Or is it a hunch? A dream or wishful thinking? Deeply subjective?
Hunches are great for innovation and growth (I wrote the book about this!) but have no place in the setting of profit goals. Profit goals must be based on the intention of achieving management effectiveness, a risk premium and owner wealth.
This week we’re exploring the idea that a firm’s profit is in part an indicator of owner wealth building.
Wealth Building Must be Planned
Very few owners start their companies with the goal of building wealth. They sort of think it will happen but that is not their driving force.
When they get a few or a dozen years in, they start to think about their company as a key financial asset–assuming it could be sold.
And that’s why profit is a key indicator of owner wealth building: there must be a portion of profit that contributes to owner wealth building, or profit is too low.
What does that mean?
You can’t just declare that x% of profit is for wealth building. You have to make it happen.
The value of a company, and hence the owner’s wealth, rises or falls based on three factors: revenue growth rate, profit increase rate, and business risk.
How to Make Owner Wealth Grow
- Increase rate of revenue growth: Owners drive the identification of markets to be served and of offerings to those markets. The owner must be on top of this issue every day. You can have a great offering and a terrific sales and marketing team but if there’s no demand, there’s no revenue.
The owner should spend most of their efforts on increasing the rate of revenue growth (i.e., from 3% per year to 5% this year, 7% the next year and 12% the next year).
- Increase the rate of profit growth: This is SCALE, although that term is often used incorrectly to mean revenue growth. Scale means the company increases revenue without increasing costs, thus profit grows steadily.
III. Risk reduction: Owners need to be cognizant of the variety of risks that can impact their professional and business services firms. Many risks are related to extensive reliance on technology, so regular technology and security audits are important. There are financial risks, which your CPA, CFO or business attorney should help you reduce. Some risks are harder to nail down, such as internal conflict and problems with company culture. When firm owners understand how these risks impact company profits, they often step up their efforts with risk reduction.
Reconceptualize the Profit Formula
Since profit is critical, I advise that professional and business services firms always keep this equation front and center:
Expenses + Profits = Revenue
This is THE conversation starter, whether with the executive team, the company’s advisory board, each employee in every role and with outside advisors.
When the owner repeatedly asks, “How does that idea/suggestion/recommendation/request help us make a profit from every sale,” people will stop and think. The more they think about this, the more they find ways to achieve it.
When the profit goal is reached and is increased each year, the owner builds wealth. It’s not a once-in-awhile thing, it’s a day-in-and-day-out thing.
What are you doing today to enhance your focus on building owner wealth?