Simple Numbers, Straight Talk, Big Profits!
Simple Numbers, Straight Talk, Big Profits!

Simple Numbers, Straight Talk, Big Profits!

Pretax profit is your earnings before taxes. That is the revenue-generating activity that your business produces for your benefit. In most of the businesses I work with, interest, depreciation, and amortization are real numbers, (Location 352)

so it’s important to understand that you should ignore EBITDA and focus on your pretax profit. (Location 354)

Gross profit is revenue less cost of goods sold. Contrary to many other accountants, I recommend that you not include any labor costs in getting to gross profit. By keeping labor out of the equation, my definition of gross profit gets you to the number that is the true economic engine of the business. (Location 357)

Cost of goods sold typically includes pass-through costs like finished goods, materials, and subcontractors. (Location 359)

By focusing on gross profit instead of revenue, most businesses from any industry can be compared side to side. (Location 360)

Gross profit minus your direct labor is then what I refer to as your contribution margin before you pay for your general operating expenses. (Location 365)

That’s why your revenue doesn’t matter. Your gross profit matters most, followed by how you get to pretax profit. (Location 371)

I’m more proud of a business owner who gets a million dollars of revenue and brings home a half-million dollars in profit than someone who’s earning $5 million dollars in revenue but is in debt up to the eyeballs. He can’t even pay himself a salary, and he’s about to go broke. (Location 380)

After we looked at breakeven analyses, we concluded that when your pretax profit is at or below 5 percent of revenue, your business is on life support. (Location 387)

The best businesses tend to operate between 10 percent and 15 percent. (Location 393)

You need enough revenue to cover the costs of paying market wages for people to perform in all of your business’s functional positions. (Location 407)

One of the things I do when I sit down with owners of million-dollar businesses is ask them to put the responsible person’s name beside these eight functional areas: (Location 409)

Between $1 million and $5 million in revenue is what I refer to as the black hole. This is the time in your business growth when you’re forced to add staffing and infrastructure before you can really afford to. (Location 431)

That means you have to hire people with the right skill sets to make the journey with you, and you have to pay them a market-based wage. If you don’t, you’re not going to get through the Badlands in one piece. (Location 453)

The need to add management infrastructure seems to naturally occur when you have about twenty employees typically, when you’re between $2 million and $3.5 million in revenue. (Location 461)

A lot of growing businesses want to hire someone who has “been there, done that” credentials, but my clients have the least success with this approach. (Location 477)

Another successful approach is hiring young talent and investing in their education. In fact, at my firm we like to hire people straight out of college. (Location 486)

Calculate how much cash you need to hire the people you need, then estimate how long it will be before your business can pay the new hires and still remain profitable. (Location 501)

You must make assumptions about when the revenue should show up and bring you back to your target profit. (Location 504)

Most venture capitalists will tell you that there isn’t a lack of money but there’s a lack of good business ideas and good deals. But there’s always money for good deals. (Location 510)

My experience always leads me back to one key factor: labor productivity. (Location 558)

Focus on your gross profit per labor dollar as your key indicator for labor productivity. (Location 563)

Not only that, Company A’s pretax profit was close to zero. (Location 570)

They made the classic mistake of adding labor to support their growth, but they failed to get enough of an increase in gross profit to drive toward profitability. They had to go back, fix the functional areas that weren’t working, and look at the business anew. (Location 576)

The company stayed within the target of 10 percent to 15 percent pretax profit. (Location 598)

which is the biggest profit sucker out there. You’re doing all those little jobs and you start thinking, “Gee, I really don’t like doing that. (Location 600)

See the difference between Company A and Company B? Company A took the typical route of not being profitable before they tried to grow to $5 million. (Location 612)

A key talent is to know what tasks to reassign to new hires and what tasks to assign to your current employees. (Location 619)

the CEO position and the sales function. (Location 623)

because somebody has to be there every day and be the boss. (Location 623)

One thing that happens at $5 million in revenue and beyond is that you continue to refine the management team and the people you’ve brought in to run operations, finance, sales, marketing, and so on. (Location 626)

Their success is based on knowing when to hire veteran talent and when to develop new talent. They have been effective at both. I stress the story of developing talent here because most entrepreneurs want quick success and resist training as a viable option for growth. (Location 648)

You have two choices. You have to cut $100,000 in salaries or you have to not spend a single dime until you produce $100,000 more in gross profit. I don’t care which one you pick, but you have to pick one of these two options.” A couple of days later, he called and wanted to talk. (Location 682)

At 10 percent, it was $100,000. This tells you that 10 percent pretax profit is your bottom line barrier because you need that difference of $50,000 to cover your salaries. (Location 700)

But that doesn’t last very long. Most customers will stretch out their payments as long as possible. Your big-time competition will offer to extend credit to these customers because they can afford to wait for payment. This is one of the barriers to entry that prevent new companies from being competitive. (Location 741)

Your core capital target is simply this: two months of operating expenses in cash and nothing drawn on a line of credit. (Location 780)

Remember, it’s about keeping your cow (your business) healthy. (Location 801)

They wait until the year is over and leave you with only bad options. (Location 839)

In most cases, this is my philosophy: Don’t pay taxes until you absolutely have to without incurring a penalty. Until you pay the taxes, you have to set the money aside and get it out of your financial calculations so you know it isn’t yours to spend. (Location 842)

People who take a low- to no-debt approach can handle bad economic news because they live more stable and productive lives. (Location 849)

There are two types of debt: lines of credit and term debt. (Location 852)

Because when you draw money on a line of credit, you’ve postponed a hard business decision that should have been made a lot sooner. Sometimes people would rather exhaust their resources than make the hard decisions. (Location 853)

you have what’s referred to as an evergreen loan. (Location 856)

lot of times I get clients who are already heavily in debt, and they have one of those evergreen credit lines. (Location 879)

profits. If you have no taxable profits, you can’t repay the debt. (Location 880)

When you take on debt, you’re forcing yourself to be profitable in the future or else you’ll default. (Location 881)

Do not confuse debt with capital. Capital is the cash you leave in the business to fund your receivables and inventory for normal business conditions, and debt is financing for special cases. (Location 895)

Let’s go back to our example in exhibit 4.3. This business had an average of $200,000 per month in operating expenses. It is no coincidence that their largest downstrokes in cash flow were approximately $400,000, or two months of operating expenses. (Location 914)

Remember, history is the best predictor of the future. You just need to look back and decide if there’s anything you can do to keep that down-stroke happening again. (Location 917)

And that’s when I knew that I’d convinced them to live on the cash side of the ledger, instead of the debt side. (Location 928)

Most entrepreneurs who have businesses between $1 million and $5 million need to build up about $2 million of liquid, safe, core assets that give them stability no matter what they’re doing in life. (Location 952)

This makes me think about the times I’ve been an expert witness in divorce cases. (Location 1012)

The only time you wouldn’t want to use a cash basis is when you consistently get paid before you have to pay your vendors, which is rare. (Location 1038)

You want to avoid paying taxes, so you buy a piece of equipment with 100 percent financing. (Location 1059)

Realistically, you should be paying last year’s taxes with the tax funds you set aside last year. (Location 1066)

Almost every entrepreneur who has a flow-through entity—which is an S corporation, LLC, or partnership—is confused about whether the company’s taxes are coming from this year’s profits or from last year’s profits. (Location 1069)

All you’re trying to do on a quarter-by-quarter basis is get close enough to the actual amount you’ll owe so you know whether to send a payment or hold it back. Either way, you have to take the money out of your financial equation. (Location 1073)

When I manage this for my clients, I have them pay the least amount possible under the safe harbor or the pay-as-you-go (Location 1110)

go methods. (Location 1111)

Their core capital is a very precious resource, so it’s not good enough for me to just make a simple calculation and tell them to base their payments on 110 percent of the prior year tax if they exceed the threshold. (Location 1115)

In a perfect scenario, you should pay yourself a market-based wage for what you do. Then withhold taxes from that wage as if the business is going to make zero profits. The goal is to be able to take your salary, pay your taxes on your salary, and live off the net amount. Base your lifestyle on the net amount, and you won’t have to rely on distributions to pay your personal bills. (Location 1122)

circumstances); it is based on your share of the net profit of the business, regardless of whether you take distributions or not. (Location 1135)

When tax distributions are paid to shareholders, one or more of them will invariably spend it instead of paying taxes with (Location 1136)

In chapter 3 I said the number one thing that causes you to be either profitable or unprofitable is how much productivity you get out of every dollar you spend on labor, including your own market-based wage. (Location 1169)

In every business, each dollar spent on labor has to show a demonstrable output for gross profit. (Location 1174)

mind: If you aren’t at 10 percent pretax profit, use what you learned about managing and raising your salary cap in chapter 3 to determine how much labor you need to cut or how much gross profit you need to add to get to that number, and then try not to add staff until you get to 15 percent pretax profit. (Location 1175)

Never give an employee a cost-of-living adjustment. If you do, you will have many employees asking for a salary increase based on what they need to make a living. (Location 1203)

My local chamber of commerce publishes an excellent wage survey each year. (Location 1235)

Not every business can tie profitability or gross profit or revenue on a per-employee basis, but many (Location 1240)

Focus on the top three to five skill sets that are required to maximize productivity for each job. (Location 1261)

The first component is a gross profit dollar scale that shows what executives can earn and what the business performance needs to be in terms of gross profit. This has various levels: a minimal acceptable performance, a target performance, and a stretch performance. In some cases, there can even be a level beyond stretch performance. (Location 1343)

There’s tremendous confusion about the word capital. Simply stated, it’s the difference between what you own (your assets) and what you owe (your liabilities). Another term for capital is equity. (Location 1394)

You should expect to get dividends with a nice rate of return, or you expect that the business will be sold and your investment will be worth much more than it was when you purchased the stock. (Location 1398)

Banks have the worst timing when it comes to repaying loans. (Location 1406)

There are so many troubled businesses that banks are unwilling to create a cascade of losses by closing everyone down. (Location 1408)

As you know, my philosophy is that your business should make somewhere between 10 and 15 percent pretax profit. That rate of profitability coupled with maintaining a core capital target of two months of operating expenses with nothing drawn on a line of credit works out to about a 40 to 50 percent rate of return on the investment that you have in the business. (Location 1432)

money. I can count on one hand how many of my clients have taken OPM and diligently protected that cash as a precious resource. (Location 1450)

If your balance sheet is right at the beginning of a period and it’s right at the end of the period, then the net income number has to be right. It’s a closed system; it has to work. So if you find an error, don’t continue to explain it month after month. If inventory is misstated, fix it. If there’s a receivable on the books that you’re not going to collect, write it off. (Location 1768)

business. I have found that deals rarely get done at lower value than this, and many times a total sale of the business will yield a higher number because the seller now has a better understanding of what the business is worth whether sold or not. (Location 1804)

To start with, if I’m going to buy 100 percent of a business, the maximum amount of time that I’m willing to wait to get my money returned to me, net after tax, is around ten years. (Location 1810)

The only risk is being unable to find a replacement who has a similar skill set, but you can often find someone who is cheaper and more capable than the selling shareholder. (Location 1853)

You use this method when there are net assets in the business but the business isn’t profitable. (Location 1928)

I’m not going to give the current owners any benefit for their stream of profits or lack of profits. (Location 1930)

In the current small-business environment, the most common valuation scenario is when there’s a damaged business and its worth is based on its net assets. (Location 1931)

That’s not based on the value of the company. That’s based on the owners’ investment in the company, which is the sum of the cash they put in plus the earnings they left in after they paid taxes, so the numbers are extremely valid. (Location 1976)

In five years, Company A created a cash flow–generating asset worth $1.4 million that started with $50,000 in cash. (Location 1981)

For the buyer who purchases Company A for $1,405,000, it would produce $158,400 per year, and at 7 percent interest to finance it, it would take 14.34 years to pay it off. (Location 2001)

Basically, when you buy a business, you have to pay attention to the net after-tax number. The value of the business over time cannot exceed that number unless you have some other reason to think it is worth more. (Location 2006)

But there are entrepreneur graveyards filled with people who bought businesses and couldn’t make them work. (Location 2016)

For instance, if you know that A/R is too high, you have a target to shoot for. You can’t just hope that A/R goes down. Hope is not a strategy. (Location 2200)

This represents the productivity of your employees. There will be some high months and some low months. Exhibit 10.1 calculates labor efficiency on a month-to-date and year-to-date basis so you can identify trends. (Location 2224)

Remember that your core capital target is two months of operating expenses in cash with nothing drawn on your line of credit. (Location 2234)

Remember, you’re not fully capitalized until you’re out of debt and you have cash in the bank to cover two months of your operating expenses. (Location 2242)

If you have debt, you won’t even find the opportunities. The people with cash always win. (Location 2245)