“The way to get started is to quit talking & begin doing”  Walt Disney

Profit, all you ever wanted to know – part 3

Written by Doug

Part 3: Operational Profit

 

Welcome back, I’m so happy that you are still here – I know that it can all seem very confusing, but stick with me and it’ll all become clear.

Not every cost is directly linked to an individual sale. For instance, your rates must be paid and your garden must be tended whether you are full or empty.

These kinds of cost are known as “Overheads”.

Strictly speaking, when the overheads are deducted from the gross profit, then we arrive at our old friend “The Bottom Line”.

SALES   X
     
COSTS OF SALE   X
     
GROSS PROFIT   X
     
OVERHEADS   X
     
NET PROFIT   X

There is, however, one more level of profit that I like to calculate before we get to the bottom. This level is what I call “Operational Profit”.

Operational profit is a measure of the health of the core business as it runs on a day-to-day basis, without external &/or owner influences.

To calculate operational profit, from the overheads, I exclude any payments to the owner(s), any interest payments to the bank and any fixed asset depreciation (we’ll talk about this one later).

SALES   X
     
COSTS OF SALE   X
     
GROSS PROFIT   X
     
OVERHEADS   X
     
OPERATIONAL PROFIT   X
     
NON-OPERATIONAL OVERHEADS   X
     
NET PROFIT   X

Why bother? Well, your bottom line could be showing a loss and you might conclude from this that the business isn’t doing very well. However, a look at the operational profit could show a healthy, profitable day-to-day core business.

So what’s going on? The answer could be that all of the profit is being wiped out by interest payments on borrowings or perhaps you are paying yourself more than the business can generate. Equally, there may be high amounts of fixed asset depreciation. Or, a combination of all three items.

The point here is that although these are real items of cost that affect the bottom line, the core business is performing correctly and as owner, you must deal with the funding of the business &/or how much it pays you.

Another benefit of operational profit to consider is that if you wish to sell your business, it is this number that should be of prime interest to a potential buyer.

So that’s profit. A lot of explanation for such a small word!

I really hope that you can see that a focus on profit can give you and your business powerful information to get you ahead and keep you ahead in a very competitive market place.

In my next article we will delve into the world of budgeting where you can begin to shape the profit you want to see for your business.

Keep up the good work!

Doug

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