Are your profits growing at the same pace as sales?

Sales growth is wonderful, and what most of us like to see happening.  But the real indicator to keep your eye on is profit.  During growth periods, there are people coming and going on your payroll, new product lines, tools and computers bought, bigger offices, more phone lines, the list goes on and on.  But the question remains – are you better off with or without the sales growth?

You don’t need to wait for your taxes to get done to answer this questions.  By merging sales data with your profit and loss, you can look at income and expenses on a standardized per unit basis, allowing you to compare how things were to how things are.  QuickBooks has a nifty export to Excel feature that make life much easier to make the calculations.

Need help with the process?  That’s what we are here for.  In person or by Skype, we give you the numbers to make better decisions.

Your taxes are done, now what?

You spent all this time gathering information for your CPA to do taxes.  Income, Expenses, Capital Purchases, Depreciation, and every other detail your CPA wanted you to dig up.  And then you paid Uncle Sam a nice chunk of money.  Most people don’t want to look at financials any more for another year, but this is exactly when you should be delving into the nuts and bolts of your business to assess your strengths and weaknesses.  What do all these numbers mean and where do you start?

When I am asked to look at the health of a business, I start with this list.

  1. EBITA  – Earnings before Interest, Taxes, and Amortization.  A look at how your efficient your business is without taxes or debt
  2. D/A – Debt to asset Ratio – how dependent upon debt is your business.
  3. ROA – Return on Assets – What percentage did you make on the total assets of your business
  4. ROI – Return on Investment – How much did you make on YOUR investment
  5. Owners hourly rate – often owners pay themselves a salary, but breaking it down to an hourly rate can give you a different perspective
  6. Cost of production per unit, compare to previous years.  Are you making improvements in cost control of critical areas.
  7. Budget vs Actual – look for how accurate your plans were.
  8. Profit and Loss, compare previous years.
  9. Inventory Adjustments  – make sure inventory purchases and use are not artificially inflating or deflating profit.
  10. Accrual vs Cash Profit and Loss comparisons- in particular, I am looking for big changes in AR and AP, Inventory values
  11. Profit and Loss, with percent of income and expenses.  Look at the big expenses and see if small changes can make a big impact on the bottom line.
  12. Develop or tweak budgets – now is the time the numbers are fresh.  Look at your plans for growth or cutting unprofitable areas of your business.  Incorporate marketing plans with financial plans.  Plan your profit levels.
  13. Balance Sheet – Look at changes in Net Worth

Ideally, you would be looking at these indicators on a quarterly or monthly basis.  Minor adjustments to spending or income timing can have big impacts on your total tax bill.  The trick is to know you need to make adjustments in the same tax year, not 3 months after.

It is a long list, and it takes time and thought to go through.  But the payoffs are there.  Don’t be intimidated by numbers!

A business without a budget

I have been having a running conversation with a person who wants to open up a storefront.  Very good ideas, and he was ready to move fast.  So when I said, “Not to be forward, but what do your budgets show for sales and expenses?”  I was met with silence.  Then a quiet “I don’t have a budget yet”.  Sadly, that is a common response.  And while the business idea may be solid, I really prefer to make mistakes on paper.

Asking about a budget did not shake his confidence in the business.  It actually took a bit more than that.  I shared a customized budget template with him and filled in a few numbers based upon conversations with him.  When he started seeing how much sales he would need to cover cost of goods sold, rent, gas, electric, internet, and that pesky thing called owner draw (that’s your pay by the way!) he started thinking about the volume needed to carry a storefront.  It was only then that he slowed down and started to see the benefits of a solid business plan.

After using this template as a framework to look at his business idea, he backed off from signing a 12 month lease.  And that’s a good thing.  He has not lost sight of his dream, but is now focusing on building up his web sales before investing in the overhead of a storefront.  Now his focus is clearly defining his target market, building up his list of potential customers and finding out not only what they want and need, but how much they are willing to pay.  Those numbers are plugged those numbers into his budget, making an even better plan.

I have often heard that a business plan rarely survives first contact with customers, and I agree wholeheartedly!  But that does not mean that you ignore the basics of finance and sales.  Instead, focus on the needs and wants of your customers as you develop your budgets and business plan at the same time.  A business plan is much more robust when you approach the process by focusing on the customer first.  Take the time to work through the numbers first – whether it is a brand new business, or an expansion of an existing business, it pays to make the mistakes on paper first.

Need help developing a financial framework to look at your business?  Want to see the sample Excel budget that helped him change his path?  Send me an email and I will be happy to share it with you!

Too busy for training?

Sometimes training seems expensive, until you take into account the savings in time.  Bear with me on the math (I’m a numbers based person!), but if 4 employees are averaging $35,000 per year, and take an 8 hour class that saves them 30 minutes per day, it takes under 2 months to pay off the class and the time spent in the class.  I have seen equipment payoffs of over 3 years in some cases!  After that, the money goes right to your bottom line.

The lesson to learn is that it pays to assess your skill sets on a regular basis and find out where you can get big payoffs.  Spend time where it is important.

 

Annual Wages  $35,000.00
Working Weeks 50
Hours per Week 40
Labor Overhead – Taxes & Benefits 50%
Dollars per hour (wages/weeks/hrs per week)*labor overhead  $26.25
Course Time (hours) 8
Per Student Labor cost during training (dol per hour * course time)  $210.00
Number of people in class 4
Total Student Labor Cost (per student cost * num students)  $840.00
Instructor Cost in Dollars per hour $125
Instruction cost (Instr. $per hour * course time)  $1,000.00
Total Cost – Student and Instructor (instr. cost + student labor cost)  $1,965.00
Total Cost of training per student (*student & Instr. cost / # students)  $491.25
Hours Saved per week as result of training 2.5
Annual Savings (hrs saved per week * working weeks * labor $ per hour)  $13,125.00
Net Savings (savings – cost)  $11,160.00
Months to recoup investment (total cost / annual savings / 12 months) 1.797

 

Is it worth monitoring?

I used to be over zealous about monitoring and tracking EVERYTHING. Now I am just zealous. It took me a while, but I have learned that if you are not using the information, why are you spending time to track it? For a numbers junkie like me, that is a very difficult conclusion to reach. However, after years of tracking everything under the sun, I have found the power of a simple and focused management metric system to be an incredibly effective management tool. It allows you to focus your management time on what you have identified as the most important variables in your business and effectively communicate that information to your people.

Don’t get me wrong; it is vitally important to track information in your business, and critical that you collect the correct building blocks of an information management system. It is much easier to enter a few pieces of data once a day than to try and recreate 6 months worth of data, just because you didn’t think it would be useful. But there needs to be a balance. I have seen accounting setups for small businesses with 150 expense account codes and setups with 4 expense codes. It doesn’t matter if you are drowning in information or starving for information, either scenario is ineffective.

So where do you start with figuring out what data to collect? With the goals for your business.

Lesson Learned: Analyze what you have and what you need, then strike a balance a to make it happen.

Focus on the Numbers: Per Unit Cost of Production

What is a per unit cost of production and why should I care?  A per unit cost of production allows you to examine your business over time as the size of the business changes, giving you a much more objective way of measuring performance.  Think of it this way, if you add 5 employees to your payroll and your net income goes up, you won, right?  Maybe, maybe not.

If you take your profit and loss statement and divide each line item by the number of employees for that same time period, you can come up with a per unit (in this case, per employee) cost.  Now when you want to look at two time periods and ask are we doing better or worse, you can reliably answer by each line item.  So if in 2016 first Quarter, you employed 10 people and made 10,000 widgets, you would expect 2016 Second Quarter with 15 people to be able to produce 15,000 widgets.  If you actually produced 12,000 widgets, you better start digging into the numbers more.  If you increased production to more than 15,000 widgets, you may deserve a pat on the back!

Now there are a ton of variables that can affect the per unit cost of production – economy, new equipment, training programs, input cost increases – all will affect the per unit costs.  But at least now you have a tool to help you objectively monitor your business by line item on your P&L.  The fun part is in asking the question why.

Per employee is not the only way to look at your production facility – I have seen managers look at per unit cost by total production, employee, per thousand dollars of investment, and many other ways, searching for the best way of describing their individual business.

Here is a  really cool trick for you to play with:  export a report from QuickBooks into Excel.  Now it is just a matter of adding a column to the spreadsheet, figuring out what per unit you want to look at, and creating a formula to do all the work for you.

Piece of cake… I know!  But that’s another day’s blog post…

Why do we have managers who can’t manage finance?

The failure rate of startups has always dismayed me. In my consulting, I see two main reasons for business failure. First, people don’t have a firm grasp of their financials. They just don’t know their numbers. Second, people underestimate the toll on their physical and mental health. Depression, divorce, heart attacks and strokes from stress are all too common and dismantle many companies that have everything else going for them.

Let’s look at the first reason for failure – Managers who can’t manage finances. The bulk of our entrepreneur class consists of people who start a business out of passion – I love to bake, to farm, to fix computers – but they don’t have any business background. How do they get their start? They are disgruntled employees who are so fed up with the way their boss does things that they quit and start their own business, with the barest of plans.

If you think about it, the entire restaurant industry has managers who do nothing but sooth irate customers and make sure people show up for work. Manufacturing is no different. From line managers to shift managers, financials are hidden from people. The focus is make your production numbers, or we will find someone who can. Anyone who has had a sales job knows it is all about hitting the sales quota. Just sell more, more, more. Rarely does anyone get to see the whole financial picture.

Is it any wonder todays entrepreneurs are missing critical skill sets? Budgeting. Reading financials. Financial controls. Cash flow. Profit and loss. Balance Sheet. Net Worth. Top that off with the misconception that having a CPA do their taxes once a year is more than enough and you have a small business at a disadvantage.

Here is a news flash. If you can’t put your hands on rock solid financial numbers to back up a decision and plan for the future, you are not managing. You are working hard and hoping for the best. Maybe it’s time to start working smarter, not harder. Focus on your financials.

Focus, but on the right thing.

Last week I met with a sales professional who was pretty darn good. At sales. She told me “last year I made 88 thousand. But in November, things got slow, and now in February, I have nothing left. I have been eating off of credit cards, and I don’t know where all that money went. I have over $12,000 in credit card debt.”

It’s not an uncommon scenario among people who make a living off of sales commissions. Real estate agents, car sales people, insurance agents – all of them are able to “sell” their way out of a financial hole. So how did she get in this financial hole? For starters, she was focused on one goal. Sell as much as possible. Generate lots of income. Period. Strong sales compensates for weak financial management skills, and when the sales dry up for whatever reason, the crash is hard and fast.

The solution?

First step: Change your focus. From sales, to net worth. Choosing the right metric makes all the difference in the world. Set realistic financial, sales, and personal goals.

Second step: Find out where you spent all the money. Download your check book register to QuickBooks, Excel, or any other program that lets you sift through the data easily and find out where you spent your money.

Third step: Create a budget. Replenish your cash reserves, plan not only your income and expense, but also your assets and liabilities. Make the budget robust enough to handle the variability in your income stream while adding to your net worth.

Fourth step: Develop processes that support your goals. Formalize your sales process to fill your sales funnel from prospects to sales. By keeping your sales funnel filled at the top and following your process, sales droughts are leveled out and financial stresses are reduced. Follow the sales processes religiously! Develop financial processes that alert you well before any financial issue becomes a business threatening disaster. Build in automation to make sales and finance functions efficient.

Fifth step: Breath. Control your thoughts and don’t panic. Decisions made in the heat of the moment are rarely good decisions. Gather data, develop a solid plan, and implement.

That’s the path out.

 

The Hidden Cost of Debt

Debt is a topic that gets people fired up.  It can make you money.  It should be avoided like the plague.  Classic good vs. evil arguments.  To me, it is just another tool that you can use.  From a business standpoint, it is very important to understand the impacts of debt and why it is called leverage.

Look at the table below.  It represents two scenarios – one where a company is making money, and another where the company is losing money.  I want to focus on ROA – Return on Assets, and ROE – Return on Equity.  If there is no debt, they are both the same.  But with debt, someone else owns a part of your company, and the amount of equity you have invested is less.  When you borrow money and have a good year, your ROE grows substantially more than the ROA.  In the example below, the difference is 20% ROA and 100% ROE.    Borrowing money allows you to make a substantially higher return on your portion of the money invested in the business.

Now for the other side of the coin.  What happens if you have a bad year?  In the second column, you see a company with 1 million in sales lost $50,000.  That’s a shortfall of 5% of total sales, and I have seen folks argue that is not much in the grand scheme of things.  But look at the ROA.  That $50,000 loss translates to a 10% loss in total assets.  And when you look at equity, that amounts to 50% of your equity in the business.

Leverage works both ways.  With debt, if you are making money, your equity grows much faster than without debt.  If you are losing money, your equity disappears much faster too.

The bottom line is, debt is an accelerator.  Make sure you know the direction you are traveling before stepping on the gas.

 

  Making Money Losing Money
Sales  $      1,000,000  $  1,000,000
COGS  $         400,000  $     600,000
Gross Sales  $         600,000  $     400,000
     
Total Expenses  $         500,000  $     450,000
Net Income  $         100,000  $      (50,000)
     
Assets  $         500,000  $     500,000
Liabilities  $         400,000  $     400,000
Equity  $         100,000  $     100,000
     
ROA 20% -10%
ROE 100% -50%
     
Equity AFTER Net Income or loss  $         200,000  $       50,000

Marketing Math

Everybody loves math! I know, people always tell me so! Hmm, now that I think about it, perhaps they were being sarcastic. What do you think?

Seriously, it is important to make decisions based upon solid numbers. Today, I want to talk a bit about marketing math. Anyone who has listened to a sales pitch for advertising should consider a few calculations before spending any money. How much does it cost you to acquire one customer? How much does one customer spend over their lifetime with you? How much do you spend to purchase the product you are selling – which is called Cost of Goods Sold (COGS)?

Here are the math formulas for you to follow along with:

Cost to acquire 1 new customer = Marketing campaign $ divided by number of NEW customers.

Lifetime spending = Average sale times average times per year a customer buys times average years a customer buys.

COGS = how much you paid for your product. If you are making or assembling a product, add up the component costs plus the labor to assemble or produce. If you know what your sales margins are, you can use that percentage to come up with an average COGS.

Now for the number crunching. I have seen people say it costs me $100 to acquire a new customer, they buy about $500 worth of product over their lifetime with us. Good deal, right? Maybe… Depends on how much your COGS is. If you spend $100 for COGS, you have 300 to go to overhead and marketing. More than $400 COGS, and you have a real problem. You have not covered the COGS and additional marketing costs might be pushing you into a rising sales and falling profits scenario, a very dangerous place to be. There are other cost factors to consider, but this simplification is a good starting point.

This is why so many businesses go under during a sales growth period. Perplexing to the folks who don’t understand the numbers and it is hard to catch in time. But if you have rising sales and yet cash flow is getting tighter, that’s your sign to delve into the numbers. Ignore the euphoria when sales are growing fast and focus on the bottom line. That’s what is important.

If you find yourself in a low margin business – businesses like grocery stores, farm markets, and gas stations, what can you do? Lower the cost to acquire a new customer, develop loyalty programs to get your customers to buy more frequently and keep them longer, and add symbiotic products to raise the average a customer spends with you.

For many, this kind of math is as boring as watching paint dry, but if you want to play the entrepreneur game for a long time, you had better get used to it. Because if you wait until tax time to figure out you had a year of costs rising faster than sales, you won’t be around for long. Don’t like doing the math? That’s fine, we do.