This book teaches the fundamentals of owner compensation, profit targets, labour productivity, cash flow, and data reporting. Clear explanations and helpful illustrations throughout make it a must-read guide for small business owners looking to achieve higher profits.
Your Capital Safety Net
Your “capital safety net” is calculated by figuring out how much cash you need to hire the people you need, and then estimating how long it will be before your business can pay the new hires and still remain profitable.
Prepare a cash flow forecast by month for the time period of the expansion to determine your capital needs.
Gross Profit And Contribution Margin
Gross Profit = Revenue – COGS
Do NOT include direct labor costs in the cost of goods sold.
Cost of goods sold typically includes pass-through costs like finished goods, materials, and subcontractors.
By focusing on gross profit instead of revenue, most businesses from any industry can be compared side to side.
Contribution Margin = Gross Profit – Direct Labor
Breaking Even Isn’t Good Enough
The target for pretax profit is 10%.
By the time you reach the breakeven point, your business is already dead.
The best businesses operate between 10 percent and 15 percent.
The Black Hole
The “black hole” exists between $1 million and $5 million in revenue.
This is a time in your business’s growth when you’re forced to add staff and infrastructure before you can really afford to.
Common Areas of Tax Fraud
- Paying yourself with distributions instead of a salary to avoid payroll taxes (S-Corps).
- Getting involved in offshore activities for the benefit of saving taxes only.
- Intentionally miscoding personal expenses as business expenses.
- Bartering by way of trading legitimate business expenses for something that is for your personal benefit.
- Not filing tax forms for subcontractors.
#4. Taking Profit Distributions
Capital formation is the sum of sweat equity, the money you invest, and after-tax profits that you keep in the business.
Consistent profits over time allow you to build equity by keeping those profits in the business, which then allows you to hit your core capital target, which then allows you to have excess cash that you can take out without damaging your business’s ability to grow.
Labour Productivity: Your Key to Surviving the Black Hole
Focus on your gross profit per labour dollar as your key indicator for labour productivity.
Stay at the 10% pretax profit mark every step of the way by adding labour only at the last possible moment.
You can’t increase pretax profit by revenue growth alone. You improve your profitability by getting more productivity out of your labour.
The profit curve should ideally mirror the revenue curve.
Evaluation Process is Key
- Your employees need to understand what is expected of them in terms of productivity.
- The best way to accomplish this is through the employee review process.
- You need to have a formal meeting with each employee at least twice a year.
- Focus on career planning and career path in employee reviews.
- Help employees understand that they are welcome to work at your company as long as you both get a fair exchange.
- It’s the responsibility of the CEO to provide employees with a vibrant environment, a fair wage, and a good culture.
Determining Your Salary Cap
Determining your salary cap is the best way to achieve your required labour productivity.
Nonsalary costs include all fixed and variable costs, including COGS, that are not paid labour.
In the example below, your salary cap for the year is $500,000. This is how much you can spend in total on wages, including all salaried and hourly employees.
Create A Cash Cow
If you’re not able to pay yourself a market-based wage, then you’re operating at a loss.
Until you pay yourself a market-based wage—and make a profit on top of that you have a sick cow on your hands.
Your goal should be to create a business that generates income for you every day (cash cow).
Calculate Your Sweat Equity
- Use sweat equity to compensate yourself when you can’t afford a market-based wage.
- Sweat equity is the value you have created for your business through your unpaid work.
- This concept helps you calculate your lost opportunity to earn market-based wages had you chosen to work elsewhere.
- If you have outside investors, it gives you a way to balance the worth of your effort with the money they invested.
Owner’s Salary: Why Your Salary and Distributions are Fogging Your View of Net Income
Don’t confuse business profits with the owner’s salary.
You get paid a salary for what you do, and you get a return on what you own.
Until you pay yourself a market-based wage and plug that number into your financials, your financial data is worthless.
If you got run over by a bus today and your heirs decided they would keep the business going in your absence, what would they have to pay someone to do your job? Answering this question determines your market-based wage.
Opportunity is missed by most people because it is dressed in overalls and looks like work.
The Salary To Give To Employees
- Companies that underpay employees tend to struggle in the long run due to high employee turnover.
- You also can’t assume that if you pay higher wages, you’ll get more productivity.
- Never give employees a cost-of-living adjustment.
- Years of experience often don’t count for much. The important thing is what people know and if they have the capacity to produce.
Managing Your Salary Cap
If you are exceeding your salary cap, decide what to do about it.
Once you get to 15% pretax profit, then you can add employees to drive your profit back down to 10% again.
If you try to raise your salary cap when you have only 10% pretax profit, you’ll drive your profit down toward 5%, which is the danger area.
Business Physics: The Four Forces of Cash Flow – #1. Paying Your Taxes
Before you spend money on anything, you have to set the taxes aside.
Don’t pay taxes until you absolutely have to without incurring a penalty.
But 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.
Market-Based Wages For All
A high employee turnover rate is very expensive.
Fair does not mean equal. Two people are rarely worth the same amount of money.
Management by committee is an absolute failure as a business model. There has to be a clear leader even if the stock ownership is equal.
Profit: The Importance of Pretax Profit
Pretax Profit = Total Sales – (COGS + Operating Expense + Interest Expense)
Pretax profit is the profit you make after you take all your sales minus all your costs before you pay taxes.
Focus on your pretax profit. Interest, depreciation, and amortization are real numbers that you need to consider in the profit calculation.
Be Careful With Incentive Plans
- Throwing money at a problem doesn’t change the outcome.
- Most entrepreneurs look to incentive plans as a substitute for management and leadership.
- It’s usually more effective to use small amounts of money along the way to recognize outstanding achievements.
#2. Repaying Debt
You can’t build wealth until you get out of debt.
People who take a low- to no-debt approach can handle bad economic news because they live more stable and productive lives.
If you borrow money, you have to forgo any after-tax profits because you have to repay debt with those profits.
#3. Reach Your Core Capital Target
As a general rule of thumb, your core capital target is equal to two months of operating expenses in cash and nothing drawn on a line of credit.
Your core capital target forces you to pay for accounts receivable, inventory, and equipment with capital or term debt.
The Lip Service On Culture
Document your culture and how it ties into your profitability as a business.
The more you document it, the easier it is to live it and maintain it.
Send an email at the beginning of the week that highlights one segment of our culture document to let everyone know what our focus of the week is.
A company with a great culture and no profits is going to die.
