Why your business needs a profit model

If you’ve never worried about your business’s profits, then you’re probably in a tiny minority of business owners.

Maybe you’re one of the lucky few that have hit on a business which is so profitable that you don’t feel the need to keep an eye on your bottom line.

But even if your business starts off generating huge profits, things can quickly get out of hand. Overheads increase, sales stagnate, and before you know it your business is suddenly in the red. How did that happen?

Yes, there are exceptions - it took Amazon five years to post its first profit after IPO in 1997. But Amazon had deep pockets and a long -term financial model that has led to huge profits - net income of over $10 billion in 2018.

Most small business can only dream of scaling to the phenomenal size and profitability of Amazon. But the same principles that enabled Amazon to grow while posting losses apply to businesses of all sizes. If you have a solid financial model - and specifically a profit model - you can set financial goals and manage your business’s performance against these.

The primary goal of your business is to maximise your profits. Even if you are a social enterprise or charity, profits are important (they are reinvested to support the organisation’s mission).

If your business fails to achieve sufficient profits then one of three outcomes is likely:

Your business limps along, barely providing enough to sustain a living

After depleting your capital reserves, you wind up the business

Your business becomes insolvent and is forced to close through compulsory liquidation

Many business owners set out a business plan at the outset, which includes goals and a roadmap for the enterprise. The business plan is often a long and comprehensive document. As a minimum, it usually outlines how you will generate revenue and the resources that you will employ to achieve this. It provides a high-level financial view including a profit and a cash flow forecast.

The profit model provides a greater level of financial detail than the business plan. Its purpose is to enable you to forecast your business’s profit and to assess the impact of options and decisions on your profits. For example, you make and sell three products; what is the expected profit based on an even mix of units sold? What would be the impact on profits of doubling the sales of one product and halving another? These are questions that can be answered by your profit model.

An effective profit model will project out for several years, with a greater amount of detail for the current year. It should be driven from your accounting system, which needs to be up to date and organised to provide the essential level of detail.

Setting up and tracking profitability against targets will avoid nasty surprises and enable you to make corrections to stay on track.

We’d be happy to discuss your business’s profit model and provide an initial assessment - feel free to contact the Cow-Shed Startup team for a no-cost consultation.