S6E13: Revenue Feels Good But Profit Pays Bills

Disclaimer: The information in this video should not be viewed and is not intended as tax/financial advice. Consult with an expert before making any decisions regarding your finances. 

Sick of “six-figure” hype but still feeling broke? Pam breaks down the real difference between revenue and profit—and why knowing it could be the smartest (and most freeing) thing you do for your business this year.

Transcript

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Foreign. Okay, welcome back to the Cash Flow Podcast where we're going to talk about the thing that we all say about our businesses that actually doesn't matter. I'm sure you've been in the rooms or filled out surveys where it says, how big is your business? And everybody brags on, I'm a six figure figure business. I'm a seven figure business. I broke a million dollars. I broke a hundred thousand dollars. And with a lot of pride, which is fine, they say this. However, what I want to talk to you about is the difference between revenue and profit. And to keep in mind, anybody, time you're hearing somebody say all that, know that there's actually a more important question than revenue. So, like, we get that dopamine big hit, like we have a big launch, or we get a new client and they're a big client, it's like, yes, I just got 50,000 in revenue. That's awesome. But then we might stop there. And the reality is that's not the real answer to a successful business. In fact, I know plenty of businesses that have tons of revenue and go bankrupt. Tons of revenue and zero profit. And profit is what I want to talk to you about. Because the real answer to how your business is doing or one of the real answers to how your business is doing is, is what of all that revenue do you actually keep? Okay, so the way I would put this is revenue is really for the ego. And profit is all about your bank account. And I'm more interested in your bank account than our ego. I certainly have the ego as well. I know I strive for certain goals every year in revenue, and that's more just to feel good. But I know that my real goals, the ones that matter, are what are my profit goals in the business? So you don't need to know like tons of numbers to do this. It's not like you have to have. You don't even have to have bookkeeping in place if you don't want to. Although I highly encourage that you can figure this out kind of in your head. I find that actually most entrepreneurs, whether I'm dealing with eight figure entrepreneurs or six figure entrepreneurs, they really know a lot of these numbers in their head and they don't have to get back and get all the details. But, you know, your calendar might be full, you might be pulling in the revenue hand over fist, but a full calendar and that revenue really is just possibly really expensive noise. All right? And we want to prevent your revenue from being really expensive noise. And one of the expressions I like about this is don't confuse action with traction. Traction is when you're making profit and you're growing your wealth in your business and you're paying yourself and you're still having net income left over. At the end of the day, that's when you've really got traction. A lot of us as entrepreneurs, when we start, you're like, you know, I'll be grateful if I can just break even. And that's a real story. Like, first year we're going to be in a loss. Second year we'll break even. Third year we might make a little bit of money. But I want to talk to you just about three little numbers that I really want you to have in your vocabulary and know what they are. And these are the three different profit margins or profits. The first one is gross profit, the second one is operating profit, and the third one is net profit, okay? And the really easy way to look at this is that you have revenue. Gross profit is how much money is left after you spend just the money you need to spend to make that revenue happen. So, for example, if you've got like a consulting business, right? And you make $1,000 from a client, but you have to spend $500 on a consultant to go do the work for you, gross profit is the $500 you have left after that, okay? So that's really simple. If it's a cost that is directly related to getting that revenue, then you have to count it as a cost because you're not keeping the whole dollar that you make, right? A piece of it's getting torn off and handed to another consultant, and now you're left with a less of a dollar bill, right? What's the second one? So that's gross profit. Operating profit is now you're going to use that dollar and all the other dollars you have or that portion of a dollar and all the other portions of a dollar you have left from all your other clients and sales to pay what we call your fixed expenses. Like this is what I call keeping the lights on. So it's paying your subscriptions, which we hit on last week, right? Paying your subscriptions, paying your employees. If you have employees that are there all the time, paying yourself, God willing, paying. You know, I don't know if you have an office, you're paying rent. If you have travel costs, it's your travel costs. So it's all those other expenses that really you're going to have them whether you have clients or not, right? They don't go away. So you have to subtract all those. So say in the example we're talking about, we charge our client 1,000 and say we have 10 of those clients, right? So now we have $10,000 of revenue. We're a five figure business. That's awesome. But we also, for each of those clients, are paying out $500 to the consultant. So all of a sudden, we only have half that money. You only have $5,000 left after all those clients. That's our gross profit. Now that$5,000 from all those clients added up has to cover these fixed expenses I just talked about. So If I have$4,000 of fixed expenses when I add up my apps and my software and my travel and my staff and my pet care and my whatever my other business expenses might be, then I only have a thousand dollars left, right? So now we've torn off a chunk that we've had to give the consultant, we've torn off another chunk of the bill to put in the pile to cover all those fixed costs we talk about, and we're left with a much smaller chunk of the bill. And that number is called our operating profit. That's the profit we made after we paid the consultants, after we've paid all our fixed costs. But we're not done. But wait, there's more Ginzu knives. Now we got to pay taxes, right? We're going to get taxed on what's left. We had a couple of episodes on this. Even if you don't pay yourself out of a business, you're going to get taxed on that money that's left. So given that you're going to get taxed on that money that's left, you now need to pull out and understand how much is tax there's going to be. And what's left after that is what hits your bank account. And your bank account equals what we call net profit. Okay, so let's go through this one more time because I want to make sure you really get it. Because I want to give you an example now of a business where net profit was zero, okay? Million dollar business, seven figures. They made $1 million. Okay? They had. They did that million dollars with two clients. So they had two $500,000 clients. I'm rounding just to make this easier. The cost of the goods and the labor to support those clients, right? They got two clients,$500,000 each to support. Each one of them costs $250,000 each, okay? So right now each of those clients has a gross profit of 250,000. We got 500. We paid away 250. We've got 250,000 left. It's only two clients, so that means we only have the sum of those two gross profits, right? 250 and 250. We now have$500,000 to cover all the fixed expenses. The fixed expenses in this case of the business were almost $450,000. So they had$50,000 left. So they were walking around bragging about being a seven figure business, which is fine, they are. But they had$50,000 left when it was all over and half of it had to go to taxes. So they had 25,000 left. So their revenue was a million. Their gross profit was 500,000. Their operating profit was 50,000 and their net profit was 25,000. And that's a tiny little number based on such a massive amount of revenue. There are hundred thousand dollar businesses with much higher profit. So think about this for a minute, right? You got to put in a ton of work to be a million dollar business. Ton. You got to hire staff, you got to do things, you got to work all sorts of hours. And you're making 25,000 in the end off. It's going into your bank. But you look next to you at an entrepreneur whose revenue is six figures. They're making 100 grand and after all their expenses, they're putting $50,000 in the bank. You gotta think, do I really want to be doing this or do I want to be doing that? And the key to this question is you don't want to scale something that's giving you that poor of a return. Okay? You don't want to work all that hard. You could get a salary for$25,000 and work a lot less. You can get three jobs and work a lot less and make three times as much. So when you hear these numbers and they sound so intimidating, sometimes when we're in networking rooms, like I know we hear like, oh, we have networking room of seven and eight figure businesses. You can't join us unless you're a seven figure business. We only deal with eight figure businesses. Well, that's naive as hell because I know a ton of eight figure businesses that are making at the end of the day in their banking account a lot less than a six figure business. So remember that when you're walking into a room and maybe getting a little intimidated by some of these claims. So as always, I want to give you a little AI tip here because this is going to be really helpful what you can do. Like some of these numbers are A little bit intimidating and a little bit crazy. You can go into AI and just type in, hey, my typical client pays me $500 a month, and I have five of those clients a month on average. I have to pay X number of dollars for supplies and labor, calculate my gross margin, and then you can say, I have to pay all these bills every month no matter what. Calculate my operating margin, and then you can say, take a stab at what the taxes would be and calculate my net margin. And all three of those can be put right in front of you. And why is this important? What I want you to know is every time you get a dollar bill, how much of it do you get to keep? And that's what these percentages are. So we translated into percentages is what you'll see a lot of the time. So what I might say is, my business has a 50% gross margin, and let's say it has a 20% operating margin and a 5% net margin. What that would mean is every dollar that I make, I get to keep what I say. 10% was the last number there. I think I said to. Maybe I said 20. I forget. Let me do that again. So why this is important is I want you to know every time you get a dollar, how much you keep. And that's why we do this in percentages. You want to know these three numbers. You want to know your gross profit margin, you want to know your operating margin, you want to know your net margin. And the net margin after you've paid all the people that are serving your clients, after you've paid for all the things that are serving your clients, after you've paid all the expenses that never go away, and after you've paid your taxes. That net margin, whatever that percentage is, is the one that you're putting in the bank. And you need to be happy that that's worth all, all the work that you're putting in to have your 6, 7, 8, 9, big, your business. And that's what I really want to focus on here. So, and, and people always ask me, so what's the best margin to have? What should that number be? And the answer is, it really depends. Like, there are businesses, if you've heard this term, low margin business, there are businesses that make very little money on a whole lot of revenue, like billions of dollars of revenue, and they're making, you know, a few hundred thousand dollars. But there are other businesses that are $100,000, and their net margin after everything's done is 50%. I have a couple clients where it's 40%, that's pretty darn good, right? So it really varies on what you do. Are you in an industry that is typically very low margin? Are you in an. Are you, have you been in business a long time? Have you got enough clients to cover your fixed costs? All sorts of things come into this picture, but here's what you can do. ChatGPT tip again, right? Hop into AI and say, Hey, I do such and such. Let's just pick an example. I run a marketing agency. I have, I make $50,000 a year in the marketing agency in revenue. And I want to know, for a typical marketing agency that does what I do and you list what you do, what is a typical net margin after variable costs, fixed costs and taxes. And that'll give you a good target. So literally describe your business, some sort of important variables about your business, how much revenue you make, what you actually do, and maybe what some of your costs are. And say, hey, chatgpt, tell me what typical people in my business make as a margin and that becomes a really good target, right? So, and again, Chat GPT is not gold. I'm not advocating chat GPT. Any AI that you've got, you can even look it up with a Google search if you want. I just happen to like Google for these things or Chat GPT because they the AI does some deeper research for you. So that's it, your three margin check. So do me a favor. Interesting. It's always interesting. See the different margins that are out there and none of them are bad or good. Like a 1% margin can be good, right? It depends on the business. So it'd be cool to see you drop in the comments here what your 3 margins are and I'll drop mine in as well in the first comment. So what's your gross margin? What's your operating margin? What's your net margin and are you happy with it? That's what determines if it's good or bad, right? If you're happy with it. If you're like, yeah, I'm pretty happy getting that much money based on whatever revenue I've got and the amount of work I do, then it's the right margin, right? If you're not happy with it, if you're thinking I work way too hard for that little money, then it might not be the right margin anymore. So challenge you to go take a peek at that. We will be back next week, I promise. Please, like subscribe Drop comments Share this podcast with your friends we really, really want to get as much information as we can out there to entrepreneurs to start to make it so that 20 or 30 or 40% make it through the first five years instead of just 5%. Have a great.