Yes, you are getting multiple credit alerts but is your business profitable?
SME Accounting 101: Why understanding the numbers behind your business could mean the difference between thriving or barely surviving.
I’ll tell you right now—this is a mistake I’ve seen so many entrepreneurs make, including myself early on. I’m talking about confusing gross profit with net profit. It sounds basic, but it’s a critical distinction. One that can make or break your business, especially in a volatile economy like ours.
Take Alex, for example. He sells a product for N10,000. Sounds great, right? But here’s where many entrepreneurs stumble: Alex gets N30,000 in total sales after a customer buys three units. But does that mean Alex has N30,000 in his pocket as profit? Not even close.
This is the illusion many business owners live with—they assume the money coming in is all theirs to spend. But here’s the truth: that N30,000 is not all profit. Not by a long shot.
The Sales-to-Profit Illusion
Early in the game, many entrepreneurs make the mistake of thinking sales and profits are the same thing. They look at their revenue and think, "This is all mine to spend!" But if you’re not keeping track of your costs—whether it’s inventory, overhead, taxes, or other expenses—you’re setting yourself up for a rude awakening.
Alex, for example, doesn’t get to keep that entire N30,000. He has to subtract things like product costs, shipping, packaging, marketing, and taxes. Those expenses can chip away at his profit quickly, and before he knows it, that N30,000 might feel more like N5,000 or less.
The Profit Engineering Formula
Here’s where financial discipline comes in. This is where you stop letting your numbers control you and start controlling them. Profit engineering is about understanding what makes your business profitable, and more importantly, how you can sustain that profit.
Ask yourself these tough questions:
Are my prices right? Are you charging enough to cover your costs and still make a profit?
Are my costs too high? Could you reduce waste or buy in bulk to lower costs?
Is my quality up to par? Are you losing money on returns and replacements?
By breaking down your business and tracking the numbers that matter—like cost of goods sold (COGS) and operating expenses—you can start to see where your money is going. And, just as importantly, where it’s coming from.
More Sales ≠ More Profit
Let me make this crystal clear—more sales don’t automatically mean more profit. You could be selling more, working harder, and still not making money if your costs are swallowing up your revenue. Just because the sales are rolling in doesn’t mean you’re profiting from them.
This is why understanding your costs is crucial. If you don’t know how much it costs to produce, market, and deliver each product, how can you expect to understand what your real profit margins are?
Case Study: Alex Revisited
Let’s take Alex back to the drawing board. His product costs him N5,000 to make. So, after the N10,000 sale, he’s left with N5,000 in gross profit. But when he factors in his packaging, marketing, and taxes, his actual net profit could be as low as N2,000—or even less.
If Alex doesn’t understand this, and he’s been spending his revenue like it’s all profit, he could find himself in a financial mess without even realizing it. That’s the trap so many small business owners fall into.
The Importance of Understanding Your Financials
The bottom line? Get to know your numbers—inside and out. Track not just your sales, but your costs and expenses. When you understand your real profit (the net profit), you’ll make more informed decisions about where to spend and where to cut back.
Should you raise your prices? Cut your expenses? Or maybe stop selling certain products that aren’t profitable, even if they’re popular? These are the tough, but necessary, questions that profit engineering helps you answer.
Sometimes, the best thing for your business is cutting out what’s costing you too much, even if it’s a product you love. It might sound counterintuitive, but if it’s not making you money, it’s not worth selling.
So, here’s the takeaway: don’t get caught in the trap of confusing gross profit with net profit. They’re not the same thing, and knowing the difference could be the key to not just surviving—but thriving in this economy.