If you’re like the vast majority of small-business owners, you’re in business to make money. Nothing wrong with that. I’ve found, though, that lots of small-business owners — who claim they want to make money — don’t understand how to make money. So let’s talk revenue, profit and profit margin.
Revenue is income received from making a sale. While it gives an indication of how much business you’re doing, I caution business owners to view revenue with a grain of salt because it doesn’t include fixed and variable costs, so it fails to convey how efficiently a business is run.
Don’t make the mistake lots of business owners make and become obsessed with revenue. You should continually look for ways to increase revenue, of course, but if your goal is to make money, your primary concern should not be increasing revenue.
Profit should be your focus. If you only remember one thing, make it this: Focus more on profit and less on revenue. While some use the terms interchangeably, they mean very different things. Revenue is what you make from a sale. Profit is what you get to keep.
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Profit (also called earnings) is what remains after you’ve paid fixed and variable costs, and unlike revenue, you get to decide what to do with profits — buy equipment, hire employees, pay yourself.
If you want your business to grow you have to find ways to create more profit, which is why your primary concern should be increasing profit. If revenue increases, won’t profit increase also? Not necessarily. You can increase revenue without increasing profit. How?
By failing to control costs.
Assume you won a contract for a $100,000 job but were forced to hire additional staff, rent or buy additional equipment, and have your employees work around-the-clock to finish by deadline. This $100,000 job could very well cost you $100,000 to complete!
In construction we call a job like this — where there is little-to-no profit — a junk job. Revenue can be deceiving, which is why I warned you not to become obsessed with it, so I recommend you analyze the numbers to ensure you’re not wasting your time on a junk job.
Profit margin is most important, though revenue and profit are the two most-often discussed terms. And profit margin is the least understood.
While profit is sales minus costs, profit margin is simply profit divided by sales. Profit margin is expressed as a percentage, and it’s the best indication of how efficiently a business is run. You should routinely compare your business’s profit margin to your competitors’ profit margins to see how well you’re controlling costs.
Comparing profit margins for different jobs can also help you to select the best job. Consider the jobs below. Which would you choose?
$1M revenue with 5% profit margin
$800,000 revenue with 10% profit margin
$500,000 revenue with 15% profit margin
I’ll say it once again because it bears repeating: Revenue can be deceiving. I know it’s true because most small-business owners I talk to talk only about revenue. When I owned my business, all I thought about was how to increase revenue.
If I’d been given these scenarios when I owned my business, I would’ve jumped at the chance to take in $1 million! But I eventually learned the importance of digging deeper and analyzing the numbers. Unfortunately, when I learned it, it was too late to save my business.
One thing I learned was the value of running slower. I use sports analogies on occasion to illustrate my points, and this is another lesson I learned first-hand.
I began running three or four times per week — several miles each time — to lose weight, and I assumed the faster I ran, the more calories I burned. I got in good enough shape to actually run a half-marathon, but when I stepped on my bathroom scale, I was disappointed to find I’d lost almost no weight. I was disappointed because my goal was to lose weight, not run a half-marathon.
I started wearing Fitbit, a fitness-activity band that measures heart rate and calories burned, and I was surprised to learn I was running too fast for optimal weight loss. If I wanted to burn fat and lose weight, I needed to run slower.
The mistake I made was, I assumed. I assumed if I ran faster, I’d burn more fat, but a fitness expert assured me I wasn’t alone: He said most people make this assumption.
In business, you may be clear about what your goal is, but don’t assume you know how to accomplish it. I know this to be true from experience: Increasing revenue doesn’t guarantee you’ll increase profit.
Another lesson I learned: Bigger isn’t necessarily better. Several construction contractors have told me they’re doing so well, they’re considering bidding for bigger jobs. Here’s why I have a problem with that: They have healthy profit margins, which will almost certainly shrink if they accept bigger jobs. The bigger jobs will bring more revenue, but they’ll also bring more costs. And most importantly, less profit.
It’s important you understand profit and profit margin. Make them a priority, and base every decision on them. Your business depends on it.
Marvin Carolina Jr. is a vice president for JE Dunn Construction. He can be reached at email@example.com.