Today we’re going to answer another frequently asked question about Profit First. If you’ve been on a journey of exploring Profit-First strategies, you’ve likely come across the term “real revenue.” In this blog post, we’ll dive into the concept of real revenue and discuss how understanding and increasing it can significantly impact your business’s profitability.
Understanding Real Revenue and Total Revenue
To kick things off, let’s clarify what we mean by “real revenue.” Often, the terms “total revenue” or “gross income” are associated with revenue, and they all essentially refer to the money that flows into your business’s checkbook. It’s the sum total of all income, regardless of its source, including checks, credit card payments, and cash.
However, managing expenses is an area where many businesses struggle. They pay their bills, make investments in new equipment or technology, and often find that there’s little or no profit left. This is where the Profit First approach differs. In this system, a percentage of your income is allocated for profit before any expenses are paid. But here’s the crucial question: what is the base number on which you calculate this percentage?
Calculating Real Revenue for Profit First
The key to implementing Profit-First successfully lies in determining your real revenue. Real revenue is the income you have left after deducting the cost of goods sold (COGS). COGS includes expenses directly related to producing your product or service, such as materials and subcontractor costs. Let’s illustrate this with an example.
Imagine you run a contracting company that brought in $500,000 in a year. To find your real revenue, you subtract the cost of goods sold, which in this case, includes expenses like materials and subcontractor fees. If these expenses totaled $200,000, then your real revenue is $300,000.
Knowing your real revenue is vital because it serves as the foundation for calculating the percentages you allocate for profit, owner’s pay, and other business needs. There’s a chart in the Profit First book by Mike Michalowicz that provides guidance on what your ideal percentages should be based on your real revenue. So, in the example of the $500,000 contracting company, it’s essentially operating like a $300,000 company for profit allocation purposes, not $500,000.
Real Revenue in Service Industries
While the contracting example makes real revenue calculations relatively straightforward, it’s important to note that service-based businesses can also benefit from understanding and applying this concept. Take a market research company, for instance. If they generate $500,000 in revenue but need to pay $250,000 to their surveyors (who are 1099 contractors), their real revenue is $250,000. They should then allocate their profit percentage based on this real revenue figure, not the total revenue.
On the other hand, in a painting company, where the cost of paint and related materials makes up less than 25% of total revenue, you may not need to separate it out for Profit First purposes. In such cases, total income is effectively the same as real revenue, simplifying your profit calculations.
Reevaluating Your Business Size
Understanding your real revenue can fundamentally shift your perspective on your business’s size and performance. It’s not just about boasting a million-dollar or multi-million-dollar company; it’s about recognizing that if your cost of goods and subcontractor costs account for a significant portion of your revenue, your real revenue may be substantially lower.
This insight makes you carefully consider your expense percentages, not just for profit but also for other crucial aspects of your business, such as employee costs and rent as a percentage of your real revenue. These numbers hold the key to strategic decision-making and growth.
Increasing Your Real Revenue
Now that you understand the importance of real revenue, let’s discuss strategies for increasing it. While many businesses focus on boosting top-line revenue, more income doesn’t always translate into more real revenue or profit. For example, in the contracting industry, a large contract might yield minimal real revenue if expenses eat into the margins.
Here are some practical steps you can take:
- Reduce Cost of Goods Sold (COGS): If you’re in a product-oriented industry, like retail or manufacturing, look closely at your COGS. Look for opportunities to streamline production, negotiate better supplier deals, or optimize your supply chain. Lowering your COGS will directly impact your real revenue.
- Operational Efficiency: In service-based industries, where COGS may not be as significant, focus on operational efficiency. Identify areas where you can reduce labor costs or improve productivity. Streamlining processes can increase your real revenue without necessarily increasing sales.
- Strategic Sales Growth: Increasing sales remains a vital goal, but it’s crucial to do so strategically. Target high-margin products or services, optimize your pricing strategy, and explore upselling and cross-selling opportunities. Effective sales strategies can boost both total and real revenue at the same time.
- Bulk Purchasing: As we mentioned earlier, buying in bulk can lower your per-unit costs for materials or supplies. Negotiate with suppliers for volume discounts, and watch your real revenue grow as your expenses decrease.
Incorporating these strategies can help you not only enhance your bottom line but also accelerate your journey toward Profit First success. Remember that at Matterhorn, we specialize in helping businesses not only grow their top line revenue, but also increase the actual profits of the business, so don’t hesitate to reach out for more guidance.
In the world of Profit First financial management, understanding and optimizing real revenue is a game-changer. It shifts the focus from total revenue to the income that genuinely impacts your business’s profitability. By calculating real revenue and aligning your profit percentages accordingly, you can achieve financial stability and sustainable growth.
So, whether you’re running a contracting company, a service-based business, or anything in between, the principles of Profit First can transform your financial outlook. Start by determining your real revenue, exploring ways to increase it, and watch as your business thrives with a newfound financial strategy.
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About Abby Johnson
Abby Johnson, is Matterhorn Business Development’s Chief Mentor, resident organizational genius and Certified Profit First Professional, helping our clients grow and organize their businesses. With a passion for empowering businesses to thrive and extensive experience in helping clients grow their revenue and manage their finances profitability, she’s committed to making a positive impact on your business.
About Greg Winteregg
Greg founded Matterhorn Business Development to assist small business owners in growing their businesses and increasing profitability at the same time.
He was an internationally recognized lecturer, sales trainer, and management consultant who spent close to 30 years working with professionals and small business owners across the US and Canada.
In 2019, he authored his book “Fun at Work.”