At its most basic, a business exists to make profits. You can’t have anything else—jobs, products, a sense of accomplishment—unless you can turn a profit. Many businesses these days are doing just that: During the first three months of 2014, U.S. corporate profits were more than $1.5 trillion; this is even after deducting falling inventory and equipment values. That’s nearly $17 billion daily!
While this sounds great, just because a company is making a profit doesn’t mean it's doing well. There are many ways to be profitable, and choosing the wrong way can lead to bankruptcy. Let's take a closer look at how we generate profits and assess if those profits are good, bad or really ugly.
Ugly Profits: Earned at Your Customers' Expense
The worst kinds of profits are those made at the expense of your customers and your company’s future growth. Choosing between a losing month and an ugly profit, many business owners go with the latter, especially if they have little cash reserves or fear violating a loan covenant. It's best to avoid this situation entirely. Once you start making money the ugly way, it can be difficult to turn around.
Examples of ugly profits include:
- Using negative-option billing to automatically charge customers for services they may not need
- Upselling customers on products or services that are high-margin but not in their best interests
- Employing hidden fees and charges
- Eliminating all research and development expenses
- Firing needed customer service staff
- Inflating prices in exchange for offering overly generous payment terms
Bad Profits: One Trick Ponies
Bad profits can’t be replicated consistently; they are a one trick pony to give your business a nice boost for the month or year, but that’s it. When looking at a total profit number, these one-time events don’t always stand out; some companies are good at hiding them. While there is nothing wrong with earning a one-time profit, they aren’t repeatable or sustainable. To an outsider, it gives the impression that your company can keep operating at that level of profitability. When the pressure is on to perform, it could lead to more bad profits or, worse, ugly profits.
Examples of bad profits include:
- Capital gains on the sale of investments held by the company
- Profits earned on discontinued products and services
- Gains earned on the sale of company equipment
Good Profits: Reliable and Dependable
You are in business to make good profits. These profits have several key traits:
- They are earned from your main lines of business
- They are repeatable, meaning nothing stops you from earning them again next month
- The sales that generated the profits are made to companies that can and will pay you
If your business falls short of good profits, you may need to consider making important changes to your operations or even consider changing your business model.
Check Your Profits
When is the last time you conducted a thorough analysis of your company profits? You should do this regularly to make sure that you aren’t relying too heavily on one-time measures or failing to invest in key sources of future growth. Prepare a table in Excel that breaks down your profits by source, then evaluate the percentage of your overall profits that come from each source—taking note of the quality of those sources. Your good profits should be at least 80 percent of your overall profits. If not, it's time to start making some hard decisions.
Read more articles on small-business finances.
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