Estimated reading time: 10 minutes
In many businesses, there is the tendency to want to hang on to profits and simply reinvest them back into the business. While this is a valid approach to some extent, it often results in the owners seeing very little of their hard-earned profits.
In fact, some businesses find themselves holding onto their cash surplus, even when there is no obvious avenue for reinvestment. This hesitation may stem from a fear that the surplus might be needed later or from the belief that every penny must be reinvested or else growth will stagnate.
These businesses, as aptly described by Mike Michalowicz in his book Profit First, can be likened to “cash-eating monsters. They devour every ounce of profit and leave little to nothing left for the owners to live on. This leaves the owners financially stressed and unable to give 100% to the business, which just deprives the business of their valuable input, making it even harder to generate profits and thus putting the owners under further stress.
In this post, I’ll discuss how to allow your business to serve you, and end the cycle of burnout. By understanding the importance of taking a profit, you can stop feeling like a slave to your business, ensuring that it becomes a source of fulfillment and financial stability for you.
The Purpose of Business
It’s often said that the purpose of business is to generate a profit. And that is indeed part of it.
But I see a business as a contract between the business owner(s) and the customer. The business owner provides value to the customer by means of the inner workings of the business; and the customer pays money, which covers all the costs of providing that value, and what’s left is profit for the business owner.
You can see it like a machine. The customer puts in their money, and the machine provides two outputs: value to the customer in the form of a product or service, and profit for the business owner.
The input is important for obvious reasons: it’s what lets the business do what it does. Without money from the customer, it wouldn’t have the energy to function. It’d be like trying to run a car engine without gasoline.
The value to the customer is an essential output. Without such value, the customer would have no incentive to provide the cash. Word would quickly spread that the business didn’t offer any value, so the customer base would dry up.
But though it might not seem obvious, the profit paid to the business owner is a necessary output, too, without which the business simply couldn’t function.
The Value of the Owners
Let me put it this way first: there is actually a second input into our business machine. That input is the value that the owner(s) bring to the business.
It could just be extra capital, in the case of an investor. It could be expertise. If you are the sole owner of your business, then it’s all of the above: all the money, time, energy, expertise, and skill that you’ve brought to your business.
Just as in the first input (cash from customers), the business couldn’t operate without the value the owners bring to it.
On the other hand, every owner of a business does what they do because they expect a return. It’s not selfishness: it’s just simple economics.
If you knew that your business would never return any value back to you, would you keep running the business? Sure, you might love what you do and truly care for your customers, but you need to live, too. If you had to keep a full-time job just to have the ability to run your business, no matter how altruistic you might be, your business wouldn’t be getting your 100%.
It’s even more obvious when you introduce other shareholders into the equation. If you wanted to get an investor for some extra capital, but you told them they would never get a return on their investment, how many investors do you think would be interested in that kind of one-way relationship?
So just as the customers give money in order to get value, so in sort of an inverse way, the owners give value (and possibly money) in order to get more money down the road.
But What About Reinvesting Profits
But you might ask, “How will my business grow if I don’t reinvest the profits?”
There are indeed businesses that provide no profit distributions to their owners at all, for the time being. Amazon is a really good example of a company that does not pay dividends.
OK, so let’s follow this thought experiment, then. Let’s say you purchase 100 shares of Amazon (AMZN), which at the time of writing are going for $139.74 per share. Your 100 shares are worth $13,974.
So let me ask you, why did you purchase those shares? Did you purchase them hoping that in a year’s time, you could get exactly $13,974 back for them?
No, of course not. You bought those shares with the hope that you could get more money back later on.
So in a year’s time, let’s say those shares have gone up30% to $181.66. You made a nice $4,192 profit.
But why did someone buy those shares from you? once again, they bought the shares because they believed they will be able to get more for them later on.
And so the cycle continues: no one buys shares unless they believe they can get more for them in the future.
Meanwhile, Amazon is happily making profits and reinvesting them back into the business. Shareholders aren’t seeing a penny of those profits. All seems well: Amazon is growing, and lots of people are making money off of selling shares for more than they were worth when they bought them.
But what gives those shares their value?
It’s the belief that those shares will one day be able to be traded in for some concrete value: that is, the belief that they are actually worth something.
If Amazon announced tomorrow they will never, ever pay a dividend — in other words, that they will never pay out profits to their shareholders — those shares would be worthless pieces of (digital) paper.
If shares are just traded from one investor to the next, but will never actually (1) result in profit distributions, or (2) be purchased back for some concrete monetary value, then the last investor in the chain will just be left holding the bag, so to speak. The value of those shares comes from the belief that they represent a stake in a company that generates profits and, eventually, can provide a return to the shareholders.
So sure, your business can reinvest its profits, but there would be no point unless you could eventually expect some return from that growth.
Your Business Needs You
“OK,” you might say, “so I’ll reinvest my profits for now, and later when my business has grown, I can start taking distributions.”
But there’s one significant difference between your business and that of Amazon: Amazon doesn’t need each individual shareholder. Each shareholder might only provide a few thousand dollars, while Amazon is worth over $1.4 trillion.
But your business needs you. It needs your vision, expertise, skillset, time, and dedication. Your contributions are the lifeblood of your business, the driving force that propels it forward. Your unique expertise, passion, and dedication are irreplaceable and invaluable. You’re not just an investor in your business — you’re its heart and soul.
Your business needs your 100%. And in order to get that 100%, it needs to reward you via the profits it generates.
So it’s of value to not only you, but also to your business, to find a way to take a profit now. It might only be a token value at first if there isn’t much profit to speak of, but the act of taking a profit is paramount to running a successful, profitable business that will serve you long into the future.
Finding a Balance
That’s not to say that reinvesting profits isn’t a good thing to do, within reason. It can indeed lead to greater growth, which leads to greater profits in the future.
It’s all about balance: taking enough of a profit now to live comfortably, while leaving enough profit to reinvest to fuel the growth of your business.
It’s not either-or. The balance depends on you and your individual needs.
However, many business owners put themselves at the bottom of the list of financial priorities, always prioritizing the business’s growth over their own well-being. They mistakenly believe that reinvesting all profits into the business is the only path to success. In reality, finding a balance between taking a reasonable profit now and reinvesting in the business is essential for long-term sustainability.
But at the same time, reinvesting isn’t always necessary or even all that feasible. For example, as a bookkeeping business, the overhead of Possible Promise Financial is rather low. There just aren’t all that many expenses.
That translates to a high profit margin, and there’s only so much I could reinvest that profit back into. I don’t have much of an advertising budget, and I’m not going to take on new expenses just because there’s the money to do so.
In fact, that’s why I wrote this post in the first place. I was looking at Possible Promise’s budget the other day and almost feeling guilty for how much of a profit there was. It almost felt like the business should have more expenses, just to have something to feed profits back into.
But I realized, the business isn’t here to amass a large cash balance. It’s here to offer the services it offers within the budget that it requires, and then the rest of the cash can, and should, flow back to me as the sole owner.
If other expenses arise, then sure, I can invest in those. But otherwise, there’s no benefit to hoarding cash just by some misguided notion that it’s better for the business.
Your Business Should Serve You
Your business should serve your customers, of course, but it should also serve you as the owner (and of course any other owners there might be, too).
Remember there are two inputs I discussed as part of any business:
- Money from your customers
- The value that the owner(s) bring to the business
Both of these inputs are equally important for the proper functioning of your business.
Similarly, there are two outputs:
- The value that your business creates for its customers
- The profit that the business generates for the owner(s)
Just as before, both of these outputs are equally important. Without either, the business could not function.
Your business is a mutually beneficial contract between you and your customers. You provide value to them, and they, in turn, provide money, which not only covers the costs but also results in a profit for you. This profit is your reward for the value you bring to the business, and it can and should be withdrawn to cover your own personal needs and wants.
Such an urge is not selfish: it is the natural result of a successful business. A business should create value for both your customer as well as for yourself. If either element is missing, then it is imbalanced and will result in issues down the road.
Your business is just the middleman, as it were, to create that value on both sides of the equation. It is quite literally a value-generating machine. If you refuse to allow that value to be expressed on your end, you are stopping your business from what it was made to do.
I hope you found this post helpful and will now feel more empowered to draw a profit for yourself.
However I know sometimes it’s hard to know how much of a profit you can even afford to take from your business. If your books aren’t accurate or up-to-date, then you’re operating on incomplete data.
As a bookkeeper, I can work with you to bring your books up-to-date and determine how much of a profit you can take to support your needs as the owner. To get started, just click the link below and schedule some time for us to discuss your needs.Schedule a Free Consultation