Why does everybody talk about “reinvesting profits” like it’s a good thing?

When they say they’re putting their life on credit cards so every penny can go back into the business, I get an ulcer.

I yell at my computer screen like a guy watching football. “No, that is NOT what profit is!”

But, alas, they can’t hear me over the sound of their own desperation because they reinvested their profits and now can’t afford rent. 🤦

When you’re running a business, you’re SUPPOSED to get money to use for your actual life from the business!!

This money, called owner’s compensation, is the equivalent of your salary at a job: it is compensation to you for doing all the things you do to run the business. Which, if you’re a solopreneur, is literally everything.

In official accounting speak, you are withdrawing equity. (The value of the business is lessened because you’ve chosen to use that money for your life instead of letting it sit in a bank account.)

Don’t let the thought that your business will be “worth less” on paper stop you from taking owner’s draws.

Your business is not worth anything to you if it doesn’t help you pay for essential life things… like food.

You should be calculating and withdrawing owner’s compensation from the very first deposit you get - no matter how much it is.  

(More on how to calculate it in a sec.)

If you have a business that is reporting as an S-corp or C-corp, the business pays you a salary, which is then considered an expense instead of an equity draw and lessens the total tax burden. Doing it this way also means that the business pays your payroll and income taxes as you go, which means you probably won't owe the IRS an arm and a leg at tax time.

This is why people file as S-corps, even though it’s more of a hassle. If you don’t know how you’re reporting, ask your accountant. If you don’t have an accountant, >>click here<<

Profit is usually calculated by subtracting all your expenses from your revenue.

Whatever is left over is profit.

The problem with this method is that you usually only see profit on paper and never in the bank account.

Since there isn’t actually several thousand dollars sitting there, you decide to “reinvest” the profits since you can’t withdraw them anyway.

At the beginning - within the first 3 years - that’s ok-ish because the business is small, growing, and needs that extra energy to continue (see >>this article<<).

But if your business is 4-5+ years old, it should be able to sustain itself from its own revenue by now, and you should be able to take that profit out and use it for your own life: to start another business, or invest, or whatever.

If you still can’t see actual profit in cold hard cash by the end of the 4th year, you have a money monster instead of a business. 

Your expenses are so bloated, they’re eating your revenue as fast as you can make it.

Making more money is not the answer. The problem will only continue.

The key is to cut back on the extra expenses - tighten the belt wherever you can - until your expenses are at least within industry averages. (Ideally, below them.)

But even within the first 3 years of business, you want to feel like you actually reinvested… instead of just saying you did because you didn’t have any other choice.

The way to make that happen is explained extremely well in the book, Profit First, which I recommend to all entrepreneurs, but the concept didn’t originate with him. (And most accountants agree that he added some unnecessary steps.)

The way I learned it was from my childhood piggy bank. 

It was shaped like a skyline, with the hollow facades of a church, a bank, and a store. My mom taught me to put 10% in the church, 10% in the bank, and the rest in the store. I could pull money out of the store to buy whatever I wanted that I had the money for; but I wasn’t allowed to get money out of the bank unless I’d been saving for that thing on purpose for a couple months. (No impulse purchases!)

This is probably the way her mother taught her. 

My grandmother’s generation had a coffee can for each category: savings, groceries, new bike, prom dress…. Whatever they were saving for, they had a can. When they needed to go get food, they had a can. And they could only do what their cans said they could.

How much does your cans say you can?

How to calculate owners comp and profit in the first 3 years:

1. Calculate your total revenue for the month or year. 

2. Add up all your absolutely necessary expenses. Divide this number by your revenue and then multiply by 100 to get the percentage for non-negotiable operating expenses. (Expenses / Revenue) x 100 = Opex %

3. Divvy up your revenue by percentages:

• Taxes should be around 30% (My other business, >>Aboveboard Bookkeeping<<, can help you calculate this exactly.)
• Put expenses down as your non-negotiable percentage (usually 40-50% when the business is still small)
• Owner’s comp should be 30-40%
• Profit is anywhere from 1-10%

4. Play with the percentages until the numbers feel right.

If you need more for business expenses and you can do with less owner’s comp, you can skew it towards expenses; but you absolutely MUST take something in owner’s comp. If you don’t, you’ll end up with a far worse kind of money monster: the one that doesn’t even let you live off of what you make. 

Remember, you are reinvesting PROFIT, not owner’s comp. That money for doing the work is yours, and the business must be paying you from the beginning or there’s no point. 

Obviously when it’s small, your owner’s comp may be $500 a month; which is not enough for anyone to live on. But as your revenue grows, your comp will grow - even if you don’t change the percentage for a while.

If you drastically increase revenue and the amount of money in opex is suddenly way more than you need for your non-negotiable expenses, you can increase your owner’s comp and profit percentages. Do that first, before you start adding more expenses. 

It’s way too tempting to decide to use that extra cash for an ad budget and really push on the growth right away, but you’ll end up >>bolting your plant if you do that<<

Take the increased revenue to solidify the systems you need to fulfill to those customers, make sure you’re getting enough money (where it looks like it will fully sustain you in a year or so), and put some away in savings before doubling down on marketing. 

The way to handle profits is - spoiler alert - to calculate and withdraw them first. 

When you have a savings account holding cold hard cash labeled “Profit,” you can literally see how profitable your business has been. 

Then, at the end of the quarter, you can reinvest those profits a) knowing how much you have to work with, and b) seeing exactly where they will help the most. 

Want help calculating your ideal percentages? Click below to download the free calculator worksheet >>