Jonathan:
We all struggle with cash flow in our business at one point or another. If you’re in the phase where you’re still struggling with cash flow or you’d like your cash flow to be even better, you’ll enjoy the rest of this video.
In this video, we’re gonna mention profit. I want to remind you of a concept and that is that as an owner of a company you get paid a salary as an employee of the company for the work, the service that you provide to the company. Then you get paid profit in the form of a distribution because you are an investor, an owner, a shareholder in the company. They’re two very different hats. A salary for what you do and a Profit because you are a founder, investor, shareholder.
Most companies state profit differently. Some will say, “I’m making 30% profit,” and another will say, “I’m making 3% profit.” We don’t generally measure profit in the same way. To arrive at a profit you have to be paying yourself a fair salary for what you’re doing. There are other factors that go into it.
A couple of weeks ago I had a video on this with Greg Crabtree. The video title is How to Report Profit Versus Salary. The concept of that video is going to be foundational to what we’re about to talk about. Here’s another video from Greg Crabtree and he is going to talk to us about the one thing in your business that will move cash flow and improve cash flow unlike anything else you could possibly do. Enjoy.
Greg Crabtree:
What we’ve determined from our research is that 5%- Most of you are probably thinking, “Oh, we’re okay at 5%.” I got news for you, 5%, you’re on life support, especially in a capital intensive business like landscaping. At 5% profitability, you’re in trouble at that point. 10% it’s the new break even, so we consider you a good business. At 15% you’re a great business. Anything above 15%, enjoy it while you can because the market’s gonna find a way to catch up. The market is not [inaudible 00:02:03]. They can see it when somebody else is successful at something and they’ll find a way to match what you’re doing. If worse comes to worse, they’ll just compete against you with price, even if it’s to their detriment. That’s just how dumb sometimes they can be.
Once you understand those levels, I want to make my case of saying that … There are people that’ll say, “Well, we need to collect better. We need to collect faster.” Absolutely. I’m all for that. But at the end of the day, if cash flow is your problem, the number one thing that changes cash flow the fastest is called profit and I’m gonna prove it to you.
I’m gonna show you at 5, 10, and 15% profit in a company doing $100,000 a month, so 1.2 million a year, 40% tax rate. Your rate might be a little lower. It’s not gonna probably be much higher unless you’re in New York or California. Then we’re gonna assume- Which this is probably like most of you guys, a 45 average days in sales and receivables. Now, if you’re billing on a monthly basis or monthly contract, you can probably push that 45 days down to maybe 25 to 30, but a lot of times the other work that you mix in on a bill-as-you-go basis, unless you’re really adamant to get paid upfront or paid as you complete a job, we still see a fairly common average in the 45 days range on this.
If those are your factors, if you’re at 5% profit and you start off with $100,000 a month, it’s gonna take you 67 months to be cash flow positive. What happens is I work for a month and I spend a month’s worth of cost and I send invoices for that month of cost. Well, I didn’t get any cash, so that’s about a 100 grand roughly, a little under, about $95,000, and so then, “Great. Yeah. We made a profit on the books, but not cash.”
So, we work the second month and we’ve sent out the invoices now, so the clocks ticking. We do another set of costs for that month of $95,000. We’re now up to $190,000 of the cost that we’ve spent money on before we’ve collected a dime. On the 15th day of the third month is when we actually collect most of our first month’s invoices. Now, then we start earning our way out of this hole. At 5% profit, the fastest I can earn my way out of that hole is 67 months. For those of you that are challenged by the multiplication tables of 12, that’s 5 years and seven months. If we were doing this live and I could see you, I would say, “How many of you would like that business?” Nobody would raise their hand.
So, let’s look at 10% profit. Well, the same trough hits almost- It’s really close, not dramatically different. Because of the profit level, I dig out of the hole in 34 months. Slightly under two months short of three years. So, that’s better, but notice the huge difference in time frame just because of going from 5% to 10% profit. Then if I do 15%, I change the slope of that curve and I get out in 22 months.
When you really think about it, as I said, what is the thing that drives cash flow the most? It’s profitability. You can go collect, get your AR from 45 down to 35 until it grows back to 45 because it won’t stay there. The market generally dictates how fast they’re gonna pay you. Unless you’ve got some other critical thing, and like I said I’m not against collecting faster. What I’m against though is giving up the margin to collect faster. What really matters is how profitable I am, not how quickly I collect the cash. Now, collecting cash might keep me in the game longer, but if I’m still not profitable and I collect it fast, I’m still gonna go out of business. Those two have to work together.
Here are the dollars to prove what I’m talking about. If you’ve got a two-million-dollar business at 2% profit, you can see that “Well, I make $40,000 in pre-tax net income, but I still owe taxes. Here’s my after tax.” Well, here’s the average debt service for a typical two-million-dollar business, so that’s fairly common. I’m negative cash flow just from a debt service standpoint. I have no ability to add anything, to grow anything. If at 5% profit, I’m still slightly negative cash flow. It takes until I’m to 10% profit before I have any positive cash flow whatsoever.
Jonathan:
I’d like to add a thought to what Greg just said. The best way to fix cash flow, the number one way, is what he said, “Make your company more profitable.” Now, as a temporary solution, and not just temporary, but as a fast solution, while you’re working on profit and a solution that you’d want to carry forward for the rest of your business, in my opinion, you want to speed up how quickly you get paid. You want to get your receivables down from the 45 days or the 26 days, the examples that he gave. The way to accomplish that is to get paid as soon as you complete the work and get paid via credit card. That has been one of the most important things I personally have ever done inside of one of my businesses. As soon as you complete the work, you get paid by credit card. You bill the client, you get paid.
Then on top of that, if you line up getting paid with payroll. For example, you get paid on a Monday for all the work that you performed the prior week or you’re getting paid as you go throughout the week and then on Wednesday you make payroll, it’s wonderful because you’re bringing in all your revenue. You have the money in the bank before you have to make weekly payroll.
If you don’t like credit cards or you don’t like the idea of billing your clients every day or every week and getting paid for all the work, in a sense as soon as it’s done, an alternative concept is to have all of your clients under a contract, which I tend to be less excited about because it complicates the business in a whole lot of ways, but you can do that. You can put everyone under a contract. This is true for residential and commercial. Then you can set them up on installment payments. That’s 12 monthly payments under the contract. Then you can invoice them in advance.
The challenge is that tends to work better for residential than it does commercial because large commercial very much dictates how we’re gonna get paid as owners. If you’re a commercial business and you have very little control over how fast you’re gonna get paid and when you’re gonna get paid, then you’re the only solution is what Greg was talking about. If you’re in residential, you can speed up cash flow by getting paid as soon as you perform the work or putting all of your clients on installment payments and getting paid at the beginning of the month for the work you’re gonna bill through the rest of the month while you work on improving the cash flow. Combined with improved profits and speeding up your cash flow through the two methods I just gave that completely transforms an organization.
Hope you got value out of this. If you want a lot more value like this, I hope you’ll attend SA4 in November because we’re gonna have Greg there speaking. He’s gonna do a three-hour workshop. This is just a little taste of what he’ll be talking about. We’ll have a whole lot of other really fascinating interesting speakers. You’ll have an opportunity to network. You’ll have an opportunity to meet others that are doing very interesting things. It’s a fantastic event. I hope you’ll join us in November at SA4. Thanks a lot.
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