What Is Profit? (Hint, It’s Not What You Think)
You may believe that you have a very clear understanding of the definition of profit in accounting and how to calculate profit at any given time. But what does profit mean when it comes to the day to day running of your business and how can you use that knowledge to your benefit? The answer to “What is profit?” may not turn out to be as simple as you first think.
What Does Profit Mean To You?
So, you’re a business owner with a few years under your belt and things are ticking along nicely. Your accountant hands you a report at the end of each financial year and you’re making a profit – great!
What are you going to use that “profit” for? Do you even know where that “profit” is?
If you suddenly find yourself a little confused, you might be thinking of profit in the wrong way. Accounting profit, at the end of the financial year, doesn’t necessarily translate to readily available and usable money to you.
With one small mindset shift, it’s time to re-think the whole way you approach your business’ profit.
Start thinking of profit as cash that you can take from your business without hurting it, NOT the number at the bottom of a page.
What is the Meaning of profit in Business?
Your accountant says that you made a profit last year, but it doesn’t mean anything to you because you can’t see the profit in either the business bank or your own.
Accounting profit doesn’t help you run your business and manage your cash flow on a day to day basis. Even more frustratingly, when your accountant hands you that report, you realise you have to pay tax on a profit that you didn’t even know you had until 6 months after the end of the financial year.
If you don’t really know what Profit is, it’s meaningless and useless to you, but when you really understand what Profit is, you can then use it to drive your business forward. It’s time to change how you define the term profit!
What is Accounting Profit
Hand in the air, I’ve been part of the problem for most of the last 30 years. As a Chartered Accountant, I’ve been handing accounts to clients that include a Profit and Loss statement and a comment along the lines of “look, you made $x profit last year”.
Of course, there were some pretty interesting concepts to get to that figure, depreciation at different rates for different assets, amortisation, prepaying this, accruing that. Second nature to some of us, but complete gobbledy gook to the business owner!
It’s no wonder the vast majority of business owners have little to no interest in being told what their Profit WAS. What you really need to know is what it is NOW and where the money is!
A mind shift, brought about by reading PROFIT FIRST, helped me better understand the purpose of Profit.
If you’re not sure what Profit First is – take a look at our detailed article “What is Profit First Accounting?” next!
If Taking Cash is Profit, How Can I Do That?
ASX listed companies don’t pay cash dividends out of accounting profit!
Sure, they may need accounting profits to justify the dividends, but they actually pay them out of surplus cash. Cash that the business has identified it does not need to run its existing operations.
Commit to 1%
If you like the sound of having readily available profit in your bank account to use however you see fit, there are 3 simple steps to take to begin your journey into the world of Profit First.
- Open a bank account with a different bank (so it’s slightly harder to get to) and call it “PROFIT”
- Every week or fortnight, when you pay wages or suppliers, transfer 1% of the income that you received to the new “PROFIT” account.
- See if you can run your business without the 1%
This is the start of a new way of thinking and an exciting step to your profitability becoming a tangible thing rather than just a number at the bottom of a page!
If you can run your business on 99% of the revenue that you receive then you have a permanently profitable business. A business that will reward you for investing in it every quarter with a cash dividend.