Reason to read:
Written for entrepreneurs running companies with up to 5 Million Dollars in revenue, this book helps you to avoid the most typical mistakes and operate your business better.
Summary & Key Insights:
Stop underpaying yourself
90% of entrepreneurs think they are overpaid, even though they are underpaying themselves and screwing their financial metrics by not paying themselves a market-based salary.
Remember this key distinction:
You get paid a salary for what you do and get a return for what you own.
But how do you know that market-based salary?
Assume you are forced to stop working tomorrow, how much salary do you have to pay to get a competent replacement? That’s your new salary.
If your Startup can’t afford to pay you that salary, then you have a business that produces “fake profit”.
Another advantage of paying yourself properly is that you can now make the switch from Operator to Owner at any time by hiring a replacement without jeopardizing the companies profitability.
Revenue is irrelevant. The relevant number is pre-tax profit.
Here are some benchmarks so you know where your business is at:
- 5% or less pretax profit means your business is on life support
- 10% pretax profit means you have a good business
- 15% or more of pretax profit means you have a great business
The Black Hole: 1-5 Million in Revenue
At that point, most companies are forced to add staffing and infrastructure, before they really can afford it which drives down profit.
What to do against that?
Make a plan to live off your market-based wage and leave every dime of profit in your business as you grow from 1 Million to 5 Million.
Watch your labor productivity:
Focus on gross profit per labor dollar as your key indicator for labor productivity.
Labor creep is one of the most common mistakes.
Use a salary cap to prevent that and achieve your required labor productivity:
You should always have at least 10% pretax profit, so the salary cap is
Salary Cap = Revenue – 10% Pre-Tax Profit – Salaries – Nonsalary costs
When you get to 15 percent pretax profit, you can add employees to drive your profit back down to 10 percent, and then you can grow it back to 15% again.
Your pretax profit and salaries are always in flux.
Remember: Never go below 10% pretax profit.
Also in that stage, it is advised that you:
- Hire slow. Fire fast.
- Hire young high-potentials
- Don’t hire the seasoned and expensive “Been There Done That” type
Your goal is to avoid overpaying or underpaying your employees.
Capital Safety Net
You have to forecast not only net income but also cashflows
Being profitable every month and year and having your cash safety net in case something unexpected hits is a great strategy.
Your core capital target is simply this: 2 months of operating expenses in cash.
In almost every case where Greg Crabtree monitored this, the worst downstroke is roughly the two months of operating expenses.
Building a War Chest
CFO Wisdom: Businesses that have cash and no debt attract magical things
Why? They can be opportunistic.
Most entrepreneurs who have businesses between 1-5 million need to build up about 2 million liquid, safe, core assets that give them stability no matter what they are doing in life.
When you reach 2 million you can set your sights even higher. Build a solid foundation first, and then you can enjoy taking some risks.
You have to know how to keep your reporting simple while still being able to recognize a flashing red light that indicates a problem. If you look at a report frequently is needs to show very small amounts of data, if it is infrequently it can be more.
Daily: Cash balance
Weekly: Cash flow forecast, sales, and productivity
Monthly: P&L, Balance Sheet, Where the cash goes
The most useful presentation of the P&L is a rolling 12 month-view. When you compare the 12 month periods side by side you start to see more of a macro view of your business.
Draw up a plan for the entire year and forecast the entire year. Then update the forecast each month as actual results become known and more information is available.
Keep it simple:
What’s my revenue?
What’s my cost of goods sold?
What’s my labor cost?
What are my operating expenses?
Updating the forecast should only take 15-60 minutes per month.
It’s important to understand that a metric is more about movement than it is about the number itself.
Remember to monitor the Salary Cap as a key metric, so you know when your labor costs are too high.