“How much profit should my business make?” is one of those classic questions without any clear answer.
It depends…although I was taught as an accountancy student that a 5% return on sales (or profit on sales) was average and 10% was good.
In fact an old employer of mine had a 10/35 club as they’d set targets of 10% return on sales and 35% return on the money invested in the business. At one stage, I believe my business was the only one in it.
Let’s get specific and look at how much money your business should be making.
Your profit should be enough to:
- Pay you the market rate for your time and energy you spend working in it.
- Provide you with a good return on the money (and other resources) you have invested in the business and have at risk through personal guarantees on business loans.
- Reward your entrepreneurial flair with super profits for your unique and special innovations in how your market and operate your business.
Earlier I talked about the difference in definitions of profit between economists (link)and accountants (link). Hopefully you remember.
Economists say that if there is perfect competition… you wouldn’t be making a profit after you’ve covered the opportunity costs … that’s the opportunity cost of your time, money and other resources you commit to your business.
And if a business can’t cover its opportunity costs, then provided the owners are rational, these loss making firms should stop trading.
Now the real world isn’t perfect and while super profits can be made, businesses can also struggle on at little above subsistence levels for many years (the Death Spiral (link) in action).
Return to P1M2 What Is Profit