Why Turnover Trumps Profit in Building a Highly Profitable Company
When preparing to sell a company, turnover or revenue often proves more important than profit for several compelling reasons. High turnover, generating a strong and steady demand for a company's products or services, can make the business more attractive to potential buyers and investors. This article delves into the importance of turnover over profit, providing an in-depth analysis and a case study to illustrate the importance of this metric.
Market Perception and Business Valuation
When preparing to sell a company, the perception of market players can heavily influence the sale process. High revenue can indicate robust demand and, consequently, growth potential. This is a key factor that many buyers and investors consider, valuing businesses using revenue multiples. In industries prioritizing expansion over immediate profitability, revenue grows more than profit margins do.
Growth Potential
A high-revenue company typically offers more opportunities for scaling operations and increasing profitability. Investors and buyers focus on companies with demonstrated growth potential, making revenue a stronger indicator of future success. As businesses expand, they generate more revenue, indicating a higher probability of achieving profitability in the long run.
Variability of Profit vs. Stability of Revenue
Revenue is generally more stable and less susceptible to manipulation or external factors such as market conditions and one-time expenses. In contrast, profit can be highly variable. A company with solid, consistent revenue demonstrates a clearer picture of operational health and performance, making it a more reliable metric for investors.
Attracting Different Buyers
Certain buyers, such as venture capitalists or private equity firms, prioritize revenue growth over immediate profitability. A high revenue figure can make a company more appealing to these investors because it suggests that the business can be scaled quickly. This focus on growth can lead to higher sale prices and better negotiation terms for the seller.
Case Study: The Rival Startups
To better understand the importance of turnover, let's consider a hypothetical scenario involving two competing startups, Turnover Inc. and Profit Machine Inc., both investing $60,000 in acquiring customers who pay $60 upfront.
The Scenario
Turnover Inc. makes $60 from customers upfront, followed by an additional $5 per month starting in the second year. This means their annual profit starts at $60 in the second year. On the other hand, Profit Machine Inc. makes $30 per month, generating an annual profit of $360, making it potentially profitable in the first year.
The Competition
Both startups allocate $30,000 to acquire 500 customers each. Profit Machine Inc., with higher immediate profits, reinvests the revenue to acquire more customers. Their revenues grow exponentially, expanding the customer base to nearly match the $60,000 investment within two months. However, Turnover Inc. immediately recaptures the full $60,000 upfront, allowing them to acquire an additional 500 customers in the first month.
By the end of the first year, Turnover Inc. has a monopoly on the market, with $30,000 in revenue and a profit of $1,500. Profit Machine Inc., however, faces a significant challenge as their customer base has been almost entirely acquired by Turnover Inc..
The Outcome
After one year, Turnover Inc. is more profitable due to the $5 monthly fee from its customers. They can start acquiring new and more expensive customers who enter the marketplace. Meanwhile, Profit Machine Inc. has no customers to acquire in the second year, fighting over crumbs. Soon after, Turnover Inc. acquires Profit Machine Inc. due to its superior customer base. Turnover Inc. then implements a price increase from $5 to $30 per month, effectively locking in customer loyalty and eliminating competition.
The Taxes and Investment Strategy
As an investor, you experience a $30,000 loss on Profit Machine Inc., but you defer the investment in Turnover Inc. as a capital gains investment, achieving no dividends and consequently, no taxes. This investment strategy, combining a loss with a profit, can be advantageous for tax purposes.
Conclusion
In conclusion, while profit is important, turnover provides a clearer picture of a company's operational scale and growth potential, making it a critical metric when evaluating and investing in businesses. By focusing on building a high-revenue company, investors and businesses can create a more stable, scalable, and ultimately, highly profitable organization.