial relationships or partnerships, sometimes ones that can be expected to bring in money in the future.
It’s important to note that most businesses wouldn’t be considered profitable if they make less money than they spend. Yet it’s a common mistake that many small businesses and new solo entrepreneurs make – thinking that if they make any sales, they’re profitable. While that money is called profit, it isn’t net profit. It’s possible (and common, in some cases) to make sales but lose money, also called running at a loss.
Now that we have the basics down, let’s determine how long you could afford to stay in business. If you have access to Profit and Loss (P&L) statements or year-end or quarterly sales reports, those documents can help you with calculations. If not, you can still use the following info, you just may need to do a little more leg work.
Calculating Run Rate
In order to determine how long you can stay in business, you need to work out your “run rate” — The financial performance of your company. You can calculate that by working out how much you’re spending, and use that together with your sales and financial buffer to determine exactly how long you can sustain your business.
Calculate Your Sales Amount
The first step is to determine exactly how much money is coming into your business. Quarterly or year-end sales reports can provide this information. If you don’t have that, you may need to manually review receipts and any other documents that show how much money you took in. It’s best to err on the side of caution with this calculation — Better to estimate your sales as being slightly under, than slightly over.
Calculate Your Business Costs — All of Them
This is the toughest part of the calculation — You need to work out exactly how much your business is spending on everything. This includes:
- Salaries: Money you pay to your employees including employer contributions for tax.
- Benefits: Including health, dental, vacation, and retirement planning.
- Office costs: Rent, utilities, insurance, property management, and cleaning.
- Product costs: Manufacturing, logistics, and shipping.
- Customer service costs: Refunds, returns, repairs, and customer service systems.
- Operational costs: Hardware, software, furniture, and hosting.
- Marketing and sales costs: Advertising, marketing, and branding.
- Transactional costs: Money you pay to credit card processing companies to take debit and credit card payments.
- Tax: The tax you have to pay on any profits.
Factor In Other Financial Sources
Now you need to look at your financial buffer — That’s the access to money that you have, whether that’s a positive cash balance, a bank loan, an investment amount, or some other type of financing.
Establish How Long You Can Stay in Business
Now you’ve got these vital figures, you can work out how long your financial buffer is going to last you. It’s a simple calculation:
Monthly sales – Monthly business costs
If you used yearly or quarterly data when figuring out your sales and costs, simply divide to get 1 month’s worth of sales and expenses.
If you’ve got a positive figure left, good news — You’re cashflow positive, meaning you’re currently profitable. You can start to put more money towards your business financial buffer (we recommend six months worth of costs at a minimum) and into sustainably growing your business.
Unfortunately, if you have a negative amount from that calculation, the news isn’t so great. You’re running at a loss and will eventually run out of money. Divide your total cash amount by how much you’re losing per month to see how many months you can afford to stay in business.
Changes You Can Make to Become Profitable
If you’re struggling to achieve profitability, there several things you can try to increase how much money you’re making:
- Increase the number of items you sell. Although bear in mind this will raise your “per item” cost.
- Increase the price of the items you sell. Be aware that this isn’t easy or always possible for price-sensitive markets.
- Reduce your costs: There are all sorts of inefficiencies in a business. Find out what your are and reduce your costs. A major area where businesses pay more than they have to is credit card processing. Comparison sites like CardFellow save businesses an average of 40% on credit card processing, which can go a long way toward saving money and achieving profitability. You can check out the free, no-obligation price checker tool to see what rates you’re eligible for.
- Extend your financing: This is only ever a short-term measure, but if you can get more investment or better credit facilities, it might be worth using them. Financing shouldn’t be used in desperation to prop up a business. It should be used in a strategic, planned way, so be sure to consult financial experts before using those options.
Another thing to be wary of with financing is merchant cash advances. They’re often offered by credit card processing companies as an alternative to loans, but while the fast access to cash seems great, it can cost you in the long run.
For achieving (and maintaining!) profitability, it’s important to have a good understanding of and control over your business finances. Once you manage to get cash flow positive, keep a close eye on your sales and costs and make sure you’re always able to turn a profit.
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Paul Maplesden is a writer specializing in business, finance, and technology. He finds research and writing about money deeply interesting.
