[SOUND]. Hi my name is Marlon Ole. And this is module two of the fundamentals of finance. And we will be talking about profitability, labor and cash flow. Module two on profitability, Labor and cash flow are some very important concepts to running a business and running your business well. I want to go over just some reminders about module one and that is when we record any transaction in a business it's called a journal entry. And we post the journal entry into our books and the books are considered to be a general ledger. So every business has a general ledger whether it's paper or in your computer in something like QuickBooks or Sage or some other accounting software. You have a general ledger. When you have activity, you will post the activity into the general ledger with a journal entry. Once I've posted all of my activities for the month, for the period then I can use the information with all of my accounts to create financial statements. I can create the balance sheet, the income statement and the statement of cash flow. This is all done by something that's called a trial balance, which is simply a listing of all of the accounts in my general ledger. And what does the general ledger or the trial balance total? If I add up all the balances in the accounts, they total zero because everything I put into my general ledger, my debits must equal my credit. Again, the balance sheet has to balance my assets equals liabilities and equity. The income statement, the total of my income statement feeds into my balance sheet by the way of the retained earnings. So included in the equity part of the balance sheet are retained earnings. And then the statement of cash flow is created from both the balance sheet and the income statement. I hope this helps as a reminder from what module one included which was the financial statement. So it really helps to go over this and remind you of what was included in that module. This is an example of an income statement where you have revenue, cost of sales, gross profit than the general administrative expenses, that I deduct from my gross profit to get to my net income. And the net income reflects the profitability of my business. And that's one of the things that I'm going to be talking about in this module, the net income and how we can make sure that our business is profitable. In this example we see that I have an income of 72,500, so it appears to be profitable. So good. If I had a bracket around that number at the bottom, it would reflect a loss, in some business owners don't realize that they're operating at a loss. So it's an important thing to know because most businesses cannot operate for very long at a loss. Now this number, this net income doesn't include things like replacing my equipment, it includes depreciation, but if I need to upgrade my IT, replace my equipment, provide training or have other deferred expenses, deferred repairs, that's not included in this income statement. So that's something that every business owners should think about. So sometimes as I'm running a business as we're running a business, we do not realize as we're increasing our revenue, were actually decreasing our gross profit or reducing our profitability with every increase in revenue. There are times when of course we chase revenue and then we're not thinking about how much it really truly costs the business. So in this instance I'm not managing my cost of sales, my cost of sales goes up, my gross profit goes down. And then you see how that affects my net income at the bottom of this income statement. And so this is one of those things, again that happens to business. I haven't managed my gross profit. My cost of sales has gone up. My gross profit goes down and guess what? My expenses are up and it happens to be in salaries. So that's happening to every business right now. As we see a reduction in the workforce, we have to sometimes pay more for the salaries. And if a business owner again doesn't watch it, look at the bottom of my income statement, I now have a net income of a negative 2500. And so that's reflecting a loss. So just those two numbers that got out of control gives me a loss on the bottom line. My net income is a loss and not income. My net profit or my profitability is equal to the revenue less expenses. But there are some costs that a lot of businesses don't think about. And I know, I competed against some of these businesses where they were charging a very low price for their services, but they were not realizing what they were doing as far as the long term effect on their business. So they were using very expensive equipment and that that equipment was really expensive to number one maintain or number to replace. So they really were not charging enough as far as the revenues to replace their equipment in a reasonable amount of time or repair it. So these are the things that we have to think about, and that's why it's so important to use 10% of your profit for these very things. If you put aside 10% of your profit that will help you to replace equipment when it needs to be replaced. Building maintenance, IT upkeep is so important in today's world and then when I have people, I need to make sure that I hire the right people and train them. So a good plan for running a business is to put money back into the business. And 10% profit is really pretty much the minimum of the amount that you want to put back into the business. When I was running a business I put back 40% of the profitability for the business to grow the business. Which was very effective than when it came to selling the business. I had grown the business to quite a good level to enable us to get a good amount on the sale of business. Whenever I have a business that has equipment or a building, I need to make sure that I have plans for maintenance and or repair for the building. And when I say replace things like computers, I used to have a plan for how frequently I would replace every single computer, and I had about 80 of them in my business. I had to have a plan to rotate a certain number of those computers every single year, because once every three or four years your computer has become obsolete. So I might take a brand new computer, I move it to an area where it's not used as much after four years, I could do that. But I still had to include in my plan for my business to set aside a certain amount of money to replace my equipment, I had some pretty large trucks. So I had to have enough money to replace or repair the trucks and you have to remember when you're running a business if you have a piece of equipment go down, how much does that cost your business? So if you look at the cost of the amount of revenue you lose because your equipment has failed, and if you do that enough times in a year really can impact your revenue. It can even impact your customer service. So you need to make sure you don't, that you allocate money so that you don't go down from equipment failure. So regular up keep, regular maintenance is an important part of running a business and making sure you have the funds for the large cost, roof replacement if you have a building is really important. So depreciation allocates some of the cost of my equipment or my building to my income statement every single month, but it does not actually reflect what the cost truly is. It is an attempt to allocate some of the cost to your income statement, but you have to have reserves to make sure you're prepared for the total cost. And again, depreciation is a non cash expense, that doesn't mean you're putting away the cash for your repairs or your replacement. So you have to think about the cash, not the depreciation expense. Cash must be set aside so that you can replace a repair equipment or you're building. This is an important part of your understanding this information, it's the review. I ask you these questions and I know you know the answer. So what are some of the hidden costs in running a business? Is it A, employee's salary, B, employer headaches, which we all have, C building maintenance and training people or D, debt management? You're so right. You said C, building maintenance and training people. Absolutely correct, good job. For most businesses technology is very important these days and I can't stress enough the importance of keeping your technology current, equipment. We used to rotate our PCs on a regular basis every three years now probably it's every two years, but every three years or so rotate your equipment. So your PCs are able to handle the software that you're using and speaking of software, update your software on a regular basis. So trying to work with outdated software will create problems for you and your staff and the loss of time from old technology is really difficult to measure. But it's there so it's really better to update your software on a regular basis every year if you have to pay a software licensing fee, so be it. That's part of doing business these days. Also your data protecting your data having a good IT group either inside your business or externally outsourcing or both is so important. So a good firewall and then testing your employees. I know the university I worked with does fake phishing every once in a while to see who's going to click on the pictures, this is such a great idea. It's obviously a coaching opportunity when your staff clicks on the wrong thing and ultimately it will help train your staff for the things that we should or should not be doing. So keep your IT current, equipment software and then make sure you have good support to protect your data. Ransomware incredibly expensive or rebuilding your data base also incredibly expensive. So no reason to go through that experience. So make sure that you keep everything current and even large businesses are being hit for ransomware. So if you're a small business don't assume it's not going to happen to you. Hiring the right people is probably one of the most important but difficult things that we do. So because if we're working with people it's really difficult to tell if the person is the right person until after they actually get into the job. But you can help to protect yourself from hiring the wrong person. So what does that mean? Interviewing properly and having tests, having hiring procedures but then making sure you monitor the person after they're hired to know if they're being productive. So I had a client that when the person that they hired wasn't able to do the job, she would move them to a different kind of a job so she wouldn't have to be the bad guy and fire them. Well you're doing everybody a disservice by keeping people in a position they're not really capable of doing. So provide people with a path to leave your business if they're not able to do what you hired them for. So I hired a person who was not able to perform the accounts receivable function as much as he tried was not able to do it. So we coached several times and finally we had to let that individual go and he ended up buying a bakery and being incredibly successful with his own business. So we did him a favor by not keeping him. And so as you're hiring people, make sure that you know if they're a good fit for the job or not and you did this by measuring. So you might have a standard, this is how long it takes to process ten sales invoices so that you can know if the person is working at a pace that's appropriate. For whatever the job has some way of measuring to see if their productive or not. A hiring process within your business makes it so much easier for your managers to be able to hire or replace somebody that's left the business. Have something set in a notebook or digitally that shares with everybody involved what the process looks like. So do they need to get approval? What does that look like? How long will it take? And then what are, what would the ads be that they would need to place? I would always have that available in a notebook for the hiring process as well as the interview questions. What are you allowed to ask? And I make sure that I train the employees on that because so many of the questions can be questions you don't want to ask and you don't want your employees to ask. And sometimes they think that they're being okay because it's a follow up on something that the interviewee said. So make sure that people are trained and knowing what not to say. So questions that people would ask then what are the testing procedures I always had as part of the hiring package, a certain type of test depending upon what we were hiring for. So if the person was going to be a receptionist, I would have a word. Letter that they were supposed to document that they were supposed to produce. So I could see if they could actually write a letter and use the software. If they were applying for an accounting position, I would have an accounting test that we had simple bookkeeping tests that would tell me if they knew their debits from their credit. And then background check that such critically important thing to do. I had a client that I hired a CFO who'd actually been arrested in other states first stealing, and if my client had done a background check she would have found that out. But instead she did not do a background check, hired the individual and ended up having quite a bit of money stolen from her. So background checks are so important in making sure that you're hiring the right people and not putting yourself in your business at risk. And then an on boarding process makes it much easier for the people coming into your business to understand what the values and the mission of your business is, what the rules are, what various departments do. I had every department manager have basically a page of what they would go over with a new hire. Even if the new hire was not in their department I would have a new part new hire hit every single department in their first one or two days. So they got an idea or a basic understanding of what each department's function was. When you're interviewing people, situational questions are key to getting answers that make sense and and really understanding the person that you're hiring. So yes or no questions really don't make sense and really don't help you. So situational questions are what you need to use when you're interviewing an employee. I have a question where I ask an employee tell me about a mistake that you made and what happened, what did you do about it? And I've had people say I can't think of a time when I made a mistake and that tells me right off the bat, that they're not being entirely honest with me because quite frankly everybody makes mistakes. So when I have a have a whole list of situational questions, that gives me an idea for somebody who is really being honest when they come to an interview or not. So then testing, there're usually tests for every position from the person that that is a receptionist, you're at your firm to highly technical positions. You want to make sure that the individuals that you're hiring have some sort of skill set. So there are Excel spreadsheet tests for somebody that's going to be in accounting or I would have a word test, ask somebody to just write a letter. For somebody who's going to be an administrative position, make sure that they can actually put together a letter. So testing is really important for your positions and then background checks, really important as far as making sure, [LAUGH]. I have had a client that hired somebody that had actually been in jail in another state, and then created a huge problem for other firm by stealing a lot of money. If that employer had done a background check, they would never have hired this individual, and for of course they hired them as a CFO for the company. So background checks are crucial and there are usually laws in every state regarding background checks. So make sure you follow those laws. So if you use a company that is qualified to do background checks, they should be able to comply with the laws. Here's another opportunity to show me how brilliant you are. What can you do to help hire the right people? A, invite the interviewee to dinner, B, have a list of interview questions ready and test the final three. C, don't drug test or d D, give them a creativity analysis. Again, you are absolutely correct. It is B, have a list of interview questions ready and test the final three. It's funny how we don't think about the importance of training with our policies and procedures. And even the people that have been in our business for years and years and years, they forget what some of the policies and procedures are. So it's good for them to be trained on this so that they are reminded of what the policies and procedures are. You develop and train your people so that you can add capacity to your manufacturing or your services, whatever your business is performing. And you also make sure that you provide them with the tools that they need. But if you have a problem, many businesses think that if they keep adding people they're going to solve the problem, and that does not always work. So make sure you understand the productivity before you add people to solve a problem. Also a salary cap for individual responsibilities is very helpful because people do understand salary caps. You can't keep increasing salaries without adding responsibilities to an individual's pay. So look at that, make sure that you have understanding your productivity, and you do this actually by measuring your revenues per man hour or some other way of measuring production. You can have KPIs to help you monitor your measurement, but make sure you measure your productivity, so that again, you understand when you're adding a salary, how much it's affecting your revenue and your bottom line. I always want to be looking at ways to move people up in the business if they want to. So I do know that there are some people that are happy with where they are in the business and want to stay in that place, but if they want to move up, it's up to me to really help them to improve. I have training programs within the business, particularly for management or whatever skill set the individual needs for their job. But I also look to outside training, because once a person hears so much from the same individual, as far as training is concerned, sometimes they don't accept the credibility. As much as an outside person either coming into your firm, or having your people go out to training to get a better understanding of how to do their jobs better or how to do the next job better. So a lot of times I've used consultants for training, particularly for management skills, but I also use Industry Association to, if there is a convention, a lot of times there are training classes with a conference or convention. So I look to that to add skill sets to my individuals and then business books. I made a practice of reading four business books a year. And this gave me a lot of great ideas for running my business. And from one of those four, I would have my managers read one of them, so I only made them read one good business book a year. But that really helped to improve them over somebody from another company where that wasn't a requirement. And I also had them trained once a month. They rotated, one of the managers would train to a particular chapter that we were recovering, so that helps your employees know the material much more. So reading good business books and having them train each other on particular chapters in the books is really a great way to, to institute a training practice. If I have a production or a service problem, I really need to understand what the problem is before I add people to my salaries. A lot of times there are people that take advantage of getting over time if you're not watching it, remember, except what you inspect, what you expect. So if there's overtime and it's you're getting the overtime creeps. Watch for people that are adding the extra 15 minutes, half an hour. Knowing that you're not watching it when there is no actual additional productivity happening for that over time. And then what are your staff doing when you're not busy? You should have some things that they can do to either improve themselves or improve the business, so you need to have a regular set. These are the things that you do when we're not really busy with service or production. And then flow charting your processes is really helpful in understanding what is going on in every step of the way before you do add people. So, and understanding your dollars. So I may be able to get a comparison of my salary, expense in my industry as a percent of revenue. And so that might be really helpful information for me to be aware of because salaries are sometimes one of the most difficult things to control or reduce my costs. So I may be actually able to add a person and reduce overtime and spend less money. So we constantly have to be looking at how we're doing our processes, who's doing what and how we can improve things without adding salaries. >> Measuring for people can be difficult. However, there's some general practices that you can use, like revenues per person. If you have some part time people, you can actually turn them into hours work so that you can calculate revenues per person based on a number of hours. And this is a really good thing to use for tracking on a regular basis. And KPI key performance indicators also output per man hour if you have a manufacturing plant. This is really helpful to make sure you maintain this on a regular basis to see if something is going on in your plant that you're not aware of. Also accounts receivable turnover for collections, accounts receivable does not have 100% control over collections. If you have a sales department that's getting a little bit careless about the customers that they're selling to, then of course that affects the turnover. But in general if you have consistency in your sales you can measure your accounts receivable turnover and your accounts receivable department activities. And then turn over for HR, again managing the people is not under HRS control. However, you can check to see or measure if they're doing all the things that they're supposed to be doing like testing before they hire proper interview questions. And, also are they doing the background checks billable hours, not always the same as revenues per person. So available hours is a good measure to make sure that you're keeping up with the expectations of the business. Then employee surveys, wow this is a great tool to use for your management staff. Making sure that the people in your company are being treated the way you want them to be treated. So employee surveys are a great tool to use to make sure that they can be done anonymously. So the employees know that they can say whatever they feel. So that you can get an accurate picture of what's going on. >> So how do you measure people performance? This is one of those questions I know you know the answer to. So A, throw a dart at the wall to see where it lands, B developed, output per man hour for some of the positions C. Ask them or D, don't bother measuring. It won't be accurate anyway, and the answer is B developed output per man hour for some of the positions. I am so happy you got that correct? Good job, you can typically get information about salaries and what a good salary ranges for your industry. By professionals, sometimes the industries produce good salary information. But you can hire an individual, it specializes in salaries, to help you with this. So what is a good salary range per function? That's crucial because I don't want somebody to be making 30% over what they should be making for their particular function. That puts me at a significant disadvantage to my competitors. And then so salary reports, there might be salary reports in your area and remember the salaries are different for different parts of the country. So you need to use a salary report that's pertinent for where you live. And then if you give a salary increase, you say the person is doing an amazing job. Great, give a salary increase. But increase the responsibilities even if it's just something small. Make sure that individuals know that with that salary increase, if they are over the salary cut that they're getting additional responsibilities. And you know what your salary per cent to revenue is and monitor that. Because if you're paying a lot of overtime or if you are adding too many people, you may lose control over your salary per as a percent to revenue. And this significantly impacts the profitability of your business. So you can find out possibly what the industry averages for the salary. But I always stay away a wake alert for people who are not really performing their function. Number one, that creates work extra work for everybody else in the firm. And it really lowers the expectations of the other employees. I want to demonstrate what I'm saying with two businesses. I'm comparing business A and business B so business A. Is growing, so both of these businesses are growing. They haven't put a lot of equity into the business, so equity assets, equal equity and liabilities. So, they haven't put a lot into the business. They're working on growing their revenues. They're growing their number of people, they really did not focus on profitability and output per person. And the profitability decreased. So this happens sometimes in businesses where we increase our revenue and end up decreasing our profitability, not good. Business B as a comparison is putting money back into the business. So they're building equity, they're growing their revenue carefully. So when they grow revenue, they're looking at only revenue that increases their gross profit. They are maintaining their profit margin target. And when I say profit margin that is profit as a percent to revenue, we want to make sure that is staying pretty much the same. Now there will be times when I increase my revenue and I decrease my profit margin percent, but my profit is still going up. But that happens when I need more resources to grow my revenue, so that's understandable. So but we want to really try to have a profitability align with our revenue increase. This is an example of the business that is growing the revenue, but not really growing the profitability. And you don't want to be here, you're doing so much more work in, particularly as a CEO, this is making you work harder for the same amount of profitability. So why do you want to do this? Instead you want to make sure that as your revenue grows, your profitability grows and your percent of profitability, profit to revenue is consistent. So we want to make sure that our percent of revenue to profitability to revenue matches our revenue. So as our revenues go up, our profitability goes up. So you are working harder, however, you're actually being rewarded for this work. So make sure you don't get discouraged by the fact that profit doesn't always exactly follow revenue why? Because there is a stairstep effect. I can increase my revenues to a certain point. But then after a point in time, I then have to add resources to be able to increase my revenue more. So that creates a stairstep effect in my profitability as it relates to my revenue. And that's okay, as long as you realize that increase in resources is going to enable you to increase your revenue. So my profit may initially decline as I add the resources, but then my revenue will grow even more, which will bring my profitability up. So I have to make sure though that whatever resources I am adding to my business, those resources are going to help the revenue grow even more. So this is a review of the income statement where I have costs of sales of 125,000, giving me a gross profit of 175,000. And I'm managing my expenses properly and I have a net income of 72,500. And what do I want to do with that? That's really crucial because I need to use some of my income to go back into the business. And so this does have a reserve of 10%. I put 40% of my net income back into the business to grow the business. Which is really effective for the owners of the business because when we could sell for 15 times EBITDA it showed that it was really effective, it was worth it. So remember put some money back into the business so you can grow the business the right way. When you're running a business, you need some KPIs, key performance indicators. They're leading indicators and lagging indicators. The leading indicators are the activities that you are doing to drive the business. An example might be a number of sales calls per week, just what is that activity that is creating success. The lagging indicators are after the fact these are things that are telling you what has happened and there's usually time between the leading indicators and lagging indicators. The lagging indicators are things like your financial statements, your cash flow and the supplies that you need. So those are the things that are telling you what has happened too late to fix it. But lagging indicators like your financial statements, if you are watching them at least, that gives you an opportunity to before the quarter is over, before the year is over, you have a chance to fix something if something is going wrong. So the lagging indicators and cash is a big one can tell you if something is going wrong in your business. And you need to make sure you're watching that so you can fix it before you run out of cash. I need to know where my cash is coming from and where it's going to what I'm using cash flow. But once I get to a positive cash flow then I want to talk to you about what you should use your cash flow for. So taxes, debt, core capital and finally when we get through all of those other prior uses of cash flow, taking profit distributions. Understanding your cash flow is such an important part of running a business. So the statement of cash flow is something is a financial statement that will tell you what's going on with the cash. And your CPA can prepare the statement of cash flow, but you really need to understand what it means. So I look at my operating cash flow. If my operating cash flow is negative, even though my cash is going up, then that is not going to be a sustainable type of function I need for my operating cash flow to increase. Now it may be okay if it decreases if I'm growing the business to some degree, but again, it's not sustainable. So hopefully you have a cash infusion if that's what's happening. You have to be careful if you're purchasing new equipment because you have cash. So sometimes that will put your current ratio in a less than favorable percentage. And a lot of times banks use the current ratio as a covenant for a business loan. So be careful when you're buying equipment, you have to make sure that you have sufficient current assets to cover your current ratio if it is part of your covenant for your bank. But we want to keep our cash flow positive if at all possible. So this make sure you have two months of expenses I really prefer you have six months of expenses. In other words, what's my total expense of running the business? Multiply that by six and that's what I would say you need. What are the four forces of cash flow? A the ability to buy a car, a boat in an airplane and a new house. B pay taxes, repay debt reach core capital, make distribution. C the ability to pay for payrolls, payroll periods in a row or D, A and C. Once again, congratulations you got this right. It is B, pay taxes, repay debt reached core capital and make distributions. So businesses are required to make quarterly payments if you have profitability from the prior year. So your C P A should be able to tell you what those quarterly payments are if you don't owe quarterly payments because you did not make a profit in the prior year. But you are making a profit in the current year. Make sure you set the money aside so that when it is time for you to pay the taxes, you have it. I have a client who's C P A did not let them know that they needed to pay quarterly taxes. So they have made no quarterly payments. They will probably incur a penalty for not paying the quarterly taxes. So you either need to set the money aside if you're making a profit in the business or pay on a quarterly basis. You don't want to also run your personal expenses through the business. Such a bad idea. So be really careful about that. There is really a strong tendency for business owners to want to do this. But it does not help you understand how profitable your business really is. So you have to be realistic that taxes are a part of running a business. Now say you decide that you do not want to pay taxes to the I R S or the state. It could be so incredibly expensive to you if not jail time for you to to define that you don't need to pay taxes. So please make sure that you make tax is part of the regular practice in running your business now. That is not a bad thing, debt can actually help you grow your business and if you leverage it. The right way then you can grow your business but there is a cost to having debt, right, it's interest. So if the interest expenses necessary then fine. But if you can get out of debt, I really will help you number one reduce your expenses and number to help you prepare you possibly for a downturn in the economy because you'll have maybe some ability to get debt if something goes wrong in the business or in the economy. So lines of credit lines of credit are actually a good thing for you to have. So say you don't need debt perfect pay the debt off that have a line of credit available in case you need it. So something that will require a line of credit is possibly growing the business so that you get a large job where you have to pay the salaries or the for the material to do the job. But you're not paid up front, you're going to need cash for that for growing the business. So lines of credit are very helpful for something like that. So make sure you use credit wisely take advantage of it if you if you can when times are bad, it really is a great time for you if you positioned yourself well to buy a competitor and grow your business that way. So use your credit wisely, pay down your debt, sorry pay down your debt if you don't need it. That will save you interest but line of credit is a very good thing to have core capital. This is what you need to protect yourself in your business. So some people say two months is necessary, I say six months and actually was the pandemic that just occurred. Six months is was really not enough for some businesses but it gives you a chance to stay in business when your competitors might not be able to. So really puts you in some degree of control. So six months of reserves is up a good amount for core capital. I know you were listening to what I just said. So here's a question, what should a business owner have as reserves? A six months, B one year C one month or D why bother? You got it six months? I say it's best to have six months as a reserve. Finally we've paid our taxes, we've paid off her debt. We have developed a reserve. Now let's talk about distributions. So at a certain point after, if you use yours, you use, you have to make sure that you are making a market wage, whatever that is. And again, there are surveys out there. If you're the ceo you can find out what a market wage should be. So distributions, then once you're paying yourself a market wage, you may be able to give yourself distributions over and above. So and so then this is when we really need to look at personal investments, I always talk to my business owners about how much they're paying themselves. Number one, number two, what are their investments outside of the business? Because and which is you need this because what if something goes wrong in the business, you want to have assets outside of the business. That will be something you can rely on, anything happens to the business and then how you run the business and your record keeping and your documentation is critical so that it's always up to date. I always updated my business plan every single year. Why, because you never know if something's going to happen and you're going to need to sell the business. Unfortunately, bad things do happen and if you do need to sell the business, there's a health issue or whatever. You're prepared to be able to sell it. If I'm managing my business properly, I'm managing my labor, my productivity and my cash flow. Wow, this will really help you sleep better at night, make you in the driver's seat for good times and bad and ultimately help the business to be much more fun. So sometimes it takes discipline and if you do not have the discipline yourself, then look to hire discipline. There are a lot of people out there that are really good at managing businesses. So if discipline is not your forte, hire somebody to help you with the discipline. In other words, the discipline means managing your labor, managing your productivity and managing your cash flow.
