Well, that wasn't what I expected from a post on asmartbear. Trite quibbling over minor semantic distinctions? For an early stage startup, spending even two seconds worrying about the exact definition of "profitable" and whether or not your definition is suitable to someone else, is two seconds one could have spent writing code or doing something productive.
Pretty much a useless article, as far as I can tell.
Wow do I ever think you (and even 'damoncali below) are wrong about this. This is the opposite of a "useless post". This is a post about how lying to yourself about the definition of "profitable" can cost you tens of thousands of dollars.
The idea Cohen is expressing is so extraordinarily simple it would almost be banal, if it didn't target such a widely held misconception:
You cannot factor out opportunity costs when accounting for your business.
When a new founder with a business throwing off $1500/mo after line-item costs like hosting claims to be "profitable", what they are effectively saying is that their own time is worth $0/mo.
In reality, that founder is almost definitely losing at least $11,000 per month --- by taking a SWAG at what any person capable of booting up a product to reliable $1500/mo can earn as an employee or freelance consultant, that SWAG being almost certainly so lowballed as to be insulting.
To my mind, not being able to tell the difference between "profitable to the tune of $1500/mo" and "losing 5 figures a month" is an alarming difference that is very much worth calling out.
Wow do I ever think you (and even 'damoncali below) are wrong about this. This is the opposite of a "useless post". This is a post about how lying to yourself about the definition of "profitable" can cost you tens of thousands of dollars.
Is it really? I mean, that makes sense if the only point of being an entrepreneur is to make money, and you're totally fine with working a $DAYJOB as an employee. But, for some of us, it's about more than the money, and fighting to make the startup succeed is totally "worth it" even if "it" is tens, or hundreds of thousands of dollars that we might otherwise have earned as an employee.
You cannot factor out opportunity costs when accounting for your business.
But if your company is bringing in $1500/mo after line-item expenses and before wages, you are making less than minimum wage; you are not profitable. Happy? Sure. Profitable? No.
You seem to be blurring the line between "the company is profitable" and "I (an individual) am profitable." It's certainly possible for the company to be profitable in a narrow sense (which can be an important bit of information) while you (the founder) as an individual are not.
But since a founder owns equity which he/she expects to become valuable in the future, it's a tradeoff some people choose to make - forgoing a salary now, so the company can thrive.
Perhaps the downvoters would like to explain their logic here? If a worker chooses to donate his/her time to the company, how is that a cost for the company? Again, there is a distinction between the finances of the company and the finances of the individual involved. It's entirely reasonable, for example, for a founder to "donate" his/her time to the company, because he/she expects to gain from their equity stake in the future.
The point is that the goal is to generate growth through reinvestable cash flow. Only when a business has money left over for owners (after they have eaten) is it profitable in this sense.
Opportunity cost has nothing to do with it. If I have created a business that pays me $50k a year (to live off of) and throws off an additional $25k in earnings that I can reinvest in the business, I have a profitable business. It can be grown through reinvestment of profits, and has value to investors.
None of that changes if I could be making $1M per year doing something else. You can't say that the business isn't profitable just because I have a high value alternative. It just means I'm not maximizing my income (which is a personal choice, not some indication of business health).
If you create a business that pays you $50k/yr and generates $25k/yr in reinvestable cash flow, I have no problem with you calling it "profitable".
But if you create a business that pays you $0k/yr, and offers $2000/mo worth of revenue to split somehow between reinvestment and wages, I have a real problem calling that "profitable". That business is "profitable" only so long as you are willing to donate your time to it.
In reality, that second class of business is virtually always pro-forma cash-flow negative; the founders simply aren't accounting for the rent/mortgage and food payments slowly draining away at their savings cushion. That cushion is a phantom capital investment on their books, but they don't want to account for it, because if they did it'd be obvious they weren't profitable.
I don't think we disagree much. I would argue that personal finances and business finances are totally separate, though. Whether or not you are making your mortgage payment is not all that relavent to the business in terms of its profitability.
For example, two founders each have identical businesses. One has a $10k/month mortgage. One lives in a $400/month apartment. Which one is more profitable? Neither. If either founder chose to sell their business, they'd get the same amount. That is, the present value of the profits of either business is the same to a would-be purchaser.
The question that needs to be adressed is not "How much do I need to live the way I want?", but "What is the market salary of someone I could hire to do my job while I sit at home and watch Shark Tank on DVR?" If you account for that, and the business comes out ahead, you have a profitable business. (Even if you're blowing the profits on your mortgage.)
That's more like "I took a pay-cut in exchange for a better quality of life", which is understandable and totally a choice I might make. But the important bit is that you would, in fact, take a pay-cut.
The article basically boils down to 'if the startup can't support you fulltime, it's not profitable'.
If you still have to be a consultant to pay the bills because your side project isn't making enough money for you to quit, don't run around telling people your 'startup is profitable'.
Speaking as someone who has done the side project thing, I was never happy having to work a full time job when I wanted to be full time on my sideproject.
I don't think the word "profitable" is the interesting part of the article--rather it's looking for inflection points in the time/utility function of your startup. It's making the point that the interesting point is not when the final figure in some parboiled accounting books is positive, but when you have enough confidence in it to use it as your primary source of income.
I'd urge you to re-read it and not fall into the trap of believing he's making an argument on semantics. There's a useful point there.
Fair enough, maybe it's just that the headline is misleading. No doubt, that inflection point does matter... But I wish he'd been clearer in saying that that's what he's talking about.
But even if we acknowledge that that inflection point is important, what conclusion is he asking us to draw from it? Does acknowledging or not acknowledging this point make much difference to any strategic or tactical decision a hypothetical startup founder is going to make? I mean, if the OP had made a point about "this is how you know when to go raise outside money" or "this is how you know it's time to shut down the "profitable" startup," then I'd have found this valuable.
Pretty much a useless article, as far as I can tell.