Last week, I came across an interesting blog post.
Giacomo Guilizzoni, who was formerly a senior engineering lead at Adobe, recently launched a software company called Balsamiq which is focused on developing plug-ins for existing "Web Office" platforms.
His first plug-in, Balsamiq Mockups, helps developers quickly and easily create mockups.
On July 11, three weeks after Balsamiq's launch, Guilizzoni announced that his new venture was "profitable."
Guilizzoni provides a nice breakdown of his expenses and revenue and even provides pretty charts. Most importantly, he notes that his company is currently cashflow positive.
Yet as several commenters on YCombinator's Hacker News point out, Guilizzoni's "profitability" is a bit misleading.
One points out that Guilizzoni isn't counting salary:
"It's a great accomplishment to book thousands of dollars of revenue within a few weeks of launch. But as the article states, this is profitability without covering salary -- a big disclaimer."
Another points out that Guilizzoni doesn't consider that there was a cost associated with the development of his products:
"And doesn't count the product development sunk costs, either."
"By his maths, my first business was profitable in the first week, including my salary."
"What makes product businesses unprofitable upfront is not the ongoing costs, it's the development costs."
Clearly, Guilizzoni's business is off to a positive start and it seems like his Mockups product has been welcomed warmly by the market.
Yet the Hacker News commenters make valid points and Guilizzoni's chart showing total expenses of $0 in July should immediately raise a red flag
After all, I would certainly expect his accountant to declare expenses including telephone and internet service, basic supplies and home office deductions.
And while Guilizzoni may consider his work a "labor of love," not placing a reasonable value on the time he's invested in developing his product, as well as further development and operations, is not an accurate means to evaluate profitability.
Time is never free. In Guilizzoni's case, I'd think it reasonable, for instance, to consider that each hour spent building his product is worth whatever the standard rate he would have charged to build the same product for a paying client.
None of this is to say the Guilizzoni won't have a "profitable" business.
Yet his situation highlights the fact that a focus on "profitability" is really only worthwhile so long as "profitability" is being defined and evaluated accurately.
While determining "profitability" in the accounting sense may expose one to accounting intricacies and ambiguities depending on the structure and complexity of the business, entrepreneurs cannot simply discount important costs.
As Guilizzoni demonstrates, the most important cost that is often discounted by entrepreneurs is the cost of their time.
Often referred to as "sweat equity," the time entrepreneurs invest in their businesses with little to no pay is easy to discount because it usually requires no outlay of capital.
Yet not only does time have a dollar value, it has an opportunity cost.
The definition of opportunity cost is:
"The cost of an alternative that must be forgone in order to pursue a certain action."
While this goes beyond Guilizzoni's evaluation of his "profitability," I think it is perhaps one of the most worthwhile considerations for an entrepreneur when making decisions and assessing outcomes.
This is because when an entrepreneur chooses to invest his time in one opportunity over another, there is certainly a cost even though this cost is often hard to determine.
In Guilizzoni's case, it could turn out that he will earn less from Balsamiq than he did as an employee of Adobe.
If, for the sake of argument, we assume hypothetically that Balsamiq earns Guilizzoni $100,000 this year yet the total cost of his compensation package at Adobe (including benefits he now has to cover out-of-pocket) was worth $150,000, his opportunity cost is $50,000.
In other words, he actually "gave up" $50,000 choosing his own business over his former job despite the fact that he has a "profitable" business.
While the ancillary benefits of owning a business (control, flexibility, etc.) may, to the entrepreneur, outweigh the risks (including, of course, the failure of the business), this type of evaluation is, in my opinion, extremely worthwhile for individuals to consider when starting a new business.
At the end of the day, most successful entrepreneurs are as detail-oriented as they are innovative or even visionary and profitability and opportunity costs are two of the details that shouldn't be overlooked.