Simple Numbers, Straight Talk, Big Profits!

1. Pay Yourself a Market-Based Wage to Understand True Profitability

You get paid a salary for what you do, and you get a return on what you own.

Accurate financial picture. Paying yourself a market-based wage is crucial for understanding your business's true profitability. Many entrepreneurs underpay themselves, distorting their financial statements and leading to poor decision-making. To determine your market-based wage:

• Research salary surveys for your role and industry
• Consider what you'd pay someone else to do your job
• Factor in all your responsibilities, not just your title

Tax implications. Paying yourself too little can raise red flags with the IRS, especially for S corporations. Underpaying yourself to avoid payroll taxes is considered a tax scam and can lead to audits. Proper compensation helps you:

• Comply with tax regulations
• Avoid penalties and audits
• Accurately assess your business's financial health

2. Aim for 10-15% Pretax Profit as the New Breakeven

Profit is like oxygen—your business can't hold its breath very long without it.

Profit targets. Redefine your breakeven point to ensure business health and growth:

• 5% or less: Your business is on life support
• 10%: You have a good business
• 15% or more: You have a great business

Growth and sustainability. Maintaining 10-15% pretax profit as you grow from $1 million to $5 million in revenue is crucial. This approach allows you to:

• Reinvest profits to fund growth
• Build a cash reserve for stability
• Attract potential buyers or investors
• Weather economic downturns more easily

3. Maximize Labor Productivity to Survive the Business "Black Hole"

The teams that win are the teams that get the most productivity for every dollar of labor.

The black hole. Businesses often struggle between $1 million and $5 million in revenue, known as the "black hole." This phase requires:

• Adding staff and infrastructure before you can truly afford it
• Maintaining profitability while scaling

Labor efficiency. Focus on maximizing gross profit per labor dollar:

• Calculate your labor efficiency ratio (e.g., $1.80 of gross profit for every $1 spent on labor)
• Monitor and improve this ratio consistently
• Consider personality profiles and thorough interviews when hiring
• Implement effective performance evaluations and career development plans

4. Master the Four Forces of Cash Flow for Financial Stability

Cash is the most powerful opportunity magnet ever created.

Four forces. Prioritize these forces in order:

1. Paying taxes
2. Repaying debt
3. Reaching your core capital target
4. Taking profit distributions

Core capital target. Aim for:

• Two months of operating expenses in cash
• Nothing drawn on your line of credit

Debt management. Use debt strategically:

• Avoid using lines of credit for ongoing operations
• Use term debt for specific, revenue-generating investments
• Repay debt with after-tax profits

5. Implement Effective Tax Management Strategies

Paying taxes is a good thing. The higher your tax bill, the better your business is doing.

Tax timing. Choose between two approaches:

1. Safe harbor: Pay 100-110% of last year's taxes
2. Pay-as-you-go: Make quarterly estimated payments based on current earnings

Avoid common pitfalls:

• Don't overspend to save on taxes
• Set aside tax money in a separate account
• Don't use the IRS as a creditor through installment agreements

Personal finances. Manage your personal taxes effectively:

• Pay yourself a market-based wage with proper withholdings
• Use business distributions first for taxes, then for building personal wealth
• Avoid relying on business profits for personal expenses

6. Understand and Optimize Your Business's Economic Value

A profitable, cash flow–generating business is the best of both worlds; it is valuable to you whether you keep it or sell it.

Valuation method. Use a blended approach:

• Last three years of pretax profit
• Plus the equity (assets minus liabilities) in the business

Five elements of value:

1. Customers: Build loyalty to your business, not individuals
2. Employees: Attract, train, and develop talent
3. Processes and know-how: Optimize operations
4. Core capital: Maintain sufficient cash and assets
5. Intellectual property: Protect and leverage unique advantages

Profitability impact. Higher profitability dramatically increases business value and distribution potential:

• 5% pretax profit: Limited growth and no distributions
• 10% pretax profit: Moderate growth and some distributions
• 15% pretax profit: Significant growth and substantial distributions

7. Use Rolling Forecasts Instead of Static Budgets

A budget is a license to spend; a forecast is your road map to profitability.

Forecasting benefits:

• Provides flexibility to adapt to changing conditions
• Focuses on future possibilities rather than past constraints
• Encourages proactive management and decision-making

Implementing forecasts:

• Use rolling 12-month forecasts updated quarterly or monthly
• Focus on key drivers of your business (e.g., sales, labor efficiency)
• Regularly compare actual results to forecasts and adjust strategies

Reporting rhythm. Establish a consistent reporting schedule:

• Daily: Cash balance
• Weekly: Cash flow forecast, sales, and productivity
• Monthly: Profit and loss, balance sheet, and cash flow analysis

Last updated: December 2, 2024