Where Are Your Profits After You Buy a Business?
You just want to buy a business. You’re willing to work hard after you buy the business, and the business is going well. The accounts look good so where is the spending money?
Is profit money in your pocket? What’s the difference between profit on paper and money you can spend?
When you own a business, one of the most exciting moments is seeing those profit numbers rise. But before you start planning that dream holiday or buying that new car, it's important to ask: is profit really money in your pocket? With many years as a business owner, coach, mentor and a business broker, I’ve seen how business buyers often misunderstand what profit really means.
Profit doesn't always mean more money in your pocket. These are some simple questions about profit and money in your pocket when buyers buy a business
How can a business be profitable, yet you don’t have cash?
Why do some business owners reinvest their profits while others take them home?
Is it smarter to pay yourself a salary or drawings?
Why is cash flow sometimes more important than profit?
How do different business structures impact how much profit you can take home?
First, let's clarify what we mean by profit. There are different types of profit, and not all of them translate directly into money you can spend.
Gross Profit is the money left after subtracting the cost of goods sold (COGS) from your revenue. It is simply what’s left over after taking away the cost to make or buy something from what you sell it for. It’s a good measure of how efficiently your business is producing or purchasing what it sells. However, gross profit doesn’t account for other expenses like rent, salaries, or utilities.
Net Profit is what's left after all expenses are deducted from the gross profit. This is the figure that most people think of as "profit." But even net profit isn’t necessarily money you can immediately put in your pocket.
Take, for example, a small retail store that has $500,000 in sales. After deducting $300,000 for the cost of buying the stock, they have a gross profit of $200,000. But once they subtract $150,000 for rent, wages, power insurance and other expenses, their net profit is $50,000. That $50,000 might seem like money in your pocket, but it’s just the beginning.
What happens to that $50,000 in net profit? As a business owner, you have a few options. Many business owners choose to reinvest their profits to fuel growth. Whether it's upgrading equipment, hiring more staff, or expanding marketing efforts, reinvesting can help the business grow, but it also means less immediate cash for personal use. For instance, a tech startup might decide to use its profits to develop a new product feature rather than distributing the profit as personal income. The long-term benefit could be huge, but in the short term, it means tighter personal finances.
If you’re running a company, you might pay yourself dividends from the profits. However, this decision comes with tax implications and the potential need to leave some profits in the business to cover future expenses. For small businesses, deciding between dividends and reinvestment can be a tough call.
Some business owners prefer to take a salary rather than draw directly from profits. This approach provides a stable income but means the profits are retained within the business for other uses. A small business owner, for example, might pay themselves a modest salary while leaving profits in the business to cover overhead or invest in new technology.
Before you can consider profits as personal income, you need to cover any outstanding obligations. If your business has loans or other debts, profits might go toward repaying those debts before you see any of it. For instance, a restaurant owner might use profits to pay down the loan they took out to renovate the kitchen. Until that debt is paid off, less money will be available for personal use.
Why do some business owners reinvest their profits while others take them home? Smart business owners often keep a portion of profits as a reserve to cover unexpected expenses or downturns in business. This is especially important in industries with fluctuating income, like retail or construction. A construction company might set aside profits during a busy season to cover slower periods or unexpected costs.
Here in New Zealand, as with most places in the world the government will also take a bite out of your profits. Its called tax. Business profits are typically subject to income tax, and depending on your business structure, this could significantly reduce the amount of money you can take home. This is where a good accountant is an asset to your business. They can structure you and your business to ensure you are legally paying the minimum amount of tax.
What’s the difference between profit on paper and money in your pocket? Another critical aspect to consider is cash flow, which is different from profit. You might show a profit on your books, but that doesn’t mean you have cash on hand. Timing differences between when revenue is earned and when cash is collected can create a cash flow crunch. For example, a consulting firm may have $200,000 in outstanding invoices, showing a profit on paper, but if those clients haven’t paid yet, the firm might struggle to have cash in the bank. For seasonal businesses, cash flow might be particularly erratic. A business might report significant profits during the busy season, but that money needs to stretch over the slow months too. A beachside café might make most of its money in the summer, but profits earned then need to cover expenses throughout the year.
While profit is an essential measure of business success, it’s not the only one. A business that’s consistently profitable is likely to be in good health, but profits alone don’t guarantee long-term success. A manufacturing company might show strong profits but if those profits are the result of cutting corners on quality, it could face costly recalls or reputation damage in the future.
Sometimes, it’s better to leave profits in the business, effectively to fund future growth. A local bakery might use profits to fund a second oven or mixer, leading to greater long-term wealth for the owner, even if it means less short-term personal income.
Keeping business and personal finances separate is crucial for understanding what profit really means. Mixing personal and business finances can lead to confusion and poor decision-making. A sole trader, for example, should keep separate bank accounts and credit cards for business and personal use. This separation helps in accurately tracking profitability and ensuring that personal spending doesn’t inadvertently reduce business capital.
Some business owners use an owner's drawings to take money out of the business. This method has its pros and cons, I am not a financial expert and it’s essential to talk to advisors, tax experts or accountants who work in this area to understand how it affects both the business’s financial health, personal taxes and cashflow. Again, the advice of qualified people is critical here.
Understanding these principles is easier when you see them in action:
A small e-commerce business earns $80,000 in profit in its first year. Instead of taking this money home, the owner reinvests it in new inventory, website improvements, and marketing. By the end of the second year, the business’s revenue doubles, and the owner is now able to take home a larger portion of the profits.
A new café owner might believe that their net profit of $30,000 in the first year is money they can pocket. However, after setting aside funds for taxes, repaying a small business loan, and building a reserve for equipment repairs, they find that only a fraction of that profit is available for them.
Given the complexities of managing profits, it’s wise to seek professional guidance from accountants who can help you navigate the best way to manage profits, tax and cashflow, whether that means reinvesting in the business, paying down debt, or maximizing personal income. Proper financial planning can make a significant difference in how much of your profit ends up in your pocket.
The structure of your business significantly impacts how profits are handled:
As a sole trader all profits pass directly to the owner, who pays personal income tax on them. In contrast, a company might retain earnings within the business or distribute them as dividends, each with different tax implications.
In a partnership, profits are typically split according to the partnership agreement. This means each partner must carefully consider how much profit to reinvest in the business versus how much to take as personal income.
Finally, profits play a crucial role in planning for the future. When planning to eventually sell or pass on the business, profits will be a key factor in determining its value. A profitable business is more attractive to buyers and can command a higher price. Is profit always money in your pocket when you own a business? Not exactly. While profit is a critical measure of success, it's also a resource that needs to be carefully managed.
I am not a financial advisor or tax expert, so I strongly suggest you talk to an accounting professional to help you get structure and tax planning right before you decide which is right for you. They will help you make decisions in the best interest of both you and your business.
Peter Nola is an Auckland based business broker, author and YouTuber with 20 years’ experience and over $100m of businesses sold, helping New Zealand business owners to buy and sell businesses.
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