By Kurt Schindler
When asked, many entrepreneurs don’t know how to calculate how much their business actually makes. For some, everything is ok as far as they can make “enough to live on and save a little”. If this is your case, then read on. If you are a business owner, I am sure that you want your company to grow and be successful. Nonetheless, maybe you don’t know how to estimate your business’ return. This exercise is important because it allows you to calculate if your company is making enough profit in order for you to save and invest. As a financial advisor I have encountered many entrepreneurs who only measure their business return with a simple equation: “I make enough to live on and I have a little extra money to save”.
But, honestly, most do not know if their business actually makes a To estimate your business return, you should be able to answer these four questions:
1. How much have you invested in your business? To answer this, you need to consider how much money you gave for the down payment and how much profit you have reinvested over the years. For example, if you initially financed $30,000 and then brought $20,000 in equipment, your total investment is $50,000.
2. What is your company’s profit after you pay all the expenses? How much is your bottom line? Let’s combine question one with question two. If you invested $50,000 and your yearly gain was $5,000, your business return was 10%. You may have noticed that I did not include the owner’s salary in the earnings because that compensation would be paid to another manager if the owner were not working there. The trick is this: you should be able to differentiate between your salary and the net return of your business.
3. Do you know your business’ value? If you are planning on selling your business, the buyer will need to know its value. As part of the transaction, you should consider that the buyer is essentially acquiring future earnings. How many years of profit can you get? You can obtain all these numbers if you can calculate the business return.
4. How much is your business worth? Are you willing to pay that amount? Clearly you will try to maximize the selling price while the prospective buyer will prefer for the transaction to be at the lowest possible price. I have encountered many owners who overestimate the value of their enterprises because they are adding to the equation the love and years devoted to the company. Just look at the numbers for now. Remember that knowing if your company is profitable will give you the opportunity to secure your capital and guarantee the best investment to protect your financial future.
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*Kurt A. Schindler is the director of Financial Education at Banco Popular de Puerto Rico. He is a Certified Financial Planner® and holds a PhD in Personal Financial Planning from Kansas State University. Recently, he was honored with the George Bailey Service Award by the American Bankers Association (ABA). The award is conferred to non-CEO bank employees who demonstrate outstanding initiative, perform highly effective work and inspire others. It is the only award conferred by the ABA as part of the Community Commitment Awards.