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Lesson #2 - Know Your Profit Margins and Other Key Business Ratios

Austin Church

by Austin Church


Apr 23, 2013


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Last week, I shared one of my best money making ideas: stop the bleeding. Stop wasting money. As sound as that advice may be, it's nothing more than a Band-Aid. So let's move on to Lesson #2: Know your key business ratios.

Guys in fancy suits and silk ties love to talk about their "profit margins." You've probably heard the term and winced. You'd just as soon eat glass as have a conversation about profit margins.

But if your business is like most that sell creative services, you might be doing good work for good clients and still coming up short each month. Or barely making a profit. 

The zeroes on the paychecks look good, but where does all the money go?

You have to keep tabs on the difference between the amount of money that a project brings in and the amount that you take home.

Let me share a recent example from my business

A local landscaping company wanted a website and some social media profiles. They wanted a hands-off experience, or what I call "the fish." They did NOT want to be taught how to fish. They just wanted my assistant and me to tell them when everything was finished.

I gave the owner a quote for $3100 for a WordPress site with a template design from Elegant Themes, content for the site, a year of hosting, some light photography work (a few portraits for the website), and set-up for 10 different social media accounts.

What were my costs?

  • Elegant Themes Lifetime Access license
  • Contract work: my assistant's time
  • Contract work: paying a developer friend to set up the new hosting account and a Gmail account
  • Contract work: paying a college kid with a good eye to go take some pictures
  • Hosting (I usually charge my clients $10/month to offset my costs for a HostGator reseller account)
  • Federal taxes!

By the time I pay everybody that I owe, including the IRS, I'll make less than $2000! 

In this case, that means I netted about 60% of my gross. I usually pay myself a "salary" that is less than 50% of what the business makes, so my family and my business will be fine.

But you can still see the potential problem, right?

If I had ignored my profit margin and other key business ratios and assumed that all of the $3000 would go straight to paying my family's bills, then I would have had an uncomfortable choice to make: not paying my personal bills or not paying my contractors and other service providers. Ouch.

Even though it's always nice to see $3000 splash in my bank account, I know it's going to take A LOT more than that to keep everything afloat!

If you mistakenly believe that you're already making enough money, you'll put sales on autopilot. You'll focus on the projects you've already got. You'll create art!

And you'll be scratching your head when your bank account has a negative balance.

Your homework is answering these questions:

  1. How much do you need to cover your monthly personal expenses, including health insurance, life insurance, savings, investments, and all that good stuff that "grown-ups" have?
  2. How much does your business cost to run each month, including overhead, utilities, service providers, employees, contractors, meals, travel, and so forth?
  3. What will be your tax liability this year? Add #1 and #2, take 10% of that total, and multiply that number times three.
  4. How much should you be spending on marketing or saving for business development (i.e., a new website, startup capital for a new business venture, hiring a full-time employee, or even a new laptop)?

Add up those four figures.

Now put on your thinking cap again (the straw fedora), and ballpark how much your average project is worth.

So how many projects do you really need each month?

Divide your monthly total by your average project price, and Presto! You now have a more precise understanding of your key business ratios. You know how many projects you need each month to truly stay profitable.

Categories: Business, Complete Elephant | Tags: key business ratios, best money making ideas


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