Since we’re talking about profit on CMBA this week, I want to make sure we’re all on the same page when it comes to understanding what profit actually is.
First off, sales are not the same thing as profit. When you look at the amount of revenue your business has taken in, this is your gross sales. In simplest terms, profit is what is left over after you subtract all your business expenses from your gross sales.
profit = sales – expenses
Now, if your business has employees that you pay, whether by hourly wage or salary, the cost of paying them counts as an expense of the business. But as a sole proprietor (or sole owner of an LLC), your salary does not count as a business expense. You are free to take money from your business at any time to spend on personal expenditures.
Which means that in your business, profit plays two roles:
- Money to expand the business.
- Money for you to live off of.
One of the crucial steps in developing a culture of profit is to switch from a focus on number and amount of sales to a focus on profit, not sales. As you develop your financial goals, start thinking in terms of profit. Ask yourself, how much profit do I need to make each moth to have a comfortable living? And, how much profit do I need to take the next step in my business?
I came to this article with trepidation – I’ve have not yet reported a profit to the gov’t come tax time in the 3 years Candied Fabrics has been a business. BUT, in those 3 years I have raised my prices and focussed on having enough money to do what I want to do with my time as an artist. And I have been able to expand my business with MY definition of expansion, which is NOT the definition that most folks would use.
Thanks Megan for making me realize this! I am NOT a failure because I’m not paying income tax on my Candied Fabrics gross! Woot! (I to pay the man plenty from the day job!)
I LOVE this topic! Thanks for opening this discussion and getting business owners thinking about this. Can’t wait to read more!
Good point! This distinction seems like a no-brainer to someone with a business background, but not every crafter is a business whiz when they first start out.
I will add, though, that I think gross sales is still important to a degree, for a couple of reasons.
I spent my first few months in business paying more attention to gross sales because I was still trying to make back my startup costs. If I worried about making a profit immediately, I thought I’d just get discouraged. But if my jewelry sold well, I knew that I had the ability to make a profit in the future, once I manage to recover my startup costs and reinvest in my business so I can increase my inventory, do more in the way of marketing, etc.
Also, I think that gross sales can play an important role in figuring how your profit works. You can have a product with a high profit margin – you can sell $500 worth of product with $100 worth of expenses, so your profit is 5x your expenses which seems impressive – but $400 a year is not enough money for anyone to live on. You can have a product with a lower profit margin, but sell huge volumes – say, $100,000 worth of sales, and $50,000 in expenses – and (depending on where you live, of course) that might be more than enough money to live on and reinvest in your business.
So a high profit margin doesn’t spell success without sufficient gross sales. Conversely, the lower your profit margin, the higher your gross sales must be for you to make a living. But, the higher your gross sales, the less of a profit margin you *need* for your business to be viable. Does that make sense to anyone else, or just me? 😉
Steph – These are great points – we certainly can’t ignore gross sales!
But I think (due to this being the only public Etsy stat) that most crafters get too worked up with number of sales. They start seeing people with low prices who have lots of sales, and think that must be the path to success, without any way of knowing if that other person is actually making a profit or not.
This post could not have come at a more perfect time. I was actually working on setting up my new business as a LLC this morning. Right now it’s just a one-woman handbound book business (with some help from my husband). I’ve just started off so I haven’t made a profit yet (I’m still working full time at my day job for now), but I had been wondering if paying myself eventually would be a business expense or not. Right now I’ve been keeping track of all sales and expenses via Outright. My question is, when I do take money from the business as my salary, how do I need to document that in my records?
I just track my expenses in Excel, I haven’t used Outright so I’m not sure how it works… but here’s how I do it:
I have one section at the top of my cash flow spreadsheet where I track my sales (I have a separate inventory worksheet where I track each item I make and when/for how much each item sells), and the monthly totals are calculated on the cash flow sheet) and a section below that where I track expenses (again, a separate spreadsheet where I track individual expenses sends the monthly totals to the cash flow spreadsheet). The difference between these two (the profit) is also automatically calculated and appears below the “expenses” section.
I record my (as of right now infrequent) salary as “owner’s withdrawal” on the expenses spreadsheet, but this category has its own line item below “profit.” When I subtract “owner’s withdrawal” from “profit,” I get the cash available for my business.
I’m sure there are plenty of other ways of doing this, but this way keeps accurate records and allows me to play around with Excel, which I enjoy, so it works for me!
Hi Katie –
When I take money out of my business account for personal use, I delete those transactions from outright so they aren’t counted as a business expense. But like Steph said, it’s important to keep track of them (using something like a separate excel spread sheet) so that you have a record.
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I always thought that profit was after u paid yourself, sole prop or not. Why wouldn’t u want to do it this way?
Hi Jenelle – Technically, if you are a sole proprietor (or LLC) you are taxed on your profits before you pay yourself. The result of this set-up is that you aren’t double taxed on your profits (you don’t have to pay taxes again when you move the money from your business to your personal bank accounts)
But for your own record keeping, it can be helpful to know how much profit your business is making after you pay yourself.
By the way, your dresses are adorable! I wish you made them for adults.