Would you rather have a half million dollar company or a million dollar company? If you answered, “It depends”, then you get to go to the front of the class.
Usually when you hear the term “million dollar company”, “multi-million dollar company” or the like, it refers to the gross sales of the company. So a half million dollar company gets $500,000 in gross sales per year. A million dollar company gets $1,000,000 in gross sales per year. Knowing that, which company do you want?
Did you say, “It depends?”
You still don’t have enough information to make that decision. That’s because you haven’t yet taken into account your costs. How much does every sale cost you? What kind of overhead costs do you have?
Typically those two types of expenses are called “direct” or “cost of goods” and “indirect” or “G & A” costs. The first group, cost of goods is directly related to the sale. So, if you sell a shovel, what is your cost of the shovel? If your janitorial company gets paid to clean a house, what is the cost of labor that went into cleaning the house?
The sales amount less the cost of goods gives you the gross profit. Gross profit numbers will vary wildly depending on the type of business you have. Once you have good monthly financial statements, you can compare your gross profit percentage to other months and to other similar businesses. In that way, you can see how efficient you are at fulfilling on the product or service.
The second group of expenses are your indirect, G & A or general & administrative costs. The G & A is comprised of all of the overhead your business has. If you don’t sell a single solitary shovel, you’ll still have to pay the rent. You may not have any cost of goods, but you still have G & A costs. G & A costs can be the hidden enemy of a business in growth mode. You may be tempted to gear up too soon and thus have a big jump in G & A. G & A has a loose relationship with the sales number, but it’s not as closely aligned as cost of goods.
Now, let’s ask the same question, with more information. Which would you rather have: A company that has $500,000 in sales with a net income of 80% or a company that has $1,000,000 in sales with a net income of 40%.
You may quickly pull out a calculator to verify, but sure enough, the net income is the same number. If this is all the information you have, it’s usually a better plan to go with the smaller sized company. There is more efficiency here If you could grow it to a million dollar in sales company with the same profit percentage, that would be a big difference.
But you still don’t have enough information to make an informed decision. We haven’t talked about how much money you have to put in the business. If the half million dollar in sales company took a half million dollars to get started, it would have a much higher capital requirement than the million dollar company that took only $10,00 to get started.
The return on investment is much better now with the million dollar company.
And one more thing to consider, especially if you have a closely held company where you do most of the work. Are you factoring in the value for your time? Or, looking at it the other way, have you accounted for all of the ‘cost of living’ type expenses that a non-owner/employee would not have?
Once you have all of that information, you can really assess how well your business is doing. And once you know how well you’re doing, you’ll know what you need to do more of, and what you need to do less of. Without that kind of analysis, all you’re doing is hoping you’re getting it right.
Watching your numbers, and interpreting the results will help you create a sustainable business that has true asset value.