Having The Cash Isn’t The Same as Profit
Many small businesses withdraw cash from the business under the mistaken impression that they are paying themselves with the profit. But there’s a big difference between making a profit and having cash.
You can avoid this misunderstanding – and best determine your actual net profits – by generating and reviewing an income statement. An income statement identifies your gross profit (income minus direct cost of goods sold) and your net profit (your income minus all costs).
Test yourself by reviewing the following case study:
John operates a surfboard shop and also offers surfing lessons. He’s priced his surfing lessons lower than his competitors because he considers the lessons to be pure profit. After all, there are no direct costs except his time. Yet, for some reason, when he does his annual accounts, his business never seems to make as much money as she expects.
Review of case study:
When John runs an income statement he sees that although there are no direct costs for the lessons, there are operating or fixed expenses associated with them – specifically insurance. He had been associating the insurance policy with the retail business, but the biggest chunk of the insurance payment was actually attributable to liability insurance for the lessons. When he subtracted the annual liability insurance costs directly from the annual revenue from the lessons, she realised she needed to price them higher in order to justify the insurance expense.
PRICING YOUR PRODUCTS
How does this relate to profit? As you can see from the case study, one of the benefits of distinguishing profits from income is that it allows you to revisit your pricing. If you see that you’re barely profiting from one item or service, you may want to reconsider whether to re-price it (or discontinue it entirely). In addition to competition, your pricing may be affected by elements such as value, demand, and costs.
A common mistake made by small business owners is pricing too low. There has never been a business to go south due to high prices, but there more than a few that did fail due to their prices being too low.
Don’t sell your product or service short. If you can deliver, charge accordingly.