Experience-Testing Question
If you sold $1 million dollars worth of product, how much money would you make?
Sometime last year, a contractor sat across from me, frustrated that I wasn’t budging on his rationale to increase his rates. “You guys have a big business,” he said. “You can afford it.”
Despite our sales being less than a million dollars, the contractor thought our business was “huge”. From his sole proprietor’s perspective, I can understand why the contrast between our two businesses was so striking to him. His modest sales volume and his level of experience were reflected in the way he ran his business: with very little distinction between he, the person, and he, the business. Whatever sales he made, he classified as income. And he justified unnecessary expenses with a classic excuse: “It’s a write off.”
In contrast, our business was mature enough to distinguish between necessary and unnecessary expenses. We knew the difference between sales and income — that not every dollar sold is a dollar made — but to try and explain that to the contractor would have been near-impossible. He just knew that our business grossed several times his and therefore we must be making tons of money. How could we not?
It’s a classic mistake, but the truth is that sales and income are not synonyms. From each dollar sold, a business must subtract:
- The cost to make the product;
- The cost to transport it,;
- The cost to import it:
- The cost to store it;
- The cost to package it;
- The cost to advertise it;
- The cost to market it; and
- The cost to sell it.
But those are only the direct costs. In addition to direct costs, additional costs must be subtracted from sales for staff, benefits, phone, utilities, rent, office supplies, computers, pens, pencils, filing cabinets, desks, legal fees, accounting fees, and on and on and on.
Then, after all that, if management has done its job, some money will still be left over. That amount left over is the amount of money that you’ve actually “made” — net profit. And right after you figure out how much you’ve made, the government comes knocking and confiscates its share.
So don’t be fooled that what a company grosses is also what it makes. As the recent embarrassments in the stock market have revealed, size means nothing. Sales do not guarantee profit. Huge companies can gross billions and still lose money. (Just ask GM and Crocs.) The central point is that sales do not equal income, and the best test is to focus on what the government focuses on: taxes. Taxes only apply to your net profit, the money you’ve actually made.
Experience-Testing Question
Q: If you sell $1 million dollars worth of product, how much money did you make?
A: What portion of the $1 million did the government tax?
