Simple Numbers, Straight Talk, Big Profits!: 4 Keys to Unlock Your Business Potential

by Greg Crabtree

You must get owner compensation right to know what your true pretax profit is. Once you know your true profit, you can set your sights on the correct target.

That’s why so much of the data in the marketplace—whether it is industry data or comparative data among other industries—is worthless. Until you apply the market-based wage filter across that data, none of it is relevant.

Paying taxes is a good thing. The higher your tax bill, the better your business is doing. This is your number one key performance indicator.

To keep it simple, when I say profit, I’m talking about pretax profit. This is the profit you make after you take all your sales minus all your costs, before you pay taxes.

In most of the businesses I work with, interest, depreciation, and amortization are real numbers, so it’s important to understand that you should ignore EBITDA and focus on your pretax profit.

I couldn’t care less how much revenue you have. It’s an important number in terms of cash turnover, but we need to focus primarily on your gross profit before we can fix your pretax profit.

Put into KPI

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

Gross profit minus your direct labor is then what I refer to as your contribution margin before you pay for your general operating expenses. Don’t think of subcontractors as your labor that you make money from.

If a construction contractor has a $20 million business, that’s great. But by the time he subtracts what he pays for subcontractors and materials, he probably has a $2 million or $3 million business that looks like any other service-based business. That’s why your revenue doesn’t matter.

Take a look at exhibit 2.1.

Vnesi v svojo tabelo:!!!!!

when your pretax profit is at or below 5 percent of revenue, your business is on life support.

Simple Numbers eNewsletter Learn strategies to increase profits with the Simple Numbers eNewsletter! Email Address Email address for eNewsletter Sign Up Categories Build Your Business Keeping Data Simple Make Your Data Talk Managing Employees Managing Taxes Sales and Profit Archives November 2015 June 2015 April 2015 November 2014 August 2014 April 2013 January 2013 October 2012 July 2012 June 2012 May 2012 April 2012 June 2011 May 2011 #1—PROFITABILITY: IT WON’T HAPPEN UNLESS YOU AIM FOR IT Posted on April 29, 2015 by Greg Crabtree in Keeping Data Simple In the “Seven Simple Numbers for Business Success” series, we’re talking about each of the Seven Key Numbers that really matter to sustainable, profitable businesses. Based on the principles in Simple Numbers, Straight Talk, Big Profits!, these insights will show you how to use the Simple Numbers Profit Tool to run a long-term, wealth-generating business. Tweet about this post Our first key number is Profitability. Monitoring profit is key because profit is not something that “just happens;” it has to be a target that you aim for. As a wise person once said, “A man who aims at nothing hits it with amazing accuracy.” In my original book “Simple Numbers, Straight Talk, Big Profits,” I shared the following fruits of my business data research: At 5% profit you are on life support, At 10% you are a “good” business, And 15% or better is a “great” business. Tweet this quote This blog is about dispelling the myth that you do not need to worry about profits. Rare and few are the business success stories that involve plenty of invested capital, allowing them to not worry about profits. Such a situation may occasionally work in the technology space, but the real world of normal business requires profits for growth. Believe it or not, you can actually grow a business while being profitable! Just a Job or Building Wealth? My central premise for helping businesses relies on the assumption that you want to build wealth from your endeavors. If you look at your business as your job and maintain that whatever meager leftover profits are yours to consume, stop right here and go back to work. If you want to be highly compensated for the job you are doing in the business you own AND use the profits that the business makes over and above your salary for building wealth at a return on investment of 50% to 100% per year, then keep reading. True Revenue I have rarely seen a business that could not be profitable if effort and capital are applied correctly to overcome the challenges that are holding it back. You must first start with validating whether your business has true profit potential. In our research, most business models can produce 10%+ profits on revenue. Those businesses where the industry standard is less than 10% are not “true revenue” businesses. In my book, “Simple Numbers Straight Talk, Big Profits,” I show an example of a construction business that is only doing 2.63% profit. In reality, they are doing 18% profit because their $20 million in revenue is not “true revenue;” it is over inflated by “pass-through” costs of materials and subcontractors. These are considered a pass-through because the Construction Company takes a draw against the job to pay for the materials (no cash out of pocket) and they typically do not pay subcontractors until they get paid. After you filter out these costs from revenue, they are at “true revenue” of 18% against gross margin. If you are a business that has these types of cost arrangements with a low margin, you need to target your profit measure against gross margin and then work backwards to what a reasonable profit percentage against revenue would be. Our Simple Numbers Profit Tool reports on both of these percentages to make it convenient to track

10 percent of pretax profit means you have a good business. 15 percent or more of pretax profit means you have a great business. If you’re above 15 percent, you better take it while you can because the market will eventually change. The best businesses tend to operate between 10 percent and 15 percent.

your number one key performance indicator is how big a check you write to the IRS.

What happens at a million dollars is that you can no longer take care of all the functional positions. You need enough revenue to cover the costs of paying market wages for people to perform in all of your business’s functional positions. If you can’t cover these costs with your million dollars in revenue, you are not making a profit, and you will quickly go out of business.

Here’s what I always tell people: hire slowly, fire quickly.

Topgrading: How Leading Companies Win by Hiring, Coaching, and Keeping the Best People by Bradford D. Smart (Portfolio, 2005)

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.

The Patriots pride themselves on their ability to maximize output for every dollar they spend on labor.

I know this may sound harsh, but even though you love your employees and you want them to help you win at the game of business, at the end of the day you have a salary cap that you have to live with. Every business has a salary cap. Even an NFL team.

Costs that stay essentially the same regardless of sales volume are referred to as fixed costs.

In these examples, you can see that you need to hit at least 10 percent pretax, so that $100,000 pretax profit is definitely the minimum target for a business that is at $1 million in revenue.

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

In almost every case where I monitor this, the worst downstroke is roughly the two months of operating expenses.

You should rely on debt only in extraordinary circumstances. 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.

So keep it simple. You need to be current with paying all your vendors and reasonably current with collecting from all your customers.

love a recession because I’ve got cash and I can buy stuff cheaper than anybody because they know that I can pay it. I can work the deals while all my competitors go out of business. I’m the only game in town because I saved my money and they didn’t.”

This ties back to the basic philosophy that if you pay yourself a market-based wage, then you can live off that salary. Then you can leave the after-tax profits in the business until it is healthy and you reach your core capital target. After that, you can start to take distributions that are beyond the tax expenses.

Discover where your cash goes (or ask your accountant to help you) by using a format similar to the example at the beginning of the chapter. Set aside your taxes in a separate account on a quarterly basis regardless of when it has to be paid to the tax agencies. Calculate how much cash you need to get your line of credit to zero. Borrow term debt only when you have a clear strategy about how you are going to generate the profits to repay the debt. Understand that you probably won’t be able to take distributions while you are repaying the debt. Once you get your business out of debt, do the same for yourself. Yes, that means paying off the house! Build cash by retaining profits until you hit your core capital target. Remember, you can retain only about 60 percent of the profits because you have to pay taxes. Take distributions on a formal basis each quarter only after you have covered your taxes and hit your core capital target.

Have your tax advisor create a simple tax calculation template that you can review each quarter, or you can download a tax calculation spreadsheet for an LLC or an S corporation from my website, www.seeingbeyondnumbers.com.

your gross profit per labor dollar is the second most important key performance indicator for your business (remember that the size of the check you wrote to the IRS is number one).

Kpi!!

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.

Your body can’t absorb it. It’s more efficient to hire people on a more regular cycle and give them more direct attention.

Not every business can tie profitability or gross profit or revenue on a per-employee basis, but many can. If you have that ability and there’s software that allows you to capture the data, it’s one of the best ways to understand and evaluate employees.

I want my employees to understand that they are welcome to work in my company as long as we are both getting a fair exchange.

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

Your gross profit per labor dollar is the second most important key performance indicator for your business.

Identify the top three to five core competencies you need for each role in your business.

Another term for capital is equity. The capital in your business is used to purchase assets, such as inventory and equipment, and allows you to have the proper amount of cash on hand to meet your core capital target, which we discussed in chapter 4.

If you start a business with your own money, you’re going to defend it to the greatest degree.

Then pay yourself a market-based wage when your business reaches 2 or 3 percent pretax profit.

Daily report: Cash balance Weekly reports: Cash flow forecast; sales and productivity Monthly reports: Profit and loss; balance sheet and where the cash goes

My definition of cash balance is the bank balance in your accounting system, assuming all outstanding checks have cleared.

The purpose of the cash flow forecast report is to make sure you have money in the bank when your bills are due. It shows a two-week projection of your expected sources of inflows and outflows.

Pick a day of the month to review your monthly reports.

Continuously refine the report to make sure you’re looking at data that’s valuable to you. If you find that some numbers aren’t helpful, then quit reporting them. That’s really the key to a useful report.

Most entrepreneurs instinctively know where the weak points are. They just need the data to support their gut feeling.