Why are small business owners so fixated on revenue over profit? Is it that high revenue numbers create the impression of success? Or is it that revenue indicates a company’s market share or dominance over a competitor? Maybe since it’s impolite to talk about how much money we make, quoting our revenue instead of our profit keeps us courteous?
There’s an old business quote that says, “Revenue is vanity, profit is sanity and cash is king.” The author is unknown, but it makes you wonder if he came from the sign business.
I occasionally get a chance to speak with new sign franchisees and one question I pose to them is, “How many of you would be happy with a store that sold $2.1 million and took home 10%?” After the show of hands, I ask, “So, which is more exciting to you, the $2.1M in revenue, or taking home the $210,000 profit?”
I find it interesting that when owners first start their business, they always answer with $210,000 net profit, but once they’re up and running, they tend to focus more on growing revenue rather than concentrating primarily on growing profit.
Let’s look at a revenue focused shop verses a profit focused shop and compare the differences. The revenue focused shop sells $2.1M and makes 10%. The profit focused shop is a $700,000 business making 30%. Both stores show a net profit of $210,000, but which store has fewer employees with less equipment, debt, risk and stress? Which owner feels like they’re making more money?
A more impactful way we can look at the net profit % of two shops is to understand what it would take for each of them to earn $100,000 more profit. Assuming their financial ratios stay the same, the 10% net profit store must sell an additional $1,000,000 in signs to take home $100k, but the 30% store only needs to sell an additional $333,000. They can make the same amount of profit, with a third less work.
Broken down even further, the 30% net profit store can take home $100,000 more a year with just an extra $1,300 a day in sales. This probably wouldn’t require any more space, employees, or equipment. The additional $1 million in sales needed for the 10% net profit store would certainly require more employees, and possibly more equipment and more space. This additional $1M of work would certainly add more risk, not to mention more stress and possibly more debt.
The factor that impacts net profit % the most in a retail sign shop is the balance between in-house and subcontracted products. We call this Product Mix. You can bet that a 30%-40% net profit retail sign shop makes almost all their products in-house. But if this shop starts to sub-contract a large percentage of their business, they’ll find their net profit % declining and will have to increase revenue to make up for the lost profit.
When you think about it, a retail sign business is essentially two separate operations. The first operation, the products we make in-house, is super profitable with very little risk. Cost of Goods is super low, with most in-house products having markups of 5x to 10x. The best part of this business is that its team members can run the majority of the day-to-day without the owner’s involvement.
The second operation consists of the products we sub-contract. These projects come with significantly more risk and much lower margins, with markups usually averaging around 2x. Since shops have little control over the quality and timeline with subcontracted projects, these jobs can create super stressful situations if products are made incorrectly or if deadlines are missed. Because of the higher price tag of most subcontracted work, the owner often feels the need to personally oversee the projects, resulting in less work being delegated to their team and more work for the owner.
Subcontracting too large a percentage of their sales will usually cause a retail sign shop to struggle with low profitability. If 50% of their business is subcontracted, they’ll water down their overall margins so much that there often isn’t enough cashflow to consistently cover wages and expenses. In many cases, a store could turn down a large portion of their subcontracted jobs and actually take home more profit. Especially if they focused their sales efforts on higher-profit, in-house customers, they could often work less, have fewer employees, and take home more money. Isn’t this really the goal of a small business owner?
When I do this math with sign shop owners, I find that the vast majority won’t give up subcontracted revenue to ultimately pursue higher and easier profits. They forget what excited them when they were brand new and will give every reason why an in-house focused business model that generates 30% – 40% net profit just wouldn’t work. It’s like someone who won’t give up a luxury car lease to become debt free. Just as the luxury car is a measure of success, the million-dollar revenue, the large shop, the cool equipment and all the employees can feel like a measure of success as well.
As entrepreneurs, we know the risks involved with starting a small business and that high-risk investments should generate high returns. If you’re just looking to just earn 10%, a good mutual fund might be a much easier route. So, which will you choose, vanity or sanity?
Roger Robinson has owned Signarama North Dallas for 23 years and teaches the brand’s Profit-Focused Sign Shop Master’s Class as part of Signarama’s Masters Academy.
This article was originally published by Wide-format Impressions