The Basics of Generating Profits and Building a Thriving Business
From the spark of an idea to the first customer, growing your business is an exciting and challenging process. One of the biggest leaps is learning how to generate profit consistently. Getting your business to profitability requires building a long-term strategy that helps you keep your costs down while growing revenue.
Revenue, expenses and profit—these financial terms can get confusing when you're trying to get your business up and running. It's key to understand each of them and how they differ.
Revenue is the overall money your business makes. This is often called the top line, because it's the total amount of income that comes into your business before any expenses are taken out.
Your expenses are the costs associated with running your business. These may include your rent, salaries for employees, inventory and business insurance. Money spent hoping to get a return on investment, or ROI, also counts as an expense, even if it helps generate sales. Common expenses in this category include your website and marketing efforts.
Profit is the money you have leftover from the top line, minus all your expenses. Generating this surplus, oftentimes referred to as your profit margins, is the goal of any for-profit business. In general, the more profit you generate, the more secure and stable your business is.
How ROI works
ROI is one way to figure out if activities or items you're spending money on are generating financial benefits. To figure out your ROI, divide any financial benefit—extra money earned—by the cost of the investment.
For example, a small local bakery decides to spend $2,000 to create a website that takes online orders. Even though the website is a big up-front expense, it turns out that after the new site was launched, sales increased by 50% the next month. Instead of bringing in $10,000 in revenue, the bakery brought in $15,000 that month.
The equation here would be $5,000—the additional revenue generated from the website—divided by $2,000, the cost of the website.
In this case, the ROI is 2.5. That means, for every $1 spent on the website, the bakery got $2.50 in return the next month. In this case, it's a good investment. In the long run, the additional revenue generated from the website is worth the expense of building it.
When business owners are working on growth, it's important to think about ROI. This metric can be the difference between making a smart money-making investment that pays off down the road or getting into financial trouble.
The track toward profitability
Beyond understanding the basics, like ROI and how to generate profits from a marketing investment, there are other some key steps business owners can take to move toward a healthy margin.
Start by creating a business budget. Then, keep track of your expenses on a monthly basis. Any expenses you can cut may help increase your profit margins.
From there, see where you can streamline costs and maximize cash flow. You can use cash on hand to pay for goods or services upfront, potentially at a discount. Be sure to track your time as well—you might be spending valuable hours on low-value activities that you could automate or delegate to other staff. You can also meet with your vendors to see if you can negotiate better prices on goods or services. If you can't, explore new options and partnerships.
Profitability is about more than saving money—it's also about spending it smartly. Focus on high-ROI investments. You might find a new website and paying for ads on social media can help bring in more customers, or they might not produce the ROI you hoped. Focus on investments that will help you find new customers who love your goods, and then your services will generate more revenue.
You can also devote additional attention to your current customers to see if you can gain a competitive advantage by better meeting their needs. Solicit their feedback through follow-up calls or surveys. They could have some great insights on new or improved products or services you could offer.
Regardless of the stage of your business, making a long-term plan will help you build toward profitability at your pace. Whether you're close to generating profits or still a way off, you can use these principles to help guide you where you want to go.
Financial insights for your business
This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.