Which business would you rather be the owner of:
- A business doing $15M of revenue with $100,000 of profit
2. A company doing $5M in revenue with $2M of profit?
Many entrepreneurs think twice about this question, and it's a problem.
It's not a trick question.
Somewhere along the line company valuations and revenue became more valuable than real cash in the bank.
Blame Twitter. Blame bloated startup valuations. Blame whoever you want, but profitable companies are the healthy ones.
You're the only one to blame for what you choose to care about.
An income statement, also known as a profit and loss (PnL) statement, is a record of all monthly revenue and expenses for the company to determine its monthly operating profit.
To put it simply, it's how your company is performing.
The traditional method of setting financial projections and forecasts begins with top-line revenue then moving into the expenses and ending up with profit.
The simplest breakdown of how most owners view it is:
Revenue ⬇️
Cost of Goods Sold or Cost of Sales ⬇️
Marketing/Advertising Costs ⬇️
Operational Expenses ⬇️
Profit 😕
What sad word is left at the bottom?
Profit.
What if we treated the bottom line like the hero instead of prioritizing our top-line revenue and hoping it drops scraps of cash down to our bottom line?
In this common approach, profit is left underneath the table like a dog hoping to catch scraps of steak.
If you go on Twitter, you see CEOs screenshotting their revenue for the world to see, which has nothing to do with profitability and everything to do with ego and the world's perception of our success. The reason founders don't brag about profit is because it's a reflection of their management ability, which isn't always a good thing, and the average person thinks big numbers of revenue are sexier.
Not me. Nothing can get me revved up like a rock-solid bottom...line.
To shift your thinking and zag while the revenue mob zigs is to inverse your income statement and ask yourself:
In order to hit $______ in profit this year, what choices do we need to make in other areas of the company?
Or
In order to get to a ___% monthly profit margin, what do we need to do?
Getting in the habit of focusing bottom-up forces you to set boundaries that ensure business health and challenges you to find creative ways to be more effective operationally.
If your business is generating $1M in revenue and you knew you only had $800,000 to spend to do it, how would you behave differently?
When you play the game of checking at month-end to see if money is left over in profit, you're already losing.
The next step is to go through and review your existing Profit and Loss allocation percentages.
An allocation percentage is the percentage of your overall revenue that is currently attributed to these large categories.
Current Total Revenue = $1,000,000 (100%)
Cost of Good Sold = $400,000 (40%)
Marketing/Advertising = $350,000 (35%)
Operational Expenses (Including payroll) = $200,000 (20%)
Profit = $50,000 (5%)
Doing this will give us a formula to determine the changes we need to make. In this instance, if our target is $250,000 of profit for the year and we sit at 5% profit monthly, then we'd need to hit $5M of revenue to generate that profit. 😳
That's probably not a great strategy to hit that target, so we will now need to address the effectiveness of our other allocations.
- COGS (cost of goods sold)
- Marketing/Advertising Costs
- OPEX (operational expenses)
Your challenge now is, how can I get to that profit mark at the current revenue trajectory? This becomes the game, which is a blast to play. It's why business is the best game in the world.
If you're not currently profitable because you're venture-backed or self-funded in the product-market fit stage, this exercise is a great tool for finding your breakeven point.
Flip that PnL and put your profit target as the top priority. By doing this, you'll pay yourself first and begin operating a healthy business with profit numbers worth bragging about.
With purpose,
KC Holiday
📬 Bonus: I began operating with the inverse income statement at QALO when we had a rough cash period. It was a small tweak that disrupted the complacency success often leads to. Recently, I stumbled across the book Profit First by Mike Michalowicz, who does a much better job of articulating this thinking. It's now one of my favorites. His book opened my eyes to a whole new structure of what it means to care about profit and cash.
In next week's newsletter, I'll share my book notes with you.
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