What Revenue Goals Are Realistic
For Your Startup?
Recently I've been putting a series of questions to people who have never owned a business. I'm asking their sense of how much money the average small business owner makes each year. And I'm asking what profit margin they think most small businesses routinely maintain.
The answers that I'm hearing confirm my suspicions. To be specific, people generally have a highly inflated picture of small business revenues and profitability.
Now, if this is true for people in general, it's safe to assume that encore entrepreneurs may slip into similar miscalculations. They can easily launch a startup with unrealistic expectations, both in terms of income or of the work required to reach that income level.
Thus, in this article I want to offer a reality check on the earning potential of sole proprietorships. They are the most common business structure for startups. My purpose is not to be discouraging, but to underscore the importance of maximizing the revenue-producing power of every hour that you devote to your business.
A Reality Check
According to IRS records, about 23 million sole proprietorships file income tax returns each year. Roughly five percent of these businesses are structured as single-member limited liability companies. The rest are purely sole proprietorships. They have no encompassing legal structure to limit their liability.
In this universe of 23 million businesses, fewer than 11% have annual receipts of $100,000 or more. And that's gross revenue, not net income. For most sole proprietors, therefore, owning a business is hardly a fast track to fabulous wealth.
In fact, when we look at sole proprietorships as a whole, almost seven in ten have an annual gross of less than $25,000. An amazing 15.5 million businesses fall in this category, with average gross revenue of slightly more than $7,000. This is based on IRS statistics released in 2012.
Why such a meager average? Because these businesses are predominantly seasonal or part-time in nature. They serve primarily to provide limited supplemental income for households. Commonly they bring in no more than a few hundred or a few thousand dollars each year. And a substantial portion of these businesses report either a loss or no net income at all.
What this tells us, then, is that part-time businesses dominate the sole proprietorship sector. And it also tells us that IRS averages are not good benchmarks for encore entrepreneurs to use in measuring their own progress or success.
That's because these averages are terribly distorted by the millions of micro-proprietorships with their minimal revenues. For example, look at these averages from 2000 to 2008 (the last year for which the IRS has published detailed data). The averages shown here are based on all tax returns filed by sole proprietors for the year in the left column.
|Year||Avg. Gross Revenue||Avg. Net Income|
These numbers are decidedly low — particularly the net income average. If you are an encore entrepreneur with a full-time venture, these averages are of no practical value as benchmarks for evaluating your financial performance.
A More Meaningful Benchmark
What would be more helpful are averages that take into account only the revenue and income for full-time proprietorships. Unfortunately, the IRS cannot break out the data that way, because tax filings make no distinction between part-time and full-time businesses.
But using IRS data, we can approximate the average gross revenues and net income for typical full-time sole proprietorships. Here's one way to make that calculation.
First, disregard the data for businesses grossing less than $25,000. As we have seen, these are not generally full-time enterprises.
On the other end of the spectrum, disregard the data for sole proprietors grossing more than $500,000 per year. Fewer than 2% of all sole proprietors fall in this range. And for the most part these are people who are highly-compensated professionals, investors, entertainers, and pro athletes.
This then narrows our focus to businesses with $25,000 to $500,000 in annual receipts. Using the most recent statistics available, the average gross revenue for this group of businesses is just shy of $97,000. Keep in mind that this is gross revenue. Net income will be notably less.
How much less depends on the margins with which the business operates. Some businesses, by their very nature have margins that are rather substantial. Perhaps they have very limited fixed costs, as is the case with many internet-based businesses. Or they may have abundant opportunities to boost their gross receipts because they are in an under-served market.
Others, such as small retail firms, have considerable overhead, which restricts their margin. And if their competitive environment is price-driven, they may have few options for rapidly increasing gross revenues.
Consequently, there is no universal rule of thumb for predicting the profit margin for a sole proprietorship. But it's instructive to know how these types of businesses fare, as a whole, in terms of net income.
For all sole proprietorships combined, annual net income is typically 21 or 22 percent of total receipts. This percentage has held true every year since 2000, with the sole exception of 2008. That year the economic downturn dropped it to 20 percent.
Now, for sake of illustration, let's assume a business with average receipts and an average margin. A moment ago we computed an average gross revenue of $97,000 for fulltime proprietorships. If we apply a margin of 22% to that gross, it gives us net income before taxes of $21,340. A bit shocking, isn't it? To put it mildly, as a sole proprietor you can't make a prosperous living being just average.
Instead, if you want to do well financially, you need to do two things. First, you must work to generate revenues far above average. And second you must beat the average margin significantly, if at all possible.
Plotting Your Own Path
Let me conclude, therefore, by suggesting an exercise. First, ask yourself what you want your net income to be from your business. For sake of illustration, let's say that it's $60,000 per year.
Next, make your best estimate as to what your margin will be. Again for sake of illustration let's put that figure at 30%. Now divide your margin into your target income to see what your gross revenue must be. In the example that we are developing, the gross turns out to be $200,000.
This then gives you specific parameters within which to develop a business and marketing plan. The plan must be adequate to generate $200,000 in revenue while holding costs and overhead to no more than 70% of total receipts.
As you implement this plan, think of your $60,000 net income as a fixed figure. That's the outcome you want. This way you know what types of adjustments you must make if your business is falling short of targeted revenue or margins.
For example, gross revenue of $200,000 is a lofty target. Keep in mind that only one sole proprietorship out of ten achieves revenue of $100,000 or more. If you discover that you are not on track for $200,000 in revenue, then you must make adjustments to ensure your $60,000 net.
When looking for adjustments, your first inclination is probably to explore ways to increase sales. But don't overlook the benefit of increasing your margin. If you improve your margin from 30% to 33%, you will be able to achieve a $60,000 net income with only $182,000 in revenue. This then incentivizes you to work as diligently at optimizing your profit margin as you do at maximizing your revenue.
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