As a business owner, I know that profit can be somewhat a philosophical discussion. If you’re like some of the business owners I talk and work with, the profit you show at the end of the year often doesn’t correlate with the amount of cash the businesses generated for your pocket.
Jim Culhane of Quality Office Furniture had a small showroom where he sold both new and used office furniture, mainly to smaller offices. Despite having a few employees, Jim wore many hats. He oversaw marketing, sales, IT, accounting, finance, and operations. Does that sound familiar? Jim had been in business for 3 years and while his CPA told him he made money every year, he could never rationalize how his initial projections had been so far off. Jim knew his numbers fairly well; he had been in the industry for several years and knew how to set his prices. He also had done a thorough job of budgeting prior to opening the business. However, like many owners, he managed his expenses based on his bank account.
From prior advice he had gotten, Jim only cut checks for expenses twice a month. His usual routine was to input his bills into QuickBooks and then print out a listing of all outstanding bills. He would then look at his bank account and determine which bills would be paid. At the end of the month, his bookkeeper would reconcile his accounts and provide him with an income statement, however, Jim didn’t pay much attention to anything other than the revenue.
Cash flow was a constant issue for Jim. No matter what he did, he couldn’t seem to get the “buffer” he was looking for with his cash balance. Like most business owners, Jim thought if he could just increase revenue by 5%, he would be able to get that buffer he was looking for. The problem was, he had done that….3 years in a row. How many 5% increases would he need before he could generate enough profit he would be able to take distributions out of the business?
I never worked with Jim. His story was relayed to me during a soccer game when I was conversing with his wife. At this specific game, Jim was not at the game because he was busy working, trying to generate another 5% increase. I told her that Jim was not alone with this situation. I told her the statistics show that Jim is not in an unfamiliar circumstance. Forty percent of small businesses are profitable, 30 percent break even and 30 percent are continually losing money. This might even describe your situation (odds are it does if you are in the 70% of break even or losing money).
What is the answer? There is good news for business owners, the response to this problem is easier than you think. I go through a process with my clients to help them budget their profit. The process is part science and art.
To begin with, I congratulate owners on their newfound profit. I get a couple sideways looks, but I tell them they are now going to take 10% of their cash receipts out of the business as profit. I tell them this is the first thing they are going to do. They will become the first and most important vendor of their business. I ask them to picture the one vendor they never dare pay late. They are now that vendor. They will pay themselves on time, no matter what from here on out.
The second most important vendor will be the IRS. Most business owners pay their taxes in one of two ways. The first is they wait until the end of the year and pay their taxes all at once around April 15. The second, more common way is they make quarterly payments. The problem most business owners find is that they take that money out of their pocket to pay the IRS. For most owners, this sucks up any profit they would have otherwise taken out of the business. That is why we must take these amounts out regularly and set them aside to pay our taxes. The great thing is, we can budget what these need to be. This is where science comes into things. The amount will always be different, but for the most part, you must set aside 5-10% of your gross receipts.
That leaves 80-85% of the anticipated cash receipts left for your business to spend on expenses. When I start working with most businesses, they find that this budget is too constrictive. Inevitably, there are expenses that they believe they just can’t run their business without. The question I always as is “will your customer notice if you don’t spend money on that expense?”. If the answer is no, then there is a good chance it is not adding to the customer experience. If an expense is not adding to the customer experience, then why are you spending your cash resources at it?
There are several strategies for attacking and cutting expenses. This is where some of the art comes into the process. The intention of this article is not to review those strategies in much detail. But know, that your business is not the first one to review and use strategies to cut your expenses.
This process starts with a budget. You must sit down and compute your anticipated cash receipts. Odds are, this is easier than you think….most businesses generate cash receipts that are within 5% of their previous year. The next step is to look at your expenses and start building a plan of what will be “allowed” expenses. In other words, what will this plan allow you to spend money on? Odds are, there will need to be cut. All owners also find expense habits they didn’t know were going on. For instance, one owner found they had a recurring payment related to DirectTV, which had been canceled some months before, still coming out of their account.
The best thing about our process is that it lets owners manage their business the way they are comfortable with…through their bank account. We are not asking them to review financial reports or starting managing their business through QuickBooks more. Nope, we are taking care of all of that by paying their two most important vendors first.
Most business owners have some level of competitive spirit. This is inherent in most owners which is one reason they started a business in the first place. The best thing about this process is that once the methods and systems are established, most owners start asking questions like “why can’t my profit be 12%?”. Their mentality of what is and is not required for their business to be successful completely changes.
The process described above definitely takes longer than the seven paragraphs suggest. As my dad always says, “if it was easy, everyone would be doing it”. The good part about this is it is a plan. Not much great started without a plan. Most plans are actually quite good, it is the execution that leads to their downfall.
Does this sound like your business? Are you ready to take more profit home? Krieger Analytics works with businesses to help them with their profits through accounting, finance, and bookkeeping. We are not the perfect match for all businesses so we have honest conversations upfront to see if we are a good match for you. Contact us now for a call to learn more about us and have a conversation about your business.