Get a group of business owners together and there are usually two questions that come up: how long have you had your business and what is your annual revenue? Both are interesting questions but are generally asked for vanity. Neither provides a good understanding of how successful the business is nor the benefit it provides to the owner. A business that has been around for 50 years and generating $100 million in revenue could be profitless and bankrupt tomorrow. On the other side, a new business with sales of $1 million could be making the owner extremely wealthy. As the adage goes, the devil is in the details.
Numbers as tools to make decisions
When I started Stimulus Technologies almost 24 years ago, I was still in high school and knew nothing about how to run a business. I relied on my father, who had run 2 businesses and helped many more become successful as publicly traded companies, to guide my brother and me. He was a numbers guy and a conservative one at that. I also relied on a CPA friend to help me understand Profit and Loss statements, Balance Sheets, and Cash Flow statements, along with how to properly file tax returns and provide government reporting. What I’ve learned over the years is accounting is generally used in business as a history reporting mechanism and not as a tool to look forward and plan for the future. In high-growth companies, planning, as well as having accurate numbers and forecasts is essential.
A few weeks ago, I attended a technology conference and heard from a speaker, financial expert Greg Crabtree, who spoke about using financial numbers to drive business decisions. A few years ago, I learned about monitoring ratios and trailing 12-month reporting. I’ve used those numbers as gauges of where the business has been but not where it is going. I immediately like the idea of using ratios in the business to make decisions on where to take the business – essentially using them to find areas where the business is successful and where it needs to change.
The business black hole
One of his points in the presentation that really struck a chord with me is that the “Black Hole is between $1 million and $5 million of Revenue ($3 Million is the deepest pain)”. As a growing small business, I have felt this black hole personally and have talked to many business owners that are in the same position. Losing a client, a shift of a vendor, a key employee leaving, or any other number of issues, can push the business over the knife edge in an instant.
He discusses two strategies for getting through the black hole.
The first is to stretch labor and stay profitable until your business hits $5 million in revenue. Strategic and successful sales and marketing can get the business past this critical mark. Once there, sustainable profits become much easier. He said this strategy is less risky and more likely to succeed.
The second is to shrink or eliminate profits to grow labor in anticipation of growth. This allows a business to feel more comfortable through the growth but creates the risk of running out of money before it reaches the critical sustainability mark. It also can create inefficiencies in the business because of excess labor.
Profit First
In his book “Simple Numbers, Straight Talk, Big Profits!”, Crabtree states, “Profit is like oxygen – your business can’t hold its breath very long without it.” If you spend any time listening to the news, it sounds like profits are evil and are just there for the rich to get richer. The big misunderstanding is that without profits, businesses can’t invest in themselves or grow. Buying equipment requires profit. Building new infrastructure requires profit. Loans are paid back with profit. Any growth requires profit.
Crabree states that profit and loss statements should be read from the bottom up. Starting with an owner’s salary – setting it at a market standard – and then building onto a strong profit. A healthy business should have at least 10% profits, where 15%-20% is a better number to be working towards. If you set a profit marker first and stick to it, the rest of the business will be easier. Another interesting point he makes is that EBITDA should not be looked at in the business. It may be a trick that bankers and investors use to analyze a business, but in the end, net profits are king in business analysis.
The Team is Key
Crabtree’s final point, in his talk, is essential: Great employees are key to the success of the business. Building a team that runs the business is vital for growth and sustainability. He shared several key ratios of labor percentages to sales in different areas of the business, including management, accounting, sales and marketing. He suggested that making some key hires and keeping those percentages in line is essential to managing growth of the business through $5 million in revenue and beyond.
Final Thoughts
I’ve become a numbers nerd. One thing that I do every month is not just review the P&L, balance sheet and cash flow statements but take a deep dive into them and make comparisons between where my forecast says they should be and where they are. It brings some sanity into the business and allows me to keep a pulse on how things are going. I’ve also built several “dashboards” that allow me to see where everything is at a glance. These all go together to help me plan each month and decide if the business is on track or off track, then take strategic action to move in the direction that I want for the company.
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