The Profitable Equation

Not being a typical money guy, I decided years ago to put the biggest financial lesson of my career (at least to date!) on the back of my business card.  The equation is this:

R – COGS – OH – DS – CI – OD – TX >= 0

It’s always fun seeing reactions to it and then watching people guess what it means.  For the sake of posterity and so that I can enjoy more time chatting about things other than this, here is the solution:

R: Most people figure out that the R stands for Revenues, which is awesome.  It’s the first thing every business owner needs to worry about financially.

COGS: I’d say about half the people I talk to figure out that this represents Cost of Goods Sold.  This is what you pay your suppliers, vendors, and contractors for goods and services you resell.  It’s really important to know this number, because deducting your COGS from your Revenues leaves you with money to pay for everything else.

OH: No, it’s not Ohio!  It’s Overhead.  These are your administrative expenses, but can also cover your sales and marketing expenses, travel, and any other expense that is not Cost of Goods Sold.

DS: I think I threw in a sneaky one here.  It’s Debt Service.  While technically not an expense in the accounting world, repaying debt means that we are paying money out of our accounts that we don’t have for our business.

CI: This is another sneaky one, but really important.  When we plow money back into the business, we help grow it.  Buying new equipment that produces more and faster, spending money on training that allow our team to service other businesses, paying the attorney for overhauling contracts… these are all Capital Investments.  And just like Debt Service technically isn’t an expense, neither are Capital Investments.  But it is money out the door, so it is a part of this list.

OD: Nope, not overdose (maybe it’s the New Yorker in me that would think this).  It’s the Owner’s Draw—your salary!

TX: The only thing certain in life are death and… Taxes.

So what does the equation say?  It says that Revenue, minus all the other Cash Outflows (COGS, OH, DS, CI, OD, TX), must be at least more than zero!

If we consistently lose money, we’re toast.  We’ll go under.  Conversely, if we make money, month after month, our businesses will gain traction, we’ll have savings in the business allowing us to grow it more, and we’ll see more and more money in our personal account, allowing us to reap the reward of the work in our business.

If you look at my story, I learned this the hard way in 2008 by getting distracted with false optimism of growth.  Once I paid attention to this equation by making sure that I always, always followed it, the game changed.  Thoughts?

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