Just like our earlier bank account example (link to the economic definition of profit), the money invested in your business could be earning a nice safe return in the bank…or you could aim for a higher but riskier return elsewhere.
You may have also given personal guarantees to your bank to secure a loan so your business is getting more money at a lower interest rate – and you should recognise that cost.
Perhaps you have so much money invested in the business, you don’t need to borrow anything…but if you didn’t have that wealth, you would have to borrow from a bank…or even worse, a venture capitalist. And they’d expect a big return on their investment.
I believe you need a return for your money invested or pledged and just like your time, you have two possible bases:
- How much you can earn elsewhere at a similar risk
- How much you would have to pay to get the money from another source
Since the first is difficult to assess, I recommend you use the second.
Before the credit crunch average bank margins for small to medium sized businesses used to be 3 to 5% over base rate.
To gain a better idea of current conditions, I suggest you ask your bank or any friends who own small businesses and borrow.
Return to P1M2 What Is Profit
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