One of the great things about profit curves is the easy way they present your total revenue (in green) against your total costs (in red). As you can see when the revenue line is above the cost line then a profit occurs. Further if we were to take Total Revenues away from Total Costs we get either a negative or positive figure. This is the bottom graph. From both we can see that firm breaks even when it reaches a quantity of 3 or Year 3.

Both graphs are exactly the same but give you a good example of how to use them. I have presented same the graph with quantity on the bottom X access at the top and time on the bottom.

Now that’s you know the HOW – I will now give you the WHY.

Profit curves present a glaring example to the board of not only whether or not your firm(s) is making any money ( profits) but on these same graphs you can draw those lovely financial projections you were given.

Even better you can also see the breakeven points for your company, which is where the Total Costs equal the Total Revenues - this is always one of the most important indicator for investors, because this will tell you when (if ever) you can expect to start to see a return on your investment.

The graph below is a true real-life graph of an Internet service provider I consulted on.

This is where fantasy meets reality. As you can see, the costs were rising faster than their revenues.

In fact the more successful they became, the faster they lost money. That is, as the number of customers increased, the faster their costs escalated, and hence the faster they would lose money. This was pretty ugly; because ISP's typically have increasing returns to scale, so they had done a pretty bad job of it.

When I presented this to the board, you could have heard a pin drop.

This was another example of a business model made on a spreadsheet with out any critical thinking. As both a turnaround consultant and IT Director I have seen this more than once; business development creating models without any idea of how the costs work in an industry and without any involvement of engineers or operations staff.

As such I strongly encourage that all angel investors at board meetings start of with one of these, because they quickly tell you not only the good or bad news but they also display it in a rather blunt and objective way.

Further because the Total Costs (TC) is drawn out, board members and investors can very quickly spot out of control spending.

Even better news, if you have a marginally profitable firm, then you can plot the total cost of each senior manager on the same graph as well.

Like the previous blog, plotting a CEO or senior manager’s compensation for x years can show the outgoing in wages against the companies marginal profit / loss.

It may be that removing mediocre managers or changing the structure of those large costs can make a marginal profit slightly more palatable.

E.g. if you have a CEO costing you £250k per year and you are only making £100,000 profit, then perhaps a cheaper CEO will do the job for £100k, in which case you are already better off by £150k per year.

The mortality of profits and the lack of shame.

Going out on a psychological bent, one thing that continually stuns me is the lack of shame by senior managers of failing companies’.

The credit crunch present numerous examples, where there apologies presented in front of government committee hearings are just so pathetic as to make one sick to the stomach. Board meetings can be the same.

Rather than being ashamed or even angry over company or investment losses, the managers tend to just ignore any questions pertaining to them.

One CFO I encountered presented spreadsheet after spreadsheet of fanciful financial projections, all the while avoiding answering the simple question of ‘has the firm ever made any revenue at all?’

I tried to explain the investors were an insurance company and that the money came from people’s pension funds; hence someone’s retirement depended upon the firm making a profit; and that we were morally honour bound to make one – regardless of any legal fiduciary arguments.

I was met with either rolling eyes or cynical grins.

Somehow it didn’t seem to get through, or perhaps it was because it did get though, that the managers refused to acknowledge that there were consequences to firms losing investors money. That people hurt at the end of the day because of the messes they created.

A quick search of the definition of shame defines it as: A painful emotion caused by a strong sense of guilt, embarrassment, unworthiness, or disgrace.

The managers present, displayed none of these.

In fact their attitude was that because they had all gone to prestigious ‘red brick’ universities or had 20 years plus experience, they were some how entitled to their positions regardless of fact that they had not made money for their investors / shareholders.

The point is, in many turnaround situations, senior managers don’t have a moral reason as to why they must make money for their shareholders. They see it something you ‘hopefully achieve’ – a nice to have – not a need to have – and worse they don’t understand the ‘why the need to have’.

As such, without this moral imperative they may acknowledge the importance of profit intellectually but emotionally they don’t understand it. As such failure in these firms under that type of management is inevitable.