How Soon Should a Startup be Profitable?

Many entrepreneurs wonder when their startups will begin turning a profit, and although there's no set answer that applies to every business, there are some calculations you can make to project how your profitability trendline will rise.

Assessing profitability enables businesses to make more informed decisions that can help drive growth. In addition, investors are leery of putting their money into a startup before the owner submits financial projections of future profitability. Check the following answers to common questions about profitability.

How to Calculate Profit Based on Current Numbers

The financial definition of profit is the amount of money left after accounting for all overhead expenses, payroll costs, income streams, debt and taxes. Several key business metrics need to be applied to measure a startup’s success – where it is making or losing money. These metrics (lifetime value, timeline to ROI, churn rate and growth rate) can help you understand what you require to be profitable.

At the most basic level, startups should assess profitability on an item-by-item basis – goods produced and sold or services delivered. Comparing these numbers over time helps management know if the company is meeting expectations. The following three terms are generally used to measure the level of profitability.

Ramen profitable — Your business makes enough money to support you, and covers basic living expenses.

Corporate profitable — You can make payments on debt, pay yourself a good salary and still have money left in the bank.

Break-even point — The money you're bringing into your business matches the money you're spending or to the investment made. Once you reach the break-even point, you can proceed to calculate an adjusted break-even point to find whether your sales are now covering all of your costs. Add your debts and desired returns to your fixed costs. Also, calculate the cost of adding a partner or experts to the payroll, production or marketing departments. Making enough to break even in your first year should be seen as a significant success. 

What's a Good Profit Margin for a New Business?

A profit margin represents the percentage of revenue after deducting all costs, business taxes, depreciation, interests and other expenses. Profit margins are industry-specific – what's "good" for one company will depend on the type of business, expansion goals and economy. For example, industries with lower overhead costs, like consulting, have higher profit margins than a business like a restaurant, which pays higher overhead costs in facilities, payroll, inventory and so on.

One recent study suggested that average net profit margins range from as low as 1.5 percent to as high as seven percent. The information varies from year to year based on economic conditions, but a seven percent net profit operating margin is a high benchmark. The study found that the average small business profit margin with no employees is $44,000 per year, and the average profit margin of a small business with 20 to 99 employees is $498,680. 

What is the Average Time to Profitability for a Startup?

The average time to profitability for a startup will depend on many factors, including the nature of the business, the state of the economy, the operation sector, capital needed to create the new products and services, and money drawn from the company for compensation and investor servicing.

While profits in the first year of business are always welcome, startups shouldn’t be expected to be profitable immediately, nor should anyone be relying on them to make a profit right away. Three to four years is the standard estimation for how long it takes a business to be profitable.

Most of your earning in the first year of the business will be used for paying expenses and reinvestment. In the second year, you can take a small draw after paying all debts and invest the remaining profit right back into a business. As a result, the company isn’t necessarily profitable on the ledger. By the third year, ideally, there will be a higher income than you had in the second year of the business. It’s this last phase that would make most entrepreneurs feel that the business should be profitable. However, a company can be successful when it shows little to no profit if it’s developing quickly and reinvesting in its growth.

Depending on the industry and a company’s particular business plan, the average time is going to be different for every startup company, as each startup has different initial costs and ways of measuring profit. For example, an online business, which has relatively very little overhead, may become profitable faster than a manufacturing company or brick-and-mortar store, which has much higher production and operation costs.

A survey by the small business lender Kabbage found that 84 percent of small business owners reach profitability within the first four years of business. This time frame is a good standard for measuring a business’ prospects for longevity and sustainability. However, always remember that every business is unique, and as long as your company is growing at the pace that's ideal for you, then you can rest assured that you're scaling appropriately.