You understand that the 5% rate of return is compensation to you for two factors: the opportunity cost of not having that money for something else; and the risk that something could happen, and you’ll lose your money. You also know that higher rates of return reflect higher risks and larger opportunity costs.
Now imagine, instead, your company books $105,000 in revenue for the year. Again, keeping this simple for our discussion today, let’s say that at the end of the year your Profit & Loss statement shows a $5000 profit. Your accountant would tell you that the $5000 profit demonstrates that the company covered all its expenses with the $105K revenue and there was $5000 left over.
This is the definition of profit, and you’ll find it everywhere. Profit = Revenue-expenses.
In the next breath your accountant or CFO will tell you that you could use the profit to invest in the company, such as through an expansion, purchase of new equipment or technology or perhaps an acquisition. The CPA or CFO might say that the profit builds equity for the owner.
What gets lost in this conversation is “why” the owner should build their equity.
Why Owner’s Equity?
Owner’s equity is the compensation for the same factors an investor considers with a financial investment: opportunity cost and risk. You might have used the money you spent (expenses) for something else–your opportunity cost; and you took the risks that your decisions and choices would generate revenue that more than covered expenses. We all know that market risks are varied and unpredictable.
I add a third reason why owner’s equity is important: It is compensation for the hard work of being the business owner. The owner’s compensation package recognizes the work inherent in the job of CEO or President, Partner or Principal.
Ownership is way more than a job. Ownership carries immense responsibilities, the company is never far from your mind, you have obligations to many stakeholders. Increases in owner’s equity is reward for the responsibilities that go far beyond the work or job description.
Ownership forms the bulk of your estate, which has implications for long-term wealth accumulation and eventual distribution. You could work hard for 30 years, and if you haven’t prioritized building owner’s equity, your wealth after exiting the business will be no more than if you had worked for someone else.
How to Make a Profit
Profit is the result of many decisions, including what you sell and who you sell it to; how you think about and deliver value; and everything you can imagine that encompasses sales, marketing and customer relationships and service.
If you’re curious about some of my methods for coordinating decisions so that they lead to owner’s equity, please go to downloads page on our website. We’ve got four downloadable profit-building Systems that will help you think about how to increase company profits and your owner wealth.
You, and only you, are responsible for building your owner wealth. Please make that your priority every single day. If you have questions or are interested in some hands-on, personalized advice, I would love to hear from you. 703-801-0345.