Business owners often ask how much their business is worth. Perhaps surprisingly, the answer is often nothing. When we look at the real profitability of the business, it often turns out that they are actually making a loss. This is because when calculating a business’s profit, key elements are left out of the calculation.
What is true profitability?
To get a proper picture of your business, you need to know its true profit, i.e. What is the profit the business is making for you as the owner? To calculate this, you need to account for the market value salary of the business owner(s). Often, for tax reasons, only a minimal salary for directors is included in the profit and loss account. However, we need to make an adjustment to include the market value of the business owners’ salary to see what the real profit is.
What is your market value salary?
The market value of your salary is how much the job your doing is worth. For example, how much would you need to pay someone else to do the job that you are doing? It has to be a fair and realistic figure. One reason for accounting for market value salaries is if you don’t pay yourself a proper wage for the work you are doing, then how can your business really be doing well? You may have a reasonable turnover, and it may seem like you should be making a profit, but if you are not paying yourself enough you need to go back and look at what the profit would look like if you include a fair market salary. Often once this has been factored in, a business will actually be making a loss.
Why true profit is important?
There are many reasons for starting a business, and if one of yours is to eventually sell the business and/or become wealthy, it is the extra profit over market salary which is important. From an outsider’s perspective, for example someone looking to buy your business, true profit, after market salaries is the relevant figure which they would be looking for.
To look at this in a bit more detail- If after adjusting for market salary, you make a loss, then you essentially have a low paid job. If you break even, then all you have is a market rate job, nothing extra. However, if you make a profit after market salary has been deducted, then your business may then be worth something.
For example, if your business makes a profit of £30,000 and your market salary is say, £40,000, then you have actually made a loss of £10,000. On the other hand, if your business makes a profit of £100,000 (ignoring tax to keep it simple) and your market salary is say £40,000 then the true profit is £60,000 which is what someone who bought the company would make each year without having to work in it.
Advanced business planning software
At Rosslyn Associates, we have software that can help you by demonstrating clearly the true profitability of your business. Our software helps to by creating a clear picture of your business which helps with decision making. By looking at the overall structure of your business you can clearly see where changes can be made to increase the profitability of your business, and with our support and guidance your business can reach its true potential.
Get in touch
If you are struggling to get your head round the numbers, if you think your business is making a lot of money but you don’t seem to be taking any home, or you just want some support with the planning of your business, get in touch! Rosslyn Associates provide business planning services to help your business grow. By using our expert knowledge in tax, accounting, coaching and business planning, and with the help of our advanced business planning software, we can help you create a great business and realise your dreams! For more information send us an email at email@example.com or call the office on 0131 445 1825 and one of our team will be happy to help.