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SimpleNumbers.me/EOGR

Greg Crabtree Greg.Crabtree@crbcpa.net

256-704-0620

SimpleNumbersP R O F I T + P U R P O S E = I M PA C T

www.SimpleNumbers.me

What the Typical Accountant Provides

#1: Financial

Statements

Audits or Reviews,

but did you really

need them or get

what you thought?

#2: Did You Read

the Financials?

Are you using the

financials produced

to actually run your

business or “check a

box”

#3: Accessible?

Can you get a call

back during Tax

Season for a critical

business decision?

What the Entrepreneur Wants

#1: No Tax

Surprises

Are you being told

taxes due at the last

moment?

#2: No Billing by the

Hour and be

Accessible

Are you being billed a

fixed monthly fee for

all of the anticipated

services you will

need in a year?

#3: Help to Run a

Profitable Business

From our access of

hundreds of

businesses, what

works and what does

The Goal

BuildWealth

CashFlow

Profitability

The Solution: 3 Keys To Unlock Your Business Potential

#1: Remove

Distortions

Are you looking at

your ‘true’ numbers

and understand your

‘true’ targets?

#2: Labor

Productivity

How are you

measuring and

improving your labor

productivity?

#3: Four Forces

Of Cash Flow

Have you set your

priorities right to

build a solid

foundation?

Growth And Profit Must Go Together

What’s your current business situation?

1.  Growing Profitably – Profit exceeds 10% and annual revenue growth is 5% or above.

2.  Profitably Stable – Profit are 10% or better, but no annual revenue growth.

3.  Need To Cut – Less than 10% profit and no growth.

4.  Grow Into My Costs – Less than 10% profit, but “trying” to grow to make up for lack of profitability.

5.  Consuming Muscle – Losing money.

What is the Single Distinguishing Characteristic?

Growing Profitably – Profit exceeds 10% and annual revenue growth is 5% or above.

Profitably Stable – Profit are 10% or better, but no annual revenue growth.

What is the Single Distinguishing Characteristic?

Growing Profitably – Profit exceeds 10% and annual revenue growth is 5% or above.

Sales & Marketing Focused CEO

Profitably Stable – Profit are 10% or better, but no annual revenue growth.

Operations Focused CEO

#1: Remove Distortions Are you looking at your ‘true’ numbers and understand your ‘true’ targets?

Three Identical Companies – Different Owners

Company1 Company2 Company3

Revenue $1,000,000 $1,000,000 $1,000,000

Salaries $400,000 $500,000 $600,000

OperaCngCosts $350,000 $350,000 $350,000

TotalExpenses $750,000 $850,000 $950,000

Pre-TaxNetIncome $250,000 $150,000 $50,000

as%ofRevenue 25.00% 15.00% 5.00%

Three Identical Companies – Different Owners

Company1 Company2 Company3

Revenue $1,000,000 $1,000,000 $1,000,000

Salaries $400,000 $500,000 $600,000

OperaCngCosts $350,000 $350,000 $350,000

TotalExpenses $750,000 $850,000 $950,000

Pre-TaxNetIncome $250,000 $150,000 $50,000

as%ofRevenue 25.00% 15.00% 5.00%

OwnerSalariesIncludedAbove $0 $100,000 $200,000

DividendsTakenOut $250,000 $0 $100,000

Market-BasedWage $100,000 $100,000 $100,000

RevisedActualNetIncome $0 $150,000 -$50,000

BusinessNetIncomePotenCal $150,000 $150,000 $150,000

CashAvailableToGrow $0 $150,000 -$50,000

Common Distortions Of Owner Comp

§  Trying to save taxes instead of business clarity

§  Multi-owner business where shareholders all make the same wage

§  “Sweat equity” in a startup

§  No guaranteed payments in an LLC

§  “Leftover’s are mine to consume” mindset

§  Not paying a market-based wage (too high or low): “As the owner, pick any job you want, but the market determines your wage.”

REVENUE

Watch Your Language – Words Matter

EBITDA Earnings before: Interest, Taxes,

Depreciation & Amortization

PRE-TAX PROFITS

GROSS MARGIN

Revenue less direct costs,

excluding labor

CONTRIBUTION MARGIN

Gross Margin less direct labor cost

Busine

ConstrucFonCompany

ServicesCompany

Revenue $20,000,000 $3,750,000 CostofGoodsSold(COGS) $17,150,000 $900,000 GrossMargin(GM) $2,850,000 $2,850,000 DirectLabor(DL) $1,000,000 $1,000,000 DirectLER(GrossMargin/DirectLabor) $2.85 $2.85 Contribu5onMargin(CM) $1,850,000 $1,850,000 OperaCngExpenses: FaciliCes $150,000 $150,000 MarkeCng $75,000 $75,000 ManagementandAdminLabor $750,000 $750,000 PayrollTaxesandBenefits $100,000 $100,000 OtherOperaCngExpenses $150,000 $150,000 TotalOperaCngExpenses $1,225,000 $1,225,000 ManagementLER(Contribu>onMargin/Mgmt.Labor) $2.47 $2.47 NetOperaFngIncome $625,000 $625,000 OverallLER(Contribu>onMargin/TotalLabor) $1.63 $1.63 OtherIncome/Expenses: DepreciaCon $75,000 $75,000 InterestExpense $25,000 $25,000 TotalOtherIncome/Expenses $100,000 $100,000 TotalPre-TaxNetIncome $525,000 $525,000 asa%ofRevenue 2.63% 14.00% asa%ofGrossMargin 18.42% 18.42%

Simplify Your Profit & Loss Report

§  Revenue – “Revenue is a vanity number.”

§  Cost of Goods Sold (COGS) – “It’s not your money.”

§  Direct Labor Cost – “Do not mix labor with non-labor.”

§  Expenses – “Too many lines on your P&L create noise.”

§  Facilities

§  Marketing

§  Management and Admin Labor

§  Sales Labor (Optional: May be tracked with Management/Admin)

§  Payroll Taxes and Benefits

§  Other Operating Expenses

§  Other Income/Expenses (Depreciation, Interest Income, etc.)

Common Distortions Of Profit & Loss

§  Owner Comp

§  % versus $ – You can’t spend percentages

§  What is a month? – Not all months are created equal

§  Seasonality – Use Rolling-12’s to remove distortions

§  Misaligned Costs or Revenue – All costs should be in the same month as booked revenue

§  Mixing Labor with Non-Labor – Details in section 2…

§  Cash Flow versus Profit…

#1: Remove Distortions – Action Items

q Simplify your P&L

q Accurately report Owner Compensation

q Focus on the “true” numbers:

q Gross Margin

q Contribution Margin

q The right pre-tax Profit Margin

q View financials in Rolling-12’s

q Understand what “paying taxes” really means

Why 10% Profit Is The New Breakeven

Pre-Tax Profitability Targets:

Life Support

Focus on improving

profitability.

The New Breakeven

When you have a “good”

business.

Great Business

When you have a “great” business.

Enjoy It While You Can

Harvest profits before market

forces catch up.

5% 10% 15% 15% ABOVE

Cash Flow Versus Profit Chart

Chart is based on the following assumptions:

§  Profit levels shown: 5%, 10%, and 15%

§  Revenue at $100,000 per month

§  Tax Rate 40%

§  A service-based business that bills at the end of the month and gets paid in an average of 45 days

Why Profit Matters: Cash Flow At 5% Profit

$300,000

$200,000

$100,000

$200,000

$300,000

$400,000

$500,000

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71

Cash-5%

Cash-10%

Cash-15%

5% Profit: Breakeven

Cash Flow in 67 Months

$300,000

$200,000

$100,000

$200,000

$300,000

$400,000

$500,000

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71

Cash-5%

Cash-10%

Cash-15%

$300,000

$200,000

$100,000

$200,000

$300,000

$400,000

$500,000

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71

Cash-5%

Cash-10%

Cash-15%

The True Picture Of Available Cash

2%Profit 5%Profit 10%Profit

Revenue $2,000,000 $2,000,000 $2,000,000

NetIncome% 2% 5% 10%

NetIncome$ $40,000 $100,000 $200,000

Tax(40%) -$16,000 -$40,000 -$80,000

ANer-TaxNetIncome $24,000 $60,000 $120,000

DebtService(detailbelow) -$60,609 -$60,609 -$60,609

AvailableCash -$36,609 -$609 $59,391

DebtPayments Amount

CompanyVehicle -$500

OfficeBuildout -$1,190

Server&Computers -$583

LOC(Termed-Out) -$2,778

AnnualDebtService -$60,609

Getting To 15% Pre-Tax Profit

§  Know your current capacity

§  Being profitable and maintaining market share can be better than growth

§  Remember that 10% is the new breakeven

§  Use the “baffle” concept to grow to 15% profit before increasing labor cost

Start Step#1 Step#2 Step#3 Step#4

4.4%Profit 10%Profit 15%Profit Backto10% Backto15%

Revenue $450,000 $492,195 $534,383 $534,383 $587,822

DirectCostsExcludingLabor $130,000 $142,195 $154,383 $154,383 $169,822

GrossMargin$ $320,000 $350,000 $380,000 $380,000 $418,000

GrossMargin% 71.1% 71.1% 71.1% 71.1% 71.1% DirectLaborCost $90,000 $90,000 $90,000 $98,333 $98,333

ContribuFonMargin(CM) $230,000 $260,000 $290,000 $281,667 $319,667 Management/AdminLabor $75,000 $75,000 $75,000 $83,333 $83,333

SalesLabor $35,000 $35,000 $35,000 $43,334 $43,334

OtherOperaCngExpenses $100,000 $100,000 $100,000 $100,000 $100,000

Pre-TaxProfit $20,000 $50,000 $80,000 $55,000 $93,000 Pre-TaxProfitas%ofRevenue 4.4% 10.2% 15.0% 10.3% 15.8%

ContribuConMarginas%ofRevenue 51.1% 52.8% 54.3% 52.7% 54.4%

OtherOperaCngCostsas%ofRevenue 22.2% 20.3% 18.7% 18.7% 17.0% LaborEfficiencyRaFos(LER):

DirectLER(GrossMargin/DirectLabor) $3.56 $3.89 $4.22 $3.86 $4.25

SalesLER(ContribuConMargin/SalesLabor) $6.57 $7.43 $8.29 $6.50 $7.38

ManagementLER(ContribuConMargin/Mgmt.Labor) $3.07 $3.47 $3.87 $3.38 $3.84

Measure And Manage Labor Efficiency

#2: Labor Productivity How are you measuring and improving your labor productivity?

Direct Labor Is The Key To Productivity

Direct Labor Efficiency Ratio (LER) measures:

§  All employees that spend the majority of their time (50%+) delivering direct value to clients

§  Do not include benefits and taxes

§  Ideally it can be viewed by client/project/segment

Gross Margin

Direct Labor Cost

Direct LER =

Management Labor is the Key to Contribution Margin

Management Labor has four primary functions:

§  Drive revenue

§  Control direct costs

§ Manage the “Salary Cap”

§ Make Direct Labor more productive

Contribution Margin

Management Labor Cost

Management LER =

Services Business Transformation Not Sustainable

What Does Management Need to Produce to Earn Comp?

Step1???ManagementLabor

TimesManagementLER

Contribution Margin is Target for Management Labor

ManagementLaborTimes

ManagementLER$433,300

Determining Direct Labor from Contribution Margin Target

$3.00Step2???

$433,300

ContribuConMarginDividedby

(DirectLERminus1)

Use DLER to Set Salary Cap

$3.00Step2???

$433,300

ContribuConMarginDividedby

(DirectLERminus1)$433,300/($3-$1)

$216,650

Services Business Transformation

Step3???

$433,300

$216,650$216,650

ContribuConMarginPlus

DirectLabor

$3.00$433,300

$216,650$216,650

ContribuConMarginPlus

DirectLabor$649,950

$649,950

$433,300

$216,650

$1,088,640

$725,760

$362,880

$1,334,287

$889,525

$444,762

Bottom Up Targeting

§  Determine the amount of Management labor dollars you plan to spend for your team

§  Set the MLER target (usually between $3.5 and $4)

§  Determine Contribution Margin (MLER times Management Labor)

§  Determine Direct Labor by taking Contribution Margin divided by DLER minus $1(CM/(DLER-1))

§  Determine Gross Margin target by adding Direct Labor and Contribution Margin.

Ways To Improve Direct LER

§  Do you have the “right” people? Any bad apples?

§  Can you provide training to improve productivity?

§  Are you selling stuff that you do well?

§  Do you have the “right” clients?

§  Can management do a better job of “managing?”

§  Are you paying people the appropriate wage?

§  Do all employees know their productivity level and how they can improve it?

Ways To Improve Management LER

§  Communicate the Contribution Margin target that justifies Management Team comp.

§  No “Cousin Eddie” roles

§  Build Management Team one key hire at a time

§  Evaluate “blended roles” so that management is not staying “busy” with low value roles to avoid the high value tasks

§  Invest in training, daily huddles and feedback processes

Example Of Building A Championship Team

§  NBA Base Salary Cap $58,700,000

§  2013/2014 NBA Finals Results:

§  Spurs win in 5 games with highest point margin of victory in history

§  Fifth NBA championship in 5 years

2013/2014MiamiHeat

LebronJames $19,067,500

ChrisBosh $19,067,500

DwyaneWade $18,673,000

Total–The“BigThree” $56,808,000

2013/2014SanAntonioSpurs

TonyParker* $12,500,000

TimDuncan* $10,361,446

TiagoSplieer* $10,000,000

ManuGinobili* $7,500,000

BorisDiaw* $4,702,500

MaeBonner $3,945,000

DannyGreen $3,762,500

MarcoBelinelli* $2,750,000

KawhiLeonard(FinalsMVP) $1,887,840

Total–9HighestPaidPlayers $57,409,286

What Is Your Salary Cap?

Company

RevenueTarget $1,000,000

CostofGoodsSold(COGS) $200,000

TotalExpenses(FaciliCes,MarkeCng,Other) $300,000

NetIncome(Target10%) $100,000

SalaryCap $400,000 CurrentTotalLaborCosts $430,000

Over/UnderSalaryCap $30,000

Sales Labor Efficiency Ratio (Subset of Management Labor)

Your Sales Labor has one primary goal: “Sell the stuff we do best.”

§  Not all revenue is created equal

§  Base sales incentives on Contribution Margin

§  View Direct LER by client to find patterns

Contribution Margin

Sales Labor

Sales LER =

Measuring Marketing Efficiency GrossMargin(Rolling12)

MarkeFngSpend(Rolling12)

GMminusMarkeFngSpend(Thislinemustgoup!)

Marketing Efficiency Ratio

How is your company using marketing to grow?

§  The goal of Marketing is to generate leads that can be closed by Sales

§  Separate Marketing function from Sales

§  “Most business do not spend enough on Marketing.”

§  Measure marketing’s impact and know when to take a break or change directions

Gross Margin (Rolling 12)

Marketing Cost (Rolling 12)

Marketing Efficiency Ratio =

#2: Labor Productivity – Action Items

q Track Direct Labor Costs separate of other costs

q Use Direct LER to measure and manage productivity for individuals, team, segments, and clients

q  Identify and manage to a “Salary Cap”

q Use Management LER to measure and manage admin staff

q Use Sales LER to measure and manage sales team

q Measure Marketing Efficiency

3 Year Planning Template Start with the Big Picture Before Getting Bogged Down in the Details

3 Year Template Process

§  Summarize P&L into Simple NumbersTM Format

§  Labor

§  Identify who is Direct Labor, by default, everyone else is in Management Labor

§  Do not split people “a butt in a bucket”

§  Salespeople are generally management labor unless “selling” is your primary activity

§  Review LER for last 3 years and look for “best performance periods

3 Year Template Process- Continued

§  Forecast P&L

§  Top Down Method

§  Set Revenue, GM targets

§  Set DLER & MLER targets to then determine salary cap for both labor buckets

§  Bottom Up Method

§  Set Management Labor $

§  Determine Contribution Margin $ Target

§  Set Direct LER at rate needed to cover current Direct Labor levels

§  Forecast Operating Expenses

§  Facilities – input from historical. Typically includes rent, utilities, repairs, telecommunications, IT

§  Marketing – control as a % of sales (below P&L in highlighted area

§  Payroll taxes and benefits – avoid combining with Labor, control as a % of all labor in highlighted area

§  Other Operating Expenses – the “Great Catchall” – all the noise but little you can really do about it. Forecast it as a % of Contribution Margin based on history.

§  Balance Sheet

§  Limited to the items that really matter

§  Inventory – put in Other Assets if you have Inventory

§  Forecast

§  A/R DSO – input days sales outstanding to drive A/R balances

§  Profit Distributions – only include the distributions that are not for tax coverage

§  Taxes – Taxes have been accounted for as “Tax Distributions”. If you pay taxes inside the company, it should represent a similar amount.

Power of One Template From Scaling Up by Verne Harnish (original concept developed by Alan Miltz)

Power of One Template

§ Gary’s Furniture Example

§  Review the data from the Gary’s Furniture tab in relation to the discussion in Scaling Up by Verne Harnish. This will give you a good understanding on how to use the template

§  LER – I have added the LER component to the original work that Alan Miltz did for Scaling Up so that you can match to the Simple Numbers P&L

§  Template Tab is an example of a smaller business without inventory as comparison

§  Blank tab is for you to input your own data

Communicating Compensation How talk about compensation drives what you get.

What drives performance?

Teams with unequal pay won fewer games when pay differences were not connected to performance. But they won more games when differences in pay were based on players’ contributions.

Equity matters more than equality. Differences in pay aren’t a problem as long as they’re fair. When players are paid less than teammates who aren’t performing any better, jealousy, resentful, and discouragement often follow. When they’re paid less than teammates who deliver more value, they understand.

Source: Adam Grant is a Wharton professor and the bestselling author of Give and Take. Sign up for his free newsletter at www.giveandtake.com

Principles of Market Wages

§  Create your own “market wage scale” §  Compare productivity by team member if possible §  Evaluate teams in total performance §  Adjust wage scale before adjusting individual

wages §  No “cost of living wage adjustments” §  Raises based on moving up a level or scale

increase

Career Labor Efficiency Curve

The Replacement Conundrum

§  Employee salary of $50,000

§  LER target for team is $2.50

§  Employee is not performing but termination would trigger unemployment cost for 2 years

§  Framing

§  Unemployment cost for 2 years is $100,000

§  Margin $ from “right employee” is $250,000 less employee cost of $100k and Unemployment of $100k netting $50k gain.

Incentive Compensation Incentive pay will never get you out of management and leadership of your team. Make sure your incentives are grounded in principles and ties to company output in a win/win.

Principles of Incentives

§  Outcome must produce a win/win scenario §  Needs to be relatively simple to calculate and is

based on a true “driver” metric that can be significantly influenced by the recipient (we like contribution margin)

§  Establish Minimum, Target and Stretch and reset scale each year

§  Base Target as a % of Base pay §  Payout Quarterly but back end load

2 Factor Executive Incentive Plan

Single Factor Executive Incentive Plan

Owner Participation

1.  Owners should only participate in incentive plans when

1.  There are multiple owners that work in the business that each have different roles

2.  There are outside investors who do not work in the business

3.  You want to participate with other executive team members who are not owners

2.  Don’t do an incentive thinking it will change your performance.

#3: Four Forces of Cash Flow Have you set your priorities right to build a solid foundation?

Four Forces of Cash Flow

Prioritized in order:

1.  Set Aside Tax Liability (Quarterly)

2.  Repay Line of Credit (LOC) Debt

3.  Core Capital Target in Reserves – 2 months of operating expenses and Direct Labor in cash with nothing drawn on Line of Credit (LOC)

4.  Pay Dividends (Distributions)

#3: 4 Forces of Cash Flow – Action Items

q Follow the Four Forces of Cash Flow in order

1.  Set aside tax liability quarterly

2.  Repay Line of Credit

3.  Build Core Capital Target in reserves

4.  Pay dividends

q Understand your Return on Equity

q Establish your weekly accounting rhythms so you can focus on the important

q Manage your business with Simple Numbers data

Wealth Building Premise

Company

Revenue $2,000,000

NetIncome $200,000

as%ofRevenue 10%

Equityneedtobefullycapitalized $400,000

ReturnonEquity 50%

TaxRate 45%

Weekly Accounting Rhythm

Deposits:

§  Take to the bank daily

§  Separate duties if possible

§  Use remote deposit

§  Log into online account to record ACH payments

§  Daily email to management on bank balance and who paid

Invoices:

§  Invoice weekly, if possible

§  Have the invoicing done by those closest to the customer

§  Break monthly billing into 4 cycles

§  If invoicing is in a separate system, reconcile weekly

Bill Payments:

§  Only pay bills once a week on the same day

§  Use the “bill” process in QuickBooks to get the right date on the expense

§  2-week Cash Flow forecast report each week

§  Turn off automatic sweep on LOC

Online Banking:

§  Check bank activity online daily

§  Use a two monitor environment

§  Do a “soft” reconciliation daily

§  Make your accounting system be the authoritative bank balance, not the bank’s

§  Use online bank alerts

Credit Cards:

§  Input charge detail into your records

§  Download activity if at all possible

§  Update once a week on the same day

Payroll:

§  If a QuickBooks user, we like QuickBooks Assisted Payroll the best, all data is held within your records

§  Use one of the major players (ADP, Insperity, Paychex, etc) if you want it separate. Try to automate the entry back into your books

§  Do not do it yourself! The #1 possibility of fraud

§  Update Labor Efficiency Ration (LER) reports after every payroll

Profit

Marketing Efficiency

Labor Efficiency Ratio (LER)

Gross Margin Thinking

Close Books Weekly

Data To Manage Your Business

Simple Numbers Dashboard Available plug-in for QuickBooks users to access Simple Numbers Dashboard.

Soon to be available for Xero as an imbedded app

Company Dashboard

Business Engine

Simple Numbers Balance Sheet

Your Company Settings

Mapping QuickBooks Accounts

SimpleNumbers Profit Tool

§  Works with QuickBooks desktop versions

§  Soon to be released for Xero

§  Mapping and consulting packages available

§  Go to www.simplenumbers.me for pricing and to subscribe

Slides at:

SimpleNumbers.me/EOGR

Greg Crabtree Greg.Crabtree@crbcpa.net

256-704-0620

SimpleNumbersP R O F I T + P U R P O S E = I M PA C T

simple numbers presentation-slides eogr...slides at: simplenumbers.me/eogr greg crabtree...

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