A Guide for Consultants and Freelancers
In my ongoing focus on the Five-line Business Framework, I introduced you to the essential components contributing to a successful business.
Today, we focus on the fifth line of our framework—profitability.
While profitability is important, especially in pricing your services to avoid losses, it is essential to recognise that cash flow takes precedence, especially in the early stages of a small business.
During this phase, your focus should primarily be on generating revenue. New businesses invest more than they earn to survive and grow.
Building a sustainable business involves survival, growth and thriving stages. That doesn't mean you need to expand or add staff rapidly; it's about creating a dependable client base who value your contribution and pay you on time.
To recap, the Five-line Business Framework consists of the following:
- Revenue from product/service sales (which must exceed costs)
- Cost to make or buy the product/service (your time, including materials and contractors and also referred to as Cost of Goods Sold)
- Cost of selling (marketing, advertising and selling costs)
- Cost of running the business (rent, insurance, utilities, subscriptions and administration)
- Profit (revenue less expenses)
- Profit, often called the "bottom line," remains after all costs are subtracted from your revenue.
Profit is More Than Just Numbers
Profit indicates your business's financial health and efficiency. It's an accounting metric that gives you an idea of how your business travels.
Accountants refer to two types of profit:
1. Gross Profit:
What you earn after deducting the costs of creating or buying your product or service from your total revenue. These costs are often referred to by accountants as 'Costs Of Goods Sold'.
2. Net Profit:
After deducting all your costs from your total revenue, this is the amount you have left. Even if your accountant reports a profit, it might not always appear in your bank account, especially for small businesses. That's because the actual cash flow can differ from recorded gains.
Increasing Profit: It's Not Just About Making More Money
Increasing your profitability means increasing your revenue and effectively managing and reducing costs—a dollar saved directly contributes to your bottom line. As an example from my own experience, running my marketing services business, 13th Beach Marketing, involves serving around 18 clients by overseeing their websites and providing various marketing services and advice.
Since many of my services and subscriptions are paid in US dollars, fluctuations in the Australian dollar impact my costs. The stronger the American dollar, the higher my expenses, directly affecting my business's revenue and overall profitability. However, continuously raising prices for certain services may make them less competitive, leading clients to seek alternatives. The danger is that some of my services become a commodity.
Consequently, analysing the profitability of specific services makes me want to change the nature of my business.
Strategies to increase profit include
Upskilling: By improving your skills, you can offer more value to your clients, justifying higher rates.
Package services: Consider bundling your services into packages rather than charging by the hour. It's often an easier sell and can improve your earnings.
Reduce direct costs: Take a hard look at your suppliers. Can you get a better deal somewhere else? Remember, time is also a direct cost. Can you be more efficient?
Consider how to increase your revenue while keeping your fixed costs steady so they become a smaller percentage of income.
Marketing efficiently: We discussed this in our article about the cost of selling. Be strategic and measure the return on your marketing spend.
Control administrative costs: As explored in the last article, keeping these costs under control can significantly improve profitability.
What to Do with Profit
Firstly, retaining some of the profit as a buffer helps smooth out the cash flow when things are slower, invest in new equipment, boost your marketing effort, or sign up for professional development to improve your skills or business operation.
Pay yourself first and charge enough to make this reasonable. Again, it will depend on your industry.
Save for taxes
A percentage of your profit is taxable in Australia and many other countries.
As a sole trader in Australia, you pay the same tax as an individual. The rate varies from 19% to 45%, depending on your income. In addition, we pay a 2% Medicare levy.
If you're operating as a company, as I do, the corporate tax rate is a flat 25% for revenue under $50m.
That means if your revenue is $100 000 and your net profit is $20 000, your tax payable would be $20 000 x 25% or $5000. Interestingly, many huge companies pay little or no tax, possibly the same for many smaller companies, depending on your profitability. Your accountant can advise you on this issue.
Optimising Your Business
The five lines may seem straightforward, but mastery over them gives you a better idea of how to think about the money side of running a business. Use the five lines to help make business decisions so that your charges reflect the actual business costs.