PODCAST - Why Most Businesses Get Profit Completely Wrong (Simple Equation Explained)
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Did you know that most businesses get profit completely wrong and even successful businesses and business owners like yourself don't always have a full understanding of how profit works in our businesses. Now, I went to business school and I studied accounting, got my MBA, earned my CPA, went and worked for one of the big four accounting firms in the world, PricewaterhouseCoopers, and throughout all of this.
[00:02:00] I was never told what the profit equation actually means for a business and how you and I can simply adjust how we run our businesses to increase profit with what we already have. Today on the show, I'm gonna start by sharing with you why most business owners and people in general get the profit equation wrong.
Then I'm gonna share with you the profit equation itself and how you and I can make decisions on a daily basis to increase the profit our business. And then I'm gonna share with you the three ways you and I can increase profit for good in our businesses. Let's start with why we all, including myself as an accountant, as a CPA, as a business owner for more than the last decade, have gotten profit wrong.
Well, here's the biggest problem. Most business owners think that profit works like this, and I understand why, [00:03:00] because this is how I always thought it was until I really dug deeper and learned after years and years of managing my business, e-learning partners and my other business athlete with asthma, that there's more to the profit equation.
Most people think that there's two ways to increase profit. What are they? The first way is to. Increase sales. If we increase sales, we're gonna increase profit. And remember, profit equals, so P is profit equals revenue or income are, or I minus expenses. So if we increase our revenue, we're gonna increase our profit, right?
If we increase our sales, we're gonna increase our profit, right? Not necessarily, and I'll get to that in a second. The second way that we increase profit is how well the other part of the equation, if we spend less money, [00:04:00] so let's decrease our expenses and then we're gonna increase profit, right? Not necessarily because there's other letters in this equation, and I understand you may be listening to this as a podcast, but it's a really simple equation.
Think of it this way, profit equals revenue or income, however you wanna put it. Revenue, the money your organization is bringing in. Your company's bringing in. Minus expenses, the money that your organization is spending to run itself? Well, the thing is that most businesses run the profit equation in this way.
At the end of the year, we look at our business, we're like, well, we wanna increase our profit next year. That means we need to increase sales, we need to increase revenue. Or we look at the end of the year and we're like, we need to cut our expenses by 10%, 20%, 30%, and that's gonna boost our profit margin up.
And then at the end of the next year, we look at everything again. And while we have [00:05:00] increased sales and we've decreased expenses, or we thought we did, our profit margin has stayed the same. And this is the thing, when you and I are looking at running our businesses, we can get really obsessed with these two things, increasing sales, decreasing expenses, but really the only number that we really need to focus on is profit.
And I'm gonna share with you exactly how you and I need to be interacting with this entire equation to increase profit in our businesses and plug the profit leak that you and I. May have. So let's start with breaking down the profit equation. In business school, I was taught most simply before I even jumped into my accounting classes, that revenue is on top.
Minus expenses, and we usually put expenses in parentheses. That means to subtract [00:06:00] equals profit. This is the equation. Revenue minus expenses equals profit. The other way, I like to look at this, and I drew this on the board as we were going through the first two points of why most business owners get it wrong.
I like to look at it as p as in profit equals revenue. R as in revenue minus expenses. I like looking at it this way because I remember growing up in middle school and all these things, we started learning about algebra and we started learning about how when we look at this as an equation, the variables in the equation, which we have R, we have E, we have P, they're all connected.
They all influence one another. And this is extremely important when we're looking at our businesses and looking at how to ultimately increase profit in our organizations and why in the past, [00:07:00] even though we increased sales. We focused on decreasing expenses. We did not ultimately increase profit in the end.
Well, I keep coming back to the equation because we really need to look at this as an entire equation. We can't just manipulate one piece of the equation at a time. And that's typically what we like to do as business owners is we like to look at this and be like, well, if we increase revenue, then we're gonna increase profit.
And it makes sense when we look at this from a math perspective, from a basic equation perspective. If we have $1 million of revenue and we have $700,000 of expenses, then we have $300,000 of profit. So if we increase our revenue to. 1.5 million. We add an extra $500,000 of revenue. Now we're looking at 1.5 million.
We should technically increase our profit [00:08:00] right wrong because how did we get this extra 500 k? Of revenue, and that is the most important part of all of this. So when we're looking at integrating, interacting with this equation, we need to do something else. This is the first thing. We need to increase revenue, not sales necessarily, because there's different ways to increase revenue, but really we need to increase revenue without increasing.
Expenses, and this is where it can get really hard and where you and I need to get really strategic because it's easy to say, well, if we're gonna increase revenue, then how do we do that? Well, we just have to bring in more sales. Well, what if in order to bring in more sales, you have to hire more salespeople?
What if in order to close an extra $500,000, you need to spend more [00:09:00] money, you need to spend more money on sales, more money on marketing. This means that maybe you close an extra $500,000, but maybe you also spent an extra $500,000, or really in general, if we look at this even deeper. In this case, if we close $500,000 more and we make $500,000 more, yeah, you're gonna be at 300 k profit.
Our profit margin hasn't changed. Our revenue went up, but so did our expenses. It's a wash, but if we wanna take this one step further, I like to look at profit margin. So we've been talking about profit, but more importantly, we want to increase our profit margin. Profit margin is the percentage of. Profit that you get out of revenue.
Lemme say that again. This is the percentage of profit you get out of revenue. So if we're bringing in $1 [00:10:00] million a year, we're spending 700,000 and we're making $300,000, this means that our profit margin is 300 K over a million. That's 30%. 30%. Keep this even simpler. Let's say that you made $10 this year.
In order to make $10, you spent $7 leaving you with $3 profit. What's three divided by 10? It's 30%. That is a profit margin of 30%. So what we really wanna do is we wanna focus on increasing profit margin, not just increasing profit. If we just focus on increasing profit, then what ends up happening is we end up spending more and more money.
A lot of businesses will actually start spending a bunch of money on advertising, a bunch of money on different tactics that we're taught to bring more sales in. This is why we don't wanna [00:11:00] focus on revenue. Focus on revenue alone. We set our businesses up for failure, which is why we need to focus on profit, on profit margin, and the levers to do this is revenue without increasing expenses.
That's lever number one. Lever number two is we can focus on decreasing expenses without. Decreasing revenue. You see how these are related? We gotta make sure that if we decide that we're gonna go at this a different way. So. Let's go back to our example here. We made a million dollars, or we made $10, we spent 700,000, or we spent $7 and we made 300 k, or we made $3, depending on what numbers you want to use.
Well, [00:12:00] if we went the other way and we said, you know what? Next year our goal is to decrease our expenses, we're gonna just decrease our expenses. We're gonna try and go from 700,000 and we're gonna cut this to 500 k. We're gonna go from $7 and cut it to $5. Won't that increase profit? Not if we accidentally cut expenses that are bringing in revenue that are directly impacting revenue.
This could actually end up hurting us. We may end up getting rid of the wrong people. So this is what a lot of organizations have been dealing with in the past couple years with AI integrating into companies and mass layoffs occurring, and then realizing, oh my gosh, we just laid off all these people.
They had all this knowledge that was making us all this money, and now that knowledge is gone. 'cause we thought AI actually had the knowledge. But no, it just has intelligence and it's artificial. It doesn't have the wisdom. It doesn't know how our business actually [00:13:00] runs. So now we gotta rehire people. But now no one trusts us because we let everyone.
Go. And even though we cut expenses, our profits fell and it's just a mess. It's a mess. It's a mess. It's a mess. So what we need to look at is when we're looking at cutting expenses, we need to look at what are the expenses that aren't creating revenue. We cut those. And then maybe we keep the $1 million a year and we end up increasing our profit to 500 K.
We spent 500 K. We make 500 K. Our profit margin has increased from 30% to 50%. This is a huge win and I would take this over increasing revenue and increasing expenses at a higher rate, or even an equal rate. I'd rather increase my profit margin. 'cause once we do that, then we can take what we learn doing this [00:14:00] and increase revenue without increasing expenses.
Amazing concept. Now I'm gonna share with you a simple concept that's gonna help you figure out what you need to focus on to increase revenue without increasing expenses and how to decrease expenses without. Decreasing revenue, and it's the 80 20 rule or the Pareto principle, the 80 20 rule, or the Pareto principle states that 20% of what we do creates 80% of results and vice versa.
80% of what we do creates 20% of results. This. Is an amazing role because what it shows you and I is that in our business, 20% of what we're doing on a day-to-day basis, 20% of what our business is [00:15:00] doing is creating 80% of our revenue. 80%. This means 20% of the expenses in our business are creating 80%. Of the revenue.
This also means that 80% of our expenses are creating 20% of our revenue. This is crazy. This is crazy. This is why this equation is so big. So when you are looking at your business and looking at what you should be focusing on, it becomes very simple. We need to identify what is the 20%. Of expenses of investment in your business that's creating the majority of your revenue.
And then let's cut everything else. Let's cut what we don't need to spend money on. Let's focus more money here, and this is going to [00:16:00] increase revenue. Decrease expenses. Ultimately increase profit and increase profit margin. If any of this sounds interesting to you, I invite you to come to my next plug, the Profit Leak Challenge, a multi-day group consulting experience where I work directly with you to uncover the profit leaks in your business.
And in a matter of just a couple of days, we're going to come up with together how to plug the leak forever and help you grow your business to levels that you may have never. Seen possible. This is a multi-day live event where we get to work together and if you buy a VIP ticket, you get to spend twice the amount of time with me, ask specific questions for your business and get consulting on what your next [00:17:00] steps are.
Now I work one-on-one. Know with really high level organizations that pay me half a million dollars plus per year to work together, and the results that I've been able to get for them, including s and p 500 companies, spending millions of dollars for decades to earn. Back millions of dollars after plugging the profit leaks in their business.
You can get access to working with me my multi-day Plug the Profit Leak Challenge and grab your ticket in the YouTube description in the show notes or go to plug the profit leak.com to grab your free ticket. I'll see you in the next episode and I'll see you in a challenge soon.
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Thanks for listening and I'll catch you in the next episode.
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