Remember when you were in high school and complaining about math class? What was it you said, “I’ll never need this stuff in the real world?” Well, now that you’re the owner of a small business, depending on your product or service, when it comes to geometry you still might be right. But, when it comes to other types of math, and the need for them, you were mistaken.
Being able to “do the math” matters. So much so, that it can be the difference between having a successful or unsuccessful company. The stories of seemly successful businesses — ones with good products or services, clients and a well known brand — closing because of bad financial management are legion.
One of the biggest mistakes 90% of owners make is not knowing or understanding the importance of their numbers. They don’t know if or which of their customers generate a profit, nor do they know how much a profit it is. They don’t understand a fundamental concept — if you don’t have a profit margin, you can’t sustain a business.
The margin is simply how much out of every dollar a business earns it actually gets to keep. For example: $1.00 (earned) minus $.90 (expenses) equals $.10 (profit). The profit margin is 10%. Many owners keep investing money, not understanding this straightforward tenet, hoping to “get the company on its feet”. However, there’s no reasonable, mathematical way for that to happen if there’s no profit (margins can be either positive or negative).
Owners should always know their margins, if they’re positive or negative at the very least, because the volume of a business doesn’t give an accurate picture of its financial health. A company with $5 million in revenue can actually be losing money if it has a negative margin. Let’s do the math for the fictional ABC Company.
In 2012 ABC had a net income (money they got to keep) of $500,000 from sales of $5 million, which gave it a profit margin of 10% ($500,000 divided by $5 million). In 2013 they got a new customer, which increased costs. But, because they ball parked the bid instead of doing the math, they made $500,000 again, only it was on sales of $5.5 million, resulting in a 9% margin.
In 2014 the client offered ABC more business, which they took once more without running the numbers. Again, expenses increased resulting in the same net income of $500,000 on $6 million, about an 8% profit. So while the company increased its volume by a million dollars over 2 years, it actually reduced its returns. Some businesses become so upside down they can’t get out of the hole they’ve dug, because selling more puts them further in the red.
Unfortunately, thousands of businesses have closed due to this phenomenon — even though they had customers and money coming in their margins weren’t good enough to sustain them. The math is irrefutable, your product or service can’t cost more to produce than what you’re charging for it, and the only way to know that is to figure it out.
