Profit Percentages

      Here's a long and thoughtful discussion about profit — how much is typical in cabinetmaking, and how to go about increasing it. November 23, 2012

What's the average profit percentage that most of you are experiencing? We've done a few spot checks on projects and come out at about 18-22%. Don't ask me where that money is... We are in the process of streamlining our operation to find and close the vortex that's sucking our profit into oblivion. Appreciate any insight on this.

Forum Responses
(Business and Management Forum)
From contributor P:
Most will try to get 20% true profit. A lot of people have no clue what their true overhead costs are and that is where their profits end up in covering those costs. For example, companies get an average of 5.5 hours of work from a worker getting paid for an 8 hour day, so that has to be figured in. Also, changes done to a job that add cost, but are so small you decide not to charge for, because you do a lot of work for that designer or contractor… When you add these up over a year, they can cost you money. The main thing is, on every job, watch all costs, from utilities to material and labor.

From contributor C:
20%? After all our bills are paid, we do a lot more than that, and I've already paid me. I have read and read and truly analyzed every move and procedure in the shop, and although we have a long way to go, we have come miles in efficiency. I would say, though, the best thing I have done is sit down and make a list of every operation, from client contact to installed product, and depositing the money in the bank, and I have exercised every wasted move out that I can.

We have checklists for everything, including one the estimators use to address every area of the scope of work, including reading the specs and listing what sections we are in for our scope. When we mock cabinet jobs up, a checklist is run to make sure everything is accounted for. Then another is used for install, the load out, the punchlist and even the billing.

I know, anal, but it seems having payroll in the bank, taxes and material money in there has become a lot easier too.

If you get a copy of True 32, there is a statement that will change your whole outlook, and it kind of says: When you employ people in a shop, you are in control and they will do what you say and follow the procedures you put in place. It really makes no difference to them, they are there to collect a check. We have truly realized that and I changed some of the collecting-the-check attitude by giving some space, but I still control the surroundings, procedures and the tempo of the shop floor.

Look at your books at the same time daily, pay your bills when they come in, and look at every procedure to extract more efficiency. You'll be shocked at the results. We pride ourselves in paying everything by the 5th of the month and in these lean times, credit for materials has become very easy.

From contributor L:
Over the last 3 or 4 years I haven't come close to 20%. Thought I was lucky to escape with my business intact. Based on our target sales of $2.5 million, by this post's reckoning I should be paying taxes on $500,000 and spending the winters in the south of France. Maybe someday I'll see you guys on the Riviera.

From contributor G:
I wonder what volume contributor C is doing. I wonder if those profit margins would be possible at a larger, more competitive level. I think that profitability has to do with supply and demand. Hence where there is more construction, there is more demand. New Mexico enjoys a lot of construction from government spending, northern California enjoyed a lot of construction from high tech, Nebraska… what, ethanol subsidies?

From contributor C:
It doesn't matter. My volume means nothing, but I will state that we curbside deliver a lot more than we install.

The most important thing is we get the materials in the shop and push like hell. We extract every dime from every movement to be profitable. We will make just as much from melamine closet packages as we will from solid surface windowsills. The guys look at casework as a joke after we push out 50-60 sinks in Corian tops with integral splashes.

We estimate and price it correctly from the start and don't tolerate waste. From estimating and materials loading to finished product, we won't tolerate waste.

Our biggest leap was putting a system in place. And learning to ask 4 vendors to price the same Jowat pellet glue - 254.00 to 131.00 for 55 lbs. Same on melamine - 19.36 a sheet to 28.72 in unit quantities. Just got to constantly work to control costs.

From contributor G:
Contributor C, I applaud your lean efforts, and I'm sure I can learn plenty from you. But do you think you are the only one who does this? Big shops got big because they are smart and compete at a different level. Economies of scale do matter.

From contributor C:
We are competing against the likes of LSIs and showrooms tacking 10% on their cost. We are also competing against shops with beam saws and KOMO's with autoloaders and crap. I really could care less what others are doing and how they are making more of economies of scale.

We run sliders, vertical panel saws and a couple of PTPs. Hell, when we are overwhelmed with a mess, we stop everything, get the chaos under wraps, then move on. No, we are not the only ones running lean or smart purchasing, but it helps us and that's what matters to us.

From contributor K:
Absolutely on the mark. When you get the idea that you need to learn to extract profit from your business, as opposed to reacting to what others in your market are doing, which you have absolutely no control over, you are starting down the path to realizing larger profit potential.

From contributor G:
Contributor K, I hear you. However, comparison is essential. I suppose you could say, compare what you are doing now to what you were doing before. Comparing notes on WOODWEB, shop tours, ideas, books, videos, discussions at trade shows, trade shows, is how one learns? I guess you could say I only learn empirically, but that is reinventing the wheel.

From contributor L:
If you are ending up with more than 20% at the end of the year, have lots of repeat business and no debt, you are doing something right.

From contributor Y:
I always care what the other guy is doing. Whether it's economy of scale or a small detail in the shop. Never know what you might learn.

From contributor K:
I was referring to pricing. WOODWEB is made to learn and share ideas. That's not what I was getting at.

Example: One-man garage-shop cabinetmaker versus cabinetmaker with 10,000 sf facility and a dozen employees. The two will never be on par when it comes to pricing, and it is totally out of each shop's control. The one-man shop cannot buy and store a truckload of materials, so he must pay more for materials, and the employer with a dozen employees has to pay much more for everything else, from taxes to electric, etc. From a competitor POV, neither can really do anything about the other's position, as it is out of their control.

From contributor C:
"You have to know where you have been to know where you are going." That's the best piece of advice I have had in a long time.

What others are doing… I just can't spend any time on it. If you direct the time spent on studying others on yourself, you can be miles ahead in short order. By writing down what I was doing daily, I got to see where I was wasting time and correct it.

Economies of scale: well, we just aren't going to cut and assemble so much that we clog the arteries of the shop with work in process. It does no good to have precious real estate taken by half completed projects.

From contributor L:
I very much agree with that. To that end, the conveyor system has been a great help. A quick visual indicator of the state of each work station and the buffers.

From contributor R:
20% is outstanding performance if it's really net 20% profit before tax - not gross profit. The last time I checked the AWI Cost of Doing Business survey, the average higher profit architectural woodworking firms were making net 12%.

I noticed the original poster said he was finding 18-20% by spot checking. Not that he was making 15-20%. I frequently make that much on individual jobs, but if I don't do enough of those jobs in a month, there is no profit. Also we can lose enough money on a blown estimate, bad engineering, shop mistake, or a purchasing error to cancel out a couple of good jobs. Eternal vigilance is the price of profit.

From contributor A:
I think if profit is 18-20% after you have maxed out 401k and matching, maxed out HSA, maxed out 179 depreciation, maxed out all expensable items ($1,000 or whatever your internal max is), bonused officers and employees and gifts, then you are running a stellar organization.

On the other hand, if a project has 20% profit but you sit still for 2 weeks, you probably ate up most of the profit in fixed overhead. It's quite easy to come up with large profits when you produce a lot of work in a short period of time. It generally gets reduced over the course of a year with operating expenses. It can come from having less overhead than expected due to the time the project was completed in, plus smart purchasing and good production management and everything else in the process.

Another place your "profit" could be sitting is in work in progress, depending on how your software relieves WIP. At 20%, for you to not see the money, your AR days would need to be quite a bit out, like 90 or more. So is your inventory overvalued? Too much WIP? Every project invoiced? All project extras invoiced? Receivables coming in or delayed? So many places to look.

From contributor O:
Most of us have experienced unusually profitable periods, but unless you have a patented idea, or in some way have a locked in market, 20% is unsustainable simply due to competition. Someone with 15% higher operating costs will be willing to get into your market at zero profit, thereby undercutting you 5% (to oversimplify). You laugh, but just look around you at your own business.

From contributor G:
Equally important is looking at the breakeven point on a regular (weekly) basis.

From contributor J:
We all know that contributor C is not making 20% + net profit margins running the size company he appears to have and doing the diverse type of work he appears to do. We're all just too polite to say so. Making 20% net profit on a project is not that unusual. Showing 20% net profit on the tax return at the end of the year is a whole other animal.

From contributor Y:
Why are we criticizing contributor C? I had a small shop with 5-6 employees and couldn't get my head wrapped around the business end. I loved designing and installing projects and thrived on figuring out quick and efficient ways, however I hated the bookwork. I respect guys like him but it's not everyone's strong suit. I suspect those criticizing are one-man shows like me or larger businesses struggling to survive. Either way, it is envy bringing the animosity. I have a good friend that I used to work for who is now retired. He ran his business like contributor C and is now doing his woodwork for the pure fun of it.

From contributor R:
So far I haven't seen anything that looks like criticism, although things can be taken the wrong way. I think the question is, what is meant by profit? I believe the original poster said he was making good profit on individual jobs but losing or not finding money on overall operations - he was looking for some reasons why. Contributor C says that he is making more than net 20, which is unusual, and very admirable. He is also clear on much of the why and how. There are some questions here about whether that is net 20 as I understand it, or some other version of net 20. It would be of interest to know what the dollar volume is, and what sums that net 20 represents. I have to struggle to make net 10, but it's on $8 million in sales, so the end result is sometimes worth the work. It does seem that the larger the dollar volume, the smaller the profit margin, but 10% of $8 million is better (or at least bigger) in the end than 20% of $1 million. I would settle for less money if attaining it was a lot easier, but that is just me.

From contributor C:
I have learned a lot from other posters on WOODWEB and I just decided to run my numbers again on contributor J's post. No offense taken.

I learned a long time ago a good month or two's profit can go away quick, so we work anything in we can. We bill for everything and not a change is made until an order is issued or an estimate is signed, period. It all adds up. If you shoot from the hip on pricing, your profit goes way down. If you buy what you need for the moment, productivity goes way down.

Contributor R, I have read and reread your posts and this one is crystal clear. I will not fight for 10% on those kind of numbers, period.

I started in my basement and left it about 7 years ago with a hot air bander, Powermatic 66 and Blum machine. After a big job with that low capacity stuff, I jumped in full tilt, bought the big stuff and about lost everything over the way I did business and all the work in progress crap and other mistakes. Yeah, I've made them, but I refuse to repeat them. I'm hoping my clear cut thinking and posts help others.

Contributor J's post is nice - it kept me up last night reviewing where we lost money on what job and why, and how not to repeat the same mistake.

From contributor J:
I hear too much theory on this website and not enough reality. It's way too easy to say you are currently making 20% profit margins when you are absolutely convinced that just around the corner you actually will be making 20% margins, even though it hasn't actually happened yet. In other words, guys that are eternal optimists that are on the path of continuous improvement will always be convinced that just around the corner are the margins they've been seeking. That's wonderful, and I often think that too. But year after year, reality rears its ugly head and reminds me that theory is actually theory, and reality is reality.

Here's an example. In another thread a few days ago, a poster asked about the 32mm system. Contributor C very confidently told him that he should:
"Go the route of the office pushing the CNC from design to cut in the screen-to-machine mode. Cabinetvision ain't cheap, but neither is standing around waiting for cutlists to be generated."

Sounds like contributor C is speaking from experience, that he has found success with this method. After all, he's claiming 20% + profit margins in this thread. But in the next sentence he says:
"That's where we are almost at. The idea of shop drawings corrected, to cutting is getting us excited enough to wet my pants."

Wait a minute, are you telling me you almost have Cabinetvision working right? So when you finally achieve screen to machine, what then, 50% net profit? Come on man, give me reality. If I am seeking advice, I don't want it from someone who thinks they might be on to something.

From contributor R:
Another track for thinking about this (and probably another thread's worth) is job costing. Rather than spot checking, it is very useful to have a job costing system that tracks critical numbers for every project. There are a dozen ways to do this. We use a construction accounting system called Masterbuilder. I look at every job at least once a month, and critical, big or difficult jobs a lot more frequently. I can tell with some accuracy how we are going to do, where we are succeeding and failing, and what to do better next time. The more I am engaged in this process, the better my company does over the year and over the long term. Accurate feedback from this process to estimating (whether you have estimators or are the estimator yourself) will help you get jobs that you should get and keep you from getting the ones you shouldn't get.

From contributor U:
We made a 6% margin last year on 1.55 million in sales.

From contributor C:
The route of pushing the shop from the office is the obvious choice. Especially when the poster just got a CNC, and wants advice on how to best implement it. Especially in the frameless world.

We use Cabinetvision daily, and all the bugs are worked out for our system. However, we don't post to our PTPs and just program it at the floor. Whatever it is the poster buys, they will need to dial it in. We don't post to our PTP, but send copy our jobs and run them to a friend. They cut it while we do our thing at our shop. It's nice to watch 30 pages of drawings turn into a job cut a few days later.

I have my own flat table, and CV ultimate, just not the link, and it's just a few months until 2 trucks and a bander's payments go away. I learned not to get too deep, especially in this economy.

From contributor G:
Once again, control or the lack thereof rears its ugly head. Control is prediction. Hence job costing is important. I myself can tell you how much money I have lost on any single job going back 20 years. Another factor that I think is important is the breakeven point - this one can be insidious.

Paul Akers talks a lot about fixing what bugs you, as what bugs you is where you are losing control. Where you are losing control is where you are losing money. If you don't have metrics or dubious metrics, that is the place to start, but don't overdo it.

From contributor K:
One of the areas that eats away at profit is debt service. I know since we retired all business debt years ago, we didn't then lower our prices, but increased our net profit. You are getting the current business, now just imagine it without this drain. What would it do to your net profit?

Next come fees (i.e. banks, late charges on invoices, utilities, etc.). One area we have had a challenge with variable costs is gas. Perhaps a better way of looking at this is, what are you doing as a company to increase profit during these times?

From the original questioner:
Thank you so much for all the comments. I think this post will change my approach to business. What we lack most (based on your info) is an accurate method of costing and tracking every job. The spot-checking method simply is not a realistic measuring tool for profit.

I'm leaning towards 20% not being the real profit when spread out over the 50 projects of varying sizes we do a year. We also lose a tremendous amount of money/profit on jobs stretching out and not being completed in a responsible timeframe. Whether we finish a project or not, the overhead/payroll continues to tax the cash flow.

Within the last few weeks we have, however, reinvented our workflow and daily/weekly goals. Also, we work on exclusively one project at a time now, from start to finish during regular hours. We were jumping around too much before, which ultimately led to damaging delays and frustrated clients.

All in all, our business is growing and I know in order to be successful we have to get serious about the business side of cabinetmaking. And from what I can tell, you guys crunch the numbers.

I would like to implement a cost/pricing/scheduling software as soon as possible. Currently we use Quickbooks for our accounting, but it isn't cabinet friendly enough for job costing/estimating. Can anyone recommend a solid affordable software for this use?

I am also very keen to learn more on Lean Manufacturing.

From contributor G:
I would go slow on the job costing software. All you need is timekeeping software. I looked at Tractivity a long time ago, but at that time it didn't do the reports I was looking for, though it did look good. I think Master Builder is owned by Intuit.

The thing that really got me to start using Lean was the Paul Akers show. I would just start listening.

From contributor Q:
It seems to me profit is what the corporation pays taxes on at the end of the year. With an entry on a ledger, one could turn that from 20 to 0% in a second. If, as you spot check, you use the word "profit," your employees will take it the wrong way. Materials are fixed time is the radical.

We made a 5% profit this year. The corporation gave my partner and I a 25% raise in July.

From contributor L:
My thoughts on job costing software: The system we have works, sort of. It is excessively complex and too expensive. My resident geek has built a system of links and we now have a workable, mostly complete system for what we need. It's easy to get carried away and spend more time than what is really needed.

The biggest variable for us has always been labor. We have a good computer based system for that, but it requires the cooperation of every employee to make it valid. If during the day an employee starts working on a different job and he doesn't log in to that one but continues to be logged into the prior one... You get the idea. Provision for tracking time must make it fast, easy and automated. We started with hand-filled-in time sheets - hopeless. The habit was to fill them in at the end of the day with what they guessed they had spent their time on. Then we got a time clock and the usual time cards with a place to write the job number. Problem was you had to walk to the clock and back to your work station. A waste of time and it didn't encourage logging in and out as needed. Sometimes you could even read them. Finally we went to a computer based system. We installed 5 shop terminals connected to a server. The software keeps track of time, can generate job specific reports, writes the checks, calculates taxes, vacation time, etc. Since we label most parts with all sorts of information at the beginning of production, finding the job number is easy. The day before payroll, a time printout is given to each employee so he can confirm the information.

We gave up trying to track some small items of inventory. Sheet materials are tracked/entered at the router and panel saw. Lumber is tracked at the rip saw. Hardware is assumed to be what was either on the bid sheet or what was on the purchase orders. The software for bidding, purchasing, inventory and production is all linked.

Things have gotten better with time, not perfect. At our end of the month job reviews, we still find things that could have gone better. We decide if they are worth the time/cost to fix, monitor or just let them be part of the lost percentage between what we had entered as our profit percent on the bid form and what it really comes out at the end of the year.

By the way, our target profit on the bid form is 14%. I'm perfectly happy with 10% at the end of the year. Where did the other 4% go? Uneven flow of work is a major culprit. Errors in time estimating is another. Reaching the breakeven point? Maybe! Damage, no-pays, the list can go on... We are a small shop with sales in the $2-3 million range.

From contributor S:
If a guy is making 20% - great job, way to go. Why all the sour grapes and questioning? In every industry from auto manufacturing to airlines to coffee shops to whatever, every day some are filling the bank with money and others are going bankrupt. Every year we read about the billionaires and Bill Gates of the world and most days I see homeless people on the corner asking for money. So should I say I don't believe Bill Gates has any money, or Apple isn't doing well? Read what Apple's net profits were last year.

There is a vast variance of profit margins in cabinet shops in North America. Some are making tons of money and others are struggling to keep their doors open. There are hundreds of reasons why.

From contributor C:
I'm not offended and could care less what others say. I used to work for an alcoholic that would never pay us. I'm real proud to pay our bills, and the guys have confidence in me that the cash is in the bank for payroll.

I honestly don't care about the percentages as much as some would think. I'm more worried about a solid line of work making the shop hum, day in and day out. I just make sure we bid the work right and when it's not a plain sliced job, we let everyone know we have such and such allowed and if anyone knows an easy way to get an odd job done, let me know.

From contributor N:
Perhaps a minor point on calculating margins: If you hope to achieve a gross profit margin of 40%, or in other words you want to gross $40 on $100 in sales, you must multiply cost x 1.67. Lots of folks fail to mark up correctly. The formula: x=1/1-y where y is the desired margin.

From contributor Z:
2009, 5.7% on 1.26 million. 2010, 7.7% on 1.2 million. 2011, 3.9% on 1 million (projected). We are currently the top shop in our market, but that is a subject for another thread.

From contributor L:
At least you have a profit! That's better than a lot of businesses in the last few years. What is your target gross sales under normal circumstances? Your target profit percentage?

From contributor Z:
We have an established shop focused on custom residential kitchen and bath cabinetry. We are a full service shop, build our own drawers and doors, offer full finish, delivery and installation. We currently have 9 full time employees, my partner and me. One of our employees is sales/design, 8 shop, my partner and I are full time active in the business. We compensate ourselves with salaries so our labor is factored into our expenses. Our average revenues over the last six years were 1.18 million with 2008 being the only year under 1 million. Our 2008 net profit on gross was -6.5%. In no year have we booked over 8% during that period. We have scrambled, taking work that is out of our historical product range to keep things going. Don't mean to sound thankless for the black ink this year, but it hasn't come easy.

From contributor V:
I have been following this discussion closely and it has been very helpful to me. We have been in business for 7 years and currently have 10 employees.

I don’t think everyone here is comparing apples to apples. Some draw a salary and others do not. Is their Net Profit Margin then not including the owner’s salary? Some include the owner's 401(k) contributions and others not.

I assume most of us are either an LLC or a Sole Proprietorship and file a Schedule C. Let's use the standard formula of: Net Profit Margin (percent) = (Net Income / Revenue) x 100

Then take from your Schedule C Net Profit Line 31 and divide that by Total Sales (after returns) Line 3 and you get your Net Profit Margin. If you have paid yourself a salary, you need to add that amount into the Net Income value.

The 401(k) contribution for the owner should not be included in the business expenses, as this is taken as a deduction from your personal taxes and not the business. Regardless of whether an owner wants to max out his 401(k) or not contribute at all, it doesn’t change the Net Profit Margin for the business.

Once we all start reporting the same source for the numbers, then the percentages will start to make sense. My Net Profit Margin has been running around 12% for the last few years.

From contributor L:
"If you have paid yourself a salary you need to add that amount into the Net Income value." Aren't you part of the cost of labor? You are confusing profit with what might better be called something else if you include your salary in profit. Or did I misunderstand?

From contributor K:
Net profit is what your company makes after you've been paid any income/bonus/etc. as well as accounted for all expenses.

From contributor V:
If you want to do a true comparison of our industry, we all need to have the same inputs into the calculations. The bottom line is how much total personal income did you get from the business that you are being taxed on? That would be salary plus business profit.

The assumption is you are a LLC or Sole Proprietorship. The business itself doesn’t pay income taxes and all income gets passed on to the owner(s). An example is below.

Business A – owner draws a salary
$1 M sales
$900 K expenses all other deductions
$100 K owner’s salary (taxable income to the owner)
$0 business profit
0% net profit margin

Business B – owner does not take a salary
$1 M sales
$900 K expenses all other deductions
$100 K business profit (taxable income to the owner)
10% net profit margin

The owner of “A” says my business made 0% profit (though he paid taxes on $100 K of income).
The owner of “B” says my business made 10% profit (though he paid tax on $100 K of income).

The bottom line is both business owners ended up with the same $100 K of taxable income, however the Net Profit Margin is very different. We cannot compare business to business unless everyone uses the same set of inputs. If you take a salary, then you need to add that into the business profit to then get the correct Net Profit Margin. I’ve seen profit numbers listed on this forum from 0% to 30%, but they are meaningless to me unless everyone in including the same set of numbers.

Contributor K, you pay tax on your salary + bonus + net income.

From contributor L:
We operate as a sub chapter S corporation, but that's not a lot different than an LLC. LLC's weren't around when we incorporated. If there are multiple owners taking different salaries, what's left to reinvest in the business or payout as desired does not include the salaries. What's left is the profit. The owners still have to pay taxes on it.

From contributor R:
I am interested in two things - how much money I make, and how much profit my company makes. I pay myself a salary that I do not consider as profit, because I perform a function in my company that I would otherwise have to pay someone else to do. I also take draws - when the company is profitable, I take more and I have more money, but the company is less profitable. The bank looks at company profit and personal net worth separately, for different reasons. So does a potential buyer of my business.

From contributor V:
The original question was: “What's the average profit percentage that most of you are experiencing?”

The only way we are going to be able to benchmark ourselves is when we all use the same set of numbers. Since the salary of the owner(s) is a high percentage in small businesses, including it or not including it changes the profit percentage dramatically. To me, all the profit percentages listed in this thread are useless numbers.

Maybe a better term we should use is cash flow. Cash flow is the movement of money in or out of the business to the owner(s). Cash flow then equals salary + bonus + company profit. When a bank or buyer looks at your business, he evaluates the cash flow of your business, not the profit of the business.

So I will ask the question differently: “What's the average cash flow percentage that most of you are experiencing?”
Cash flow = Owner(s) salary + bonus + profit from the business
My Cash Flow Percent has been running around 12% for the last few years.

From contributor K:
Your business tax is different than personal tax and based on your actual net profit. Your personal tax has all sorts of deductions before you actually get to your net income. Your personal income is your gross personal income before deductions to get to your net taxable income, like your company's gross profit before expenses to get to your taxable net profit.

In your A & B example above, if the owner takes a salary or does not, but instead a draw, the $100K is removed from the gross profit in both cases, so in both scenarios, after doing so, it leaves a 0% net profit. It doesn't matter which way you draw it out, the net profit is the net after you do so.

The net profit is the same set of numbers if you are talking net and not gross profit, hence the original question. I see where you are going, but your cash-flow method just adds confusion to the mix. It asks for three components (owner salary, bonus and then, I assume, company net profit). To get your cash flow number, you still have to determine the net profit. The simplest method is net profit as it is the most naked number for measurement.

That said, if a company has already established capital reserves, etc. but has debt, there should be no net profit, but additional payment to the debt principle to remove the debt burden and retire it earlier. If you carry debt, but want to be able to say you carry a net profit, you are actually eating away at future net profit by paying taxes to the government on the existing company net profit, and additional interest towards the debt.

Contributor R: "I also take draws - when the company is profitable I take more and I have more money, but the company is less profitable."

As usual, right on the money. The money left over after all income, draws, bonuses, expenses, etc. is the profit. Net profit, that is. If you draw it all out, there is no net profit. If you don't, the company income sheet gets the net profit and is taxed based upon that.

From contributor V:
There is some incorrect information here. First of all, this whole discussion is for businesses set up as LLCs or Sole Proprietorships that report their business income and expenses on Schedule C. I believe most of us here are set up under one of these two. If you are a true C-Corp, this doesn’t apply to you. I’m not sure about S-Corp, since they are a hybrid between a C and LLC.

Also, I am referring to federal taxes and not state or local taxes. Most state taxes follow the federal guidelines, but I’m not sure of every state. NY state follows the federal guidelines.

When I refer to the owner, this means Single Member LLC, Multiple Member LLC, Sole Proprietors and Partnerships, basically the owners of the company, and it could be one or many.

Basically, if you file a Schedule C, your business pays no income tax, zero, nothing. Schedule C passes all income to the owner and the owner pays the tax on his personal tax return. This is called a Pass-Through entity.

For example, Schedule C Line 31 is the Net Profit/Loss from the company. That number is then carried over to the 1040 line 12.
Form 1040:
Line 7 Wages: This is wages you paid yourself through the W-2 process.
Line 12 Business Income: This is the value of Schedule C Line 31 from above.
Line 22: Total income: The total of wages and business income, and a lot of other income, but that is not important here.
You pay tax on your total income. The business itself pays no taxes.

To see this, go to your last income tax return and look at the 1040 and Schedule C. If you don’t have them available, do a Google search for Schedule C and take a look at the form. Nowhere on the form will you see the words "income tax." Also ask your CPA or tax preparer. They will confirm that the business itself doesn’t pay income taxes.

Now, getting back to the original question, how do we benchmark ourselves in an apple to apple comparison? With the calculation of:
Net Profit Margin (percent) = (Net Income / Revenue) x 100
Net income then includes the owner's wages paid through a W-2 plus the Schedule C Net Profit/Loss.

Also, it doesn’t matter whether you take a salary or take draws during the year, the bottom line is the same - it is all included in the business profit. For example, I take monthly draws based on my estimated profit/12. I don’t have to report a W-2 but I do pay quarterly estimated taxes. If you get a paycheck (W-2) income, then you are paying the taxes every time a check gets issued.

Basically, for Schedule C filers, there is no real capital reserve for tax purposes. Since all profit is distributed to the owner at the end of the year, there is no capital to put into the reserve. Now, in reality, not everyone takes all the actual cash from the business, so there is a capital cash fund that is available for you to use, but in reality that is your personal cash because you have already paid income tax on it.

The company doesn’t pay taxes; the owners do. Taking a salary or drawing an amount from the business doesn’t change profit. Profit or loss is a result of an activity and a measurement of that activity. For example, a sale is made, employees work, material is purchased, utilities get paid, etc. Issuing a payroll check to the owner is an accounting transfer from the business account to the personal account. No real activity took place to change the profit or loss of the company.
Once we all start reporting the same numbers, we can then establish a benchmark to see how we compare to each other. When stating your Net Profit Margin (percent), you don’t need to report your total sales.

From contributor Z:
If our original questioner doesn't know where his 18 to 20% spot check profit has gone, I think it would be helpful for him to know the true costs of his business operation. Regardless of his position as an owner, if he provides services to his business that support its activities, his time should be expensed as either overhead or labor. If he isn't active in the business, he is paying someone to do this and it is recognized as such.

Our business pays myself and my partner (both owners) a salary based on what we reasonably think it would cost to have someone do our jobs. I personally also consider what I would make employed somewhere else using my skills.

I don't think it matters whether it is a lemonade stand or a large corporation, compensation for labor expended is an expense that wouldn't exist without the business activity and should be treated as such.

One can state that their business profits X relative to revenues, but if the owner is putting work into it and not accounting for his salary, he is inflating the business profit by understating labor expenses. An unaccounted labor subsidy.

Should one want to seek financing/investing or sell out, the other party will want to see these figures using GAAP. Since there is no tax advantage from the standpoint of a proprietorship, partnership, LLC or SCorp, there is no reason for it not to be accounted for as a labor expense.

From contributor C:
Can anyone state the facts of how to make sure we are accounting for the cost of doing business and calculating the net profit ?

From contributor F:
I think part of the confusion is figuring how the business owner - who works in the business - arrives at his income. Flip the switch - let's say you as an owner are strictly an investor in the business. If there is money left over after all expenses, salaries, etc. are paid, that is your net profit.

From contributor Z:
Net Profit = Gross Revenues less all business related expenses.
Net Profit Percentage = Net Profit/Gross Revenues x 100

Not including compensation for active owners in line with their function in the company understates expenses and inflates profits. My wage has nothing to do with the company's net profit except when I am giving myself my performance review. It is a valid expense and is treated as such in my profit/loss calculations.

I base it on many factors including recent job listings, my top paid man, my personal employment best, etc. It is enough for me to live on and competitive enough that my partner could get help if I became incapacitated or left. My partner and I may or may not take extra out on a good year - it depends on everything. Every situation is unique and decisions about profit allocation are as varied as the owners that make them.

There are variations in the profit percentage that seem to run along revenue lines. A company doing 1.2 mil may do 7%, 84k net and a guy may do 250k at 20%, 50k net. Both examples from my personal experience. For the record I am not satisfied with our recent or current performance.

Net Profit Percentage is useful as a benchmark, and comparing with others is interesting but little more. Comparing it to your own history and your previous projections is where its true value is.

From contributor R:
Well put, again. Also, as to profit percentage, every business has a sweet spot. My profit percentage was lowest when I was at my largest dollar volume a few years ago, and as I shrunk back to a more manageable size, my percentage has grown. Profit percentages seem to run higher in well run, smaller companies. My observation is that growth for the sake of growth is futile, and often fatal.

From contributor L:
I'll back up what contributor R said. Not only has my profit percent been greater at 18 than when we were at 24 employees, but the actual dollars were greater too.

From contributor G:
I think that reduction in staff is a two-for-one deal in that you have more control with fewer employees, but you also increase what is expected from the remaining employees.

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