Simple Numbers, Straight Talk, Big Profits
Learn simple but vital metrics to determine your firm’s potential success.
You’ve got a small company and it seems that things are going smoothly. You’ve been able to withstand the first several unsettled months and have even be able to slightly expand the business. What’s your next step?
Based on popular opinion, you’d need to begin paying attention to your revenue and making the most out of sales. Therefore, you start to borrow money in order to enlist more staff members and you take as many order as possible just so that you can make sure that money keeps on coming.
However, that’s not the correct route. The next paragraphs will tell you why abiding by that common, but incorrect strategy with put you on the path towards total collapse.
It’s not about the money coming in, rather, what matters is what’s going out. Revenue is meaningless if you end up spending much more than you’re earning. Profit is the leader and down below, you’ll learn how to protect you.
You’ll be taught:
- Why every company’s head must pay themselves the amount that they deserve
- How come you should never go into debt
- Why you should be paying your employees the same way a winning NFL coach would
Business owners should always pay themselves the correct market wage.
You probably won’t expect this, but 90% of small business owners actually pay themselves less than what is expected in the fair market wage.
This is mostly a rational decision given the fact that by decreasing their own wages, the business owners are able to make pre-tax profits seem a whole lot healthier.
That being said, business owners would be better of paying themselves the right market wage and there are two reasons as to why this is true.
For one, when you don’t pay yourself, or your staff members for that matter, a market-based wage, you business is actually undercut. Both pre-tax pforts and labor expenses are some of the main points that impact very crucial financial measures like labor productivity or the percentage of pre-tax profits to revenue.
We’ll learn later that those two metrics are quite important when it comes to describing the success of your company. Artificially changing them could impact your ability to grow your business.
In addition, you should be aware that the U.S Internal Revenue Service has incorporated that tactic, the tactic of underplaying wages, in the list of “dirty dozen” tax scams that are utilized by closely held, also known as “S”, corporations. As a result, the federal tax agency decided to audit firms that seem questionable in regards to that practice more and more often.
Secondly, it’s important that you pay yourself a market-based wage when you need to sell your company or leave altogether. This is due to the fact that a company’s profitability is the main factor when it comes to figuring out its fair market value.
Therefore, when someone from the outside takes a look at your books before buying your business. Artificially lowered wages have a chance of putting doubt on your business’s value in the eyes of a possible buyer.
On the other hand, paying yourself the market-based wage right from the start will allow your company from dealing with any cash flow problems along with the undesirable surprise of decreasing profits, should you choose to leave and have another CEO take your place, expecting to make the market wages.
Focusing on healthy profits will guide your business through its critical adolescent years.
At one point or another, every company has the risk of going down into a black hole. No, we don’t mean space travel but rather when a company’s revenue makes over the million mark and there’s an elevated necessity for employees and yet you don’t have enough money for new ones.
Here, a lot of business head start focusing on balancing the budget, however that won’t suffice. Should you want to escape the black hole, you need to reach towards a 10-15% pre-tax profitability.
In other words, when you try and get through a black hole, think of it as a pioneer taking a wagon journey from Kansas all the way to California. Regardless of whether you stock up on supplies for the start, if you end up using up all of your resources too fast and you don’t add any more as you continue or, in other words, if you build up losses but don’t build profits as you expand, you will never end up in California.
This is exactly why your mission needs to be able to amass healthy profits as you expand. When you reinvest your profits and create your capital reserves, you’ll be able to get through the black hole.
In addition, the advantages of being profitable when you’re inside of the black hole doesn’t go away when you are out of it. This is due to the fact that when you choose to sell your company, historical profitability will have a huge impact on your business’s value.
Potential buyers will like to see the past three years of pre-tax profits as well as business equity, which is a widespread measure that is used in order to gauge a business’s value. Therefore, a business that’s been able to get a 10-15% pre-tax profitability will have a significantly higher market value in comparison to some other company that has either less profits are absolutely none.
Would you like to position your business in order to receive optimal market value? Nine time out of ten, you would! The next section will tell you how.
Keep labor costs down and protect ten percent of your profits by implementing a salary cap.
In the previous section, we had talked about how 10-15% of profitability needs to be your company’s mission. However, how are you able to make that happen when you’re in the black hole, which is when you need to enlist new employees in order to cater to the expanding demand?
First of all, you need to have a good understanding of the relationship between labor expenses and profitability.
You are already aware of the fact that labor is pretty expensive when it comes to running a business. However, on the contrary of rent and supplies, labor is something that you are able to control. As a result, this is why you need to bring about a salary cap in order to secure no less than 10% of your profits.
Suppose that you’re making $1 million in revenue. In this situation, you need to strive towards profits of around $100,000. Therefore, just add up all of your non-labor expenses and deduct them from your $900,000 operating budget. Whatever you end up with is your company’s total salary cap which should have every labor cost, including your own market-based wage.
However, in order to keep expanding, utilize the salary cap as an anchor to alternate between 10-15% profitability. Therefore, as soon as you’ve got a salary cap that’s based on 10% of your profits, you are able to set your eyes on making 15% by redoing your salary cap accordingly.
During this time, you need to pay attention to improving your productivity instead of increasing your revenue.
As soon as you’re at 15%, you are able to pay for new employees strategically, with the intention of raising your revenue, up until your profits are back, close to 10%. Going through this process over and over is your best bet if you want to safely expand your company while always staying profitable.
Should you be afraid that your salary cap will hinge your business’s capacity to perform, take into consideration many of Bill Belichick’s victories. This New England Patriots coach has won the Super Bowl an excessive number of times, which viewers have accredited it to his cunning navigation of the National Football League’s strict salary caps.
Belichick gets more for each dollar that he spends when he enlists younger talent and puts money into their future. You can do the same thing!
Increasing labor productivity is a crucial part of meeting your salary cap and achieving profitability.
We’ve found out that a lot of the time, you need to pay attention instead improving the productivity of your current staff on the contrary of just getting new ones.
However, what do you actually need to do in order to boost and manage labor productivity?
Begin by measuring the productivity at your company by utilizing this equation: productivity equals gross profits divided by the amount spent on labor. In order to count the gross profits, subtract the cost of goods sold from the revenue.
Although this may seem easy, it’s a very influential tool since it gives confirmation for your intuition as well as lets you spot things fast and react to negative trends. As soon as you’ve calculated that metric, you are able to begin implementing new practices in order to improve the productivity at your firm.
Begin by making sure that your staff are being properly compensated. That is crucial because when you don’t pay enough, you’ll get a high turnover. That’s both cost as well as troublesome to the work environment while harmful to productivity.
Overpaying is also problematic since it eats away into gross profits. That poorly impacts productivity. You may be overpaying someone if their position now needs less skills than it did back then thanks to the creation of new technology, for instance.
Therefore, instead of either under or overpaying, try to pay your staff a reasonable market-based wage. As soon as you’ve fine-tuned the compensation structure, you can incorporate an evaluation system in order to further enhance productivity.
The advantages of doing that include putting into operation an improved way of managing employee expectations, a way to pinpoint the areas necessary for improvement, and it moves your focus in the direction of career planning.
The last part is incredibly advantageous when it comes to productivity since it pushes staff towards the development of their skills and it keeps them motivated. It also helps companies hold onto their staff longer, which saves both time and money.
In order to receive the most out of staff evaluations, it’s helpful to determine which three to five skills would help enhance the productivity for every role. In addition, it’s nice to ask every staff member to outline how their position impacts the company’s targeted profitability level.
Pay attention to the four forces of cash flow: tax, debt, core capital target and distributions.
Apart from labor costs, you need to understand the four forces of cash flow if you want to run a healthy company.
They are the following:
- Tax: Make sure that you put some money aside in order to pay taxes. If you don’t, you’ll be faced with liquidity problems, regardless of whether your business is profitable or not.
- Debt: If you fail to meet debt payments then there’s a chance of default or foreclosure.
- Core Capital Target (CCT): This is a buffer in order to cover typical fluctuations in cash flow. Read down below to find out more.
- Distributions: As soon as you’ve covered the initial three forces, you can harmlessly begin to distribute a bit of the business’s profits to yourself.