ScalingUpCashApplyingtheCashDecisionQues6onsto:•  ScaleUpCash•  Profitability•  TheWealthBuilding

Capacityofyourbusiness

Presentedby:GregCrabtree,CPA,Authorof“SimpleNumbers,StraightTalk,BigProfits”andcontributortoScalingUp(Chapter13)

CashDecisionQues6ons

1.  Thebusinessisstructuredandoperatedasifitwerebeingsoldtomorrowtomaximizemarketvalue.

2.  Profitabilityisrunningat3xindustryaverage.3.  Cashflowisahighpriorityi.e.we’refocused

oncon6nuallyimprovingthebusinessmodeltogeneratemorecashasthebusinessscales.

CashDecisionQues6ons

4.  Wereceive6melyandaccuraterepor6ngofkeydataforourdaily,weekly,monthly,andquarterlymee6ngrhythms.

5.  Weknowprofitability,grossmargin,andrevenuebycustomer,project,loca6on,lineofbusiness,teamand/oremployeewhereapplicable

CashDecisionQues6ons

6.  IndividuallineitemsontheP&LandBalanceSheethavepeoplespecificallyaccountableforeach.

7.  Wehavearollingforecastlookingforward12to18monthsupdatedatleastmonthly.

8.  Wehave3xto10xthecashreservescomparedtoourcompe6tors.

CASHDECISION#1THEBUSINESSISSTRUCTUREDANDOPERATEDASIFITWEREBEINGSOLDTOMORROWTOMAXIMIZEMARKETVALUE.

UnderstandingROIC

•  ROIC(ReturnonInvestedCapital)– AnnualPre-taxProfitdividedbyyourinvestment

•  YourInvestment– Cashandpropertyyoucontribute– SweatEquity

•  Doesnotincludeterminalvalueonasale

TypicalSelfFundedEntrepreneurStartup

ThePowerofCompounding

ROICTakeaways

•  Economyisgrowingmuchfasterthanwethink

•  PrivateCompaniesnowdominatetheeconomy

•  Cashisnottheinhibitortogrow.Themaininhibitorsare:– Unabletobuildcapacity– Notconfidentingrowth– Desiretoconsumeprofitsinsteadofgrowth

Runninga“ReadytoSell”Business

•  Effec6veBusinessStructure(legalandtax)toeitherkeeporsell

•  Opera6onalexcellencewithdocumentedprocessesthatbeingfollowed

•  Knowingandmonitoringwhatdrivesmarketvalueforyourbusiness

•  Regularlyscrubinternalfinancialsfor“dealadjustments”

3Essen6alBusinessValueDataPoints

•  EconomicValue–Whatisthebusinessworthtoyouonacashflow/ROEbasiswithoutselling

•  CurrentMarketValuesimilarbusinessesinsizeandindustryaresellingfor

•  ReplacementReturnneededifyousoldatMarketValue

EconomicValue

•  SeeChapter9of“SimpleNumbers,StraightTalk,BigProfits”byGregCrabtree

•  Developedtomanageshareholderormanagementbuyoutconceptsbasedonalertaxcashflowandareasonable6meframeforpurchase

•  5yearstobuyouta50%owner,10to14yearsdependingoninterestratefora100%sale

•  Formula–36mesNetIncomePlusEquity

CurrentMarketValue

•  Canbeamul6pleofEBITDA(alerdealadjustments)(5isgenerallyconsideredneutral)

•  Canbeamul6plierofRevenue,GrossMarginorValueperqualifiedcustomer

•  Ifyouarecarryingdebt,yougenerallyhavetopayoffdebtfromproceedsoradjustpriceiftheykeepthedebt

ReplacementReturnNeeded

•  Calculate“NetAlerTaxProceeds”(useanaverage25%taxrateforillustra6on)

•  DivideNetIncome(alerdealadjustments)bytheNetAlerTaxproceeds

•  Ifreplacementreturnneededisabove15%,reconsiderwhethersellingisthebestdecisionorareyouatapointinlifewhereyouwillnotneedtoconsumemorethantheannualearningsofthereplacementinvestment

CASHDECISION#2PROFITABILITYISRUNNINGAT3XINDUSTRYAVERAGE.

ProfitabilityKeys

•  HaveyourP&Lspeak“truth”byelimina6ngdistor6ons

•  SetProfitTargetsonyour“TrueTopLine”– CompanieswithGrossMarginbelow40%shoulduseGrossMarginasthe“TrueTopLine”

•  LaborProduc6vityisthe#1KeytoProfitability– Op6mizedManagementLaborproduc6vitysetsthestageforDirectLabortobeefficient

ProfitabilityKeys-Con6nued

•  Becarefulcomparingto“industry”datathathasnotbeennormalizedfordistor6ons

•  Compareyourperformancetobusinesseswithsimilarmodelsthatmaynotbeinthesameindustry(contrac6ng,staffing,retail,manufacturing,etc)

•  IsolateexpensespendingthatisforfutureyearsandconsiderdisplayingitbelowNetOpera6ngIncometonotdistortcurrentopera6onalperformance.

CASHDECISION#3CASHFLOWISAHIGHPRIORITYI.E.WE’REFOCUSEDONCONTINUALLYIMPROVINGTHEBUSINESSMODELTOGENERATEMORECASHASTHEBUSINESSSCALES.

CashFlowKeys•  Understandthe6melagbetweenprofitandcashflow– U6lizeAlanMiltz’sPowerofOneandCashFlowStorytoolsorcustomprojec6onmodelwww.cashflowstory.com

•  5Compe6ngForcesforCashFlow–  R&Dorreinvestmentforgrowth–  Taxes– DebtService–  CoreCapitaliza6on–  ProfitDistribu6ons

FiveCompe6ngForcesforCash

Prioritized in order:

1.  Make Reinvestments into Business at 50% ROI

2.  Set Aside Tax Liability (Quarterly)

3.  Repay Line of Credit (LOC) Debt

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

5.  Pay Dividends (Distributions)

CASHDECISION#4WERECEIVETIMELYANDACCURATEREPORTINGOFKEYDATAFOROURDAILY,WEEKLY,MONTHLY,ANDQUARTERLYMEETINGRHYTHMS.

Repor6ngRhythms

•  BreakfreefromtheCalendar!– Embracetheweeklyaccoun6ngrhythm– AdoptRolling12dataastheperformancemeasurementGoldStandard

– Gooddatafastisbererthanperfectdatalate– “Accoun6ng”doesnothavetobedoneby“Accountants”,imbedaccoun6ngintoopera6onalprocesseswherethegreatestknowledgeofthetransac6onisclosesttothetransac6on

RecommendedReports

•  Daily– CashandLineofCreditBalances

•  Weekly– 2WeekCashFlowForecast– Revenue,GrossMargin,DirectLabor&Contribu6onMargin(Reportshows,week,trailing4week,trailing13weekandtrailing52weekdata)alongwithanyotherkeyac6vitymetrics

RecommendedReports

•  Monthly– FullFinancialModel(BalanceSheet,P&L&CashFlowandbusinesssegments)

– StartwithRolling12P&L,movetoRolling3P&LandthentoMonthlyP&Ltoavoidshorttermdatabias

– Specificallyreforecastnext3monthsandusetrendstoforecastoutto12to18months

– Reviewotherkeyra6osandmodelcashflowtrends

RecommendedReports

•  Quarterly– Reviewspecialtysegmentreports•  ByCustomer•  ByProject•  ByProduct(GMROIforinventoriedgoods)•  Anyothersegmentthatrequiresextraefforttocreateandisnottotallyautomated

– Closerreviewoflongertermforecast

CASHDECISION#5WEKNOWPROFITABILITY,GROSSMARGIN,ANDREVENUEBYCUSTOMER,PROJECT,LOCATION,LINEOFBUSINESS,TEAMAND/OREMPLOYEEWHEREAPPLICABLE

ProfitCube–Effec6veSegmentRepor6ng

•  Keepsegmentrepor6ngsimplebytracking– Revenue– DirectCosts•  GrossMargin(RevenueminusDirectCosts)

– DirectLabor•  Contribu6onMargin(GrossMarginminusDirectLabor)•  DirectLER(GrossMargindividedbyDirectLabor)

ProfitCube–Effec6veSegmentRepor6ng-Con6nued

•  Recommendtoavoidalloca6ngOverheadorPayrollTaxesandBenefits

•  FocusonContribu6onMarginbysegmentandcompareDirectLERtosearchforwhichparernisthemostefficientwithlaborbutalsoyieldshigherContribu6onMargin$

•  HighRatesofperformancearenogoodifyoucannotgetenoughvolume,conversely,volumeisnogoodifitisatabadrate

MarginbyCustomer

CASHDECISION#6INDIVIDUALLINEITEMSONTHEP&LANDBALANCESHEETHAVEPEOPLESPECIFICALLYACCOUNTABLEFOREACH.

LineAccountability

•  BalanceSheet– Allthe“deadbodies”areonthebalancesheet– Avoidimmaterialadjus6ngforprepaidexpensesandaccrualsunlesstheyarematerial

– Usebookdeprecia6oninsteadoftaxformanagementstatements

– ConsiderRelatedPartyReceivablesasareduc6onofequityinsteadofanassetsincetheyarenotlikelytoberepaidany6mesoon

LineAccountability

•  P&L– Assignresponsibilityattherolleduplevel(SimpleNumbersformat)

– Responsibilitywillbetoreviewpastperformanceaswellatforecaster(avoid“budgetthinking”)

– Rolling12trendismostauthorita6vedata– Keeptotalmodelinperspec6ve•  Nocostsaretrulyfixedandnocostsaretrulyvariable•  Bemindfulofcostcharacteris6csandsearchfor“unproduc6ve”coststhatproducelirletonovalue

CASHDECISION#7WEHAVEAROLLINGFORECASTLOOKINGFORWARD12TO18MONTHSUPDATEDATLEASTMONTHLY.

ArtofForecas6ng

•  “Amanwhoaimsatnothinghitsitwithamazingaccuracy”

•  Rolling12dataisusuallyabletopredict3tosixmonthsoutjustfromtrendparerns

•  TopDownmethod– Determineexpectedrevenue– Predictcostsneededtosupportac6vity

ArtofForecas6ng

•  BoromUpMethod–  Iden6fyManagementLabor– Mul6plyManagementLaborbymLERtargettogettheContribu6onMargintarget

–  Iden6fydLERratetargetedtocalculateDirectLabor(CM/(dLER-1))

– SumofDirectLaborandContribu6onMarginisGrossMarginTarget

– DivideGrossMarginbyGM%toes6mateRevenue

Step#1ManagementLabor6mesmLER

=Contribu6onMargin

Step#2Contribu6onMargin/(dLER-1)

=DirectLabor

Step#3Contribu6onMargin+DirectLabor

=Grossmargin

Step#4–GM/GM%=Revenue

CASHDECISION#8WEHAVE3XTO10XTHECASHRESERVESCOMPAREDTOOURCOMPETITORS.

CoreCapitalTarget

•  Whenismybusinessfullycapitalized?– Whenyouhave:•  2monthsofopera6ngexpenses(includingdirectlabor)incash(essen6ally,anythingyoudonothavetermson)•  Nothingdrawnonalineofcredit(wouldincludelinesthathavebeentermedout)•  Currenttaxeshavebeensetasideandarenotinthecashreservenumber

•  AllotherBSra6osaresecondaryifyouhitthislevelofcash

CoreCapitalTarget&ROE

•  Ifyouachievethe2monthscashandhave10%netprofit

•  Youshouldhaveaminimumofa50%Returnonequityyearoveryearwithoutsellingthebusiness.Mostbusinesseshave75%to100%thatdonotrequireheavycapitaliza6on

•  YoucanachieveahigherROEwithdebt,butyouaretakingaddedrisktodoit