Science of Business Wealth

Small Business and Productivity

What You Don’t Know about Cashflow Will Kill You

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“I hired a counterfeiter the other day. I told him, “As for your salary, how much you make is really up to you.” I love a business model where the employee pays the employer.”       Jarod Kintz, This Book is Not For Sale

 

As a small business owner you are often the employer and the employee. If there is ONE thing you need to have a maniacal focus on, it is CASH.

You can survive if your revenues dip a little or a key employee leaves or you lose a critical customer. But you cannot survive without cash. Cash is to your business as oxygen is to your vitality.

No cash. You die. Period.

Business growth can be exhilarating. But growth sucks cash. Fast.

You need an easy way to calculate your cash and your cash flow. This post gives you a method and tool to do this.

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What to say - When talking about your clients financial statements

All you need is the income statement and balance sheet

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What is the personality of your business? Debt to Equity Ratio explained

shark tank

 

Each of the sharks above have a different personality and propensity for risk.  Mr. Wonderful want to know you know your numbers or else he retorts "you are dead to me!"

Mark Cuban mulls quietly and pounces quickly often shutting the other sharks out.

Even though they are billionaires they worry if they invest with you, how will they get their money back?  They want to know what kind of risk taker you are and how safe their money will be.

In our last blog (Making Money from Other People’s Money) we discussed the role of Debt in helping you with your wealth creation strategy.  

The key insight was if your business generates a significantly greater return than the interest rate at which you can borrow money then increasing your debt is an effective strategy for growing your company.

Now we are going to layer on a second component to managing debt, something the sharks look for, are you disciplined in the way you consider overall business risk.

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Three levers to improve profit--which one will you choose?

Copy of Price

“Management doesn’t get paid to make shareholders comfortable. 
            -We get paid to make them rich”
                        Robert Goizeuta former Chairman & CEO Coca Cola Company

 

Here at the Science of Business Wealth we want to help you develop great answers to the following questions:

1.  Are you making money?

2. Do you have enough cash to run your business?

3.  Are you building long term wealth?

This post focuses on question 1.  There are three levers to increase profit and we will examine each in turn to show you how to make more money.

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The 7 stages of working ON the business

Through our observation and studies, we have identified 7 stages of evolution that an organization goes through when it comes to working ON the business.

These stages are not definitive many organizations show tendencies to mix components of each stage yet the successfuls master each stage before progressing in an effective manner to the next.

There are many conditions that determine the velocity of the evolution but in the main the key variables that create either constrains or rapid progress include

  • Leadership
  • Culture
  • Money

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Strategic growth rate – the new standard or is it

Congratulations revenue growth as the main measure is slowly been challenged.

We all love growth as an easy measure of success (and failure)

As I always say when you change the way you look at things the things you look at change. (I have needed to use that expression a little more than I possibly would like)

Recognition is now placed not only on growth as the key measure but a combination of revenue growth and EBIT growth as the new strategic measure.

Strategic growth is now measured as the amount of the revenue growth % plus the EBIT or profitability growth %.

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Secrets from the Science of Business Wealth

 

Good to Great by Jim Collins is a great book that explains “Why Some Companies Make The Leap and Others Don’t”.

The challenge for small business owners is much of it may not be relevant as the average size of the 28 companies in the study was over several billion dollars.

The startling fact is 50% of small businesses fail within their first five years. We wanted to know how to avoid that failure and what successful owners did to consistently grow their business.

So we launched our own unique multi year study of 164 small businesses whose revenues ranged from $500,000 to $10,000,000.

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Marginal Income Ratio (MIR) Dilemma

The MIR can be a powerful and fast way to evaluate your next business case. Be aware of potential false precision potholes that you may encounter


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It was a cold Saturday morning and Jack Frost was pondering about the interview he had on Friday with Sally Bigsales. Jack liked using his Saturday morning for what he called working on the business.

Sally was most impressive and the time has come to grow again there has been a period of stagnation within the business and Sally could just be the required medicine

Sally articulated he plan that looked most achievable with an expectation to get an additional $1.5M in revenue

To determine Sally’s benefit case Jack deploys the Marginal Income Ratio (MIR) tool.

As a way of a quick introduction.

MIR is the contribution to operating profit based on the next revenue dollar or the dollar growth that you are anticipating in your business.

MIR is also used to determine the Break-Even Sales (BES) that are required to cover the fixed costs and make no profit.

Jack extracted a summary income statement for the last 12 months. To do this he defines his variable and fixed costs.

Variable costs are those costs that vary in direct proportion to revenue changes. Commission paid to salespeople are a good example of this. In Jack’s case, his variable costs were to a third-party warehouse that performed his shipping and logistical functions.

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Keep in mind costs don’t behave the way you classify them they behave the way you manage them.


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Jack was reasonably proud of his accomplishments with operating profit (EBITDA) at 9% on his total $12M of revenue.

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To define his MIR Jack isolated the variable costs and deducted these costs from revenue. This delivered what Jack called his Marginal Income (MI). Representing the contribution before to his fixed costs and required profit.

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The next step is to determine his fixed costs. Jack wanted to know the “cost base” that his marginal income had to cover. This included his fixed costs plus the current profit that he was achieving.

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Jack knew that Sally would costs him a base of $80K to deliver the additional $1.5M in revenue.

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The next step was to determine the new cost base with the know information. This was relatively easy starting with the existing fixed costs he added the additional cost for Sally plus his achieved profit.

Jack pondered on what his expectations were if Sally was to deliver her required sales. His thought process was that he at least wanted to see a 10% growth in operating profit.

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With all of this in mind the revised cost base was now $2.498M. The new revenue to produce cover this costs base (fixed costs plus required profit) was close to $13M simply calculated by dividing the MIR into the cost base.

The additional revenue required to achieve the goal is close to $1M. Knowing that Sally plan should deliver $1.5M Jack gut feel was now been supported with sound evidence.

Jack thought about the guys at the Science of Business wealth and smiled, what did they always tell me “Passion for intuition Powered by evidence”. This is what working on your business is all about.


What Jack did not realize is that he was potentially falling into the what we call the false precision trap


Jack being a conservative fellow stress tested his revenue capabilities going forward combining his expectation of what his current business growth and Sally new revenue would look like

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The total estimated revenue growth would be $2.7M with the required growth to cover his additional profit and Sally’s costs to be close to $1M. Why would this not work Jack thought.

He quickly computed what the income statement would look like based on the minimum required revenue

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Jack smiled with $13M in revenue I can deliver an EBITA of $1.188M giving me my additional 10% profit growth and the possibility is that I can easily exceed that revenue going forward.

As the story goes a year later in the traditional Saturday working on the business session Jack reviewed his results. The following income statement lay before him.

Jack knew things we not going as well as he thought but he did monitor the revenue growth and that was going to plan and thus over time he believed it would get better.

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Now that the full trading year had passed Jack wanted to gain insight on the results. Looking at the bottom line first (isn’t that what we all do) Jack looked into his cup of coffee and thought that it needed something stronger than pure coffee in it.

Jack pondered. I know I am all over my costs and they have not increased, I can also see that my gross profit margins have declined slightly but that could not be the reason for this relatively disappointing result.


What happened with all this revenue I am making less money


Jack did a side by side comparison with the previous year showing how the additional revenue impacted his profit.

It was most disappointing to see the additional revenue of $2.7M delivering $148K less in profits, all that work for basically nothing.

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But what puzzled Jack was the additional margin. $87k additional margin on $2.7M additional revenue computes to a little over 3% margin. There was no way that Sally or anyone delivered their revenue at those margins.

What happened. Sally introduced a new customer loyalty program that provided her customers with a 10% discount. Jack had authorized this program and thought it was quite innovative. His previous policy was to sell value not price. The success that Sally brought to the business was impressive. This tactic was quickly adopted by the other sales people and the new customer loyalty program over time became a standard offering. The result was not that impressive.

What was originally intended to bring in new customers became the standard behavior for the other sales people.

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At the end of the day the average discount amounted to a little over 5%. This translated to a net deficit in operating profit of $148K.

What is the moral of the story we call this false precision as Jack did the right calculations. He even stress tested his ability to attain the additional revenue what Jack did not do was stress test his MIR.

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IF Jack at the time of deciding on the Sally strategy said what if my marginal income ratio declines. At what level do I need to ensure that this ratio does not fall below to still provide me with the profit that I require.

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If Jack had done this his focus on margin management might have been very different.

Jack weekly scorecard now reflects the average margin percentage that he is attaining.

In summary, the MIR tool is an effective way to assess a business case. The key pitfalls that need to be looked at must include.

  • The additional revenue safety cushion.
  • The sensitivity to changes in the marginal income ratio
  • What would happen if costs behave differently than expected.
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Investor ready checklist - Questions to ask you client

How to use this checklist

  • As a way to engage your client towards business improvement objectives
  • Help clients who are thinking about selling their business
  • For clients who are looking for aspirational change.
  • Remember Investor Ready is not only for business owners that wish to exit.

2 components to the checklist

  1. Questions to ask the owner

Use these to gain a perspective from the owner

  1. Validation of the owners perspective
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HOW TO READ FINANCIAL STATEMENTS LIKE A BOOK IN 5 MINUTES INTERACTIVE COURSE

read1Rapidly learn the language of business

  • Enhance your career if you are in business this is a critical skill for you advancement.
  • Help your clients with their financial goals
  • Know how your business is performing and what you need to focus on to make more profit, cash and improved returns
  • Know how to speak to your banker
  • Know what to look for when you want to invest in a business
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How to Make Money using Other People’s Money

Moustrap debt

 

Wouldn’t it be great if you knew your business was a well-oiled machine capable of building wealth? All you need to do is to go the bank borrow their money at say 5% interest and put it into your business machine which converts it to a 20% return.

You pay back the bank and enjoy the fruits of your 15% return and you never needed to use a dime of your own money!

It is possible and requires you set up your Balance Sheet as a Wealth Creation Engine. Of course it is not straightforward, but there are basic disciplines you must master to get there.

Our research of successful business owners shows they are very comfortable and capable of leveraging debt (other people’s money). This post shows you how to use good debt and not fall prey to bad debt.

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How to enjoy the life of a millionaire without working like a slave

 

KEEP CALMYOU DONT NEED TO WORK LIKE A SLAVE TO LIVE LIKE A MILLIONAIRE


Are you a small business owner with 5-25 employees or aspire to grow to that level? 

You probably chose to be an entrepreneur so you could work on your own terms and build a great lifestyle. Sadly, many business owners just like you feel like employees trapped in a horrible nightmare.

  • Do you lurch from paycheck to paycheck?
  • Does your income statement say you made a net profit at the end of the year but you have no cash to show for it?
  • Are you frustrated that as your grow you expect life to be easier yet you find yourself working even harder?
  • Do you find you find you can’t even leave the business at the weekend because there are so many things for your to do?
  • Has your family forgotten your name?!


Look- You don't need to work like a slave to live the life of a millionaire”

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CPA power

By now it is well known that the CPA either internal or external to the business is expected to be “more strategic”

But what does this more strategic really mean!

The answer is to look at what business owners need and want.

Owners and business managers at their core strive to improve how effectively the business competes. The ultimate scorecard of this result is reflected in the financial statements. And who is the owner of the financial statements the CPA of course.

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Are You Growing Broke?

empty pockets man jail costs

“When I was boxing I made five million and wound up broke, owing the government a million.”
Joe Louis

 

Over 60% of the businesses we work with consume precious cash when they grow.  Sadly, most of them did not know this fact.  They happily celebrated their increasing revenues and rising profits until one day they ran out of cash.  Game over.  Done.  

 

We term this malady “Growing Broke”.  

 

Have you and your business been infected by this sly and debilitating illness?  It quietly eats you up.  As you struggle to make sales you breathe a sigh of relief blissfully, but dangerously not realizing that the cash rash has spread all over your body and you are really like one of the zombies in the series “The Walking Dead”.

We don’t want this to happen to you so we are giving you an easy way to tell if you are healthy and wealthy or you have the cash rash—if you are infected we will give you an early diagnosis and course of treatment.

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Mick Holly & Andre Gien

Wealth Scientists

You want to grow your business and have peace of mind?

Click here to learn the Science used by Successful Entrepreneurs.