Owner’s salary: why your salary and distributions are fogging your view of net income
Know what your market-based wage is for your role. If the business cannot afford to pay you, keep track of the wages you’re giving up. If you’re profitable and you pay yourself wages that are too low, you run a high risk of IRS audit which you don’t want.
Aim for profitability over tax savings. Avoid distorting our net income because of improper owner compensation.
Use market-based wages for everyone, including shareholders. Pay back your investors before you share profits, and create reasonable financial expectations for your shareholders. And when you transition out of management, consider working in a limited capacity with a lower wage.
Profit: Why 10 percent is the new breakeven
EBITDA (earnings before interest, taxes, depreciation and amortization) is a financial indicator that you as a small business owner should pay attention to. However, you should always include interest, depreciation and amortization as part of your pretax costs. Focus on pretax profit instead of EBITDA. Ignore revenue and focus on gross profit.
Your breakeven point is 10 percent:
- 5 percent or less of pretax profit means your business is on life support
- 10 percent of pretax profit means you have a good business
- 15 percent of pretax profit means you have a great business
As a business grown from $1millio to $5million in revenue, it’ll pass through the black hole. To survive, you must allocate adequate resources and hire additional staff to take on new responsibilities for key functional areas.
Learn how to attract talents and take time to bring people on board. And then take time to train them. To get through a black hole, you need a capital safety net. Prepare a cash flow forecast by month for the time period of the expansion to determine your capital needs. Raise your capital safety by either reserving profits or seeking funds from investors. Make a plan to live off your market-based wage and leave every dime of profit in your business as you grow in revenue.
Labor productivity: your key to surviving the black hole
Shoot for a minimum pretax profit of 10 percent as you grow to $5million revenue. Leave any profits after taxes to fuel growth instead of relying on outside capital. To maximize your labor productivity, pay attention to labor creep. Avoid hiring staff for a function that you can do well. Consider what functions you can outsource and refine your leadership team.
Calculate and maintain your salary cap. If you’re exceeding the cap, decide if you’re going to hold wages constant until you hit your profit target or cut labor. There’s also a possibility that you’ll have to do both.
Get to 15 percent pretax profit before you raise your salary cap and drive your profit back down to 10 percent. The higher your pretax profit, the quicker you reach a cash-positive state. Control your profit by getting the most productivity out of every labor you spend on.
Business physics: the four forces of cash flow
Discover where your cash goes either by yourself or with the help of your accountant. Set aside your taxes in a separate account on a quarterly basis. Calculate how much case you need to get your line of credit to zero.
Borrow term debt only when you know exactly how you’re going to pay them back. Be willing to forego distributions while you’re repaying debt.
Build cash by retaining profits until you hit your core capital target. Remember you can retain only about 60 percent of the profits because you have to pay taxes. Arrange distributions on a formal basis each quarter only after you’ve covered your taxes and hit your core capital target.
Taming the tax monster under your bed: tax management that works
Decide if you should use a cash-basis system or an accrual-basis system in your business. Spending a dollar to save 40 cents is out of the question.
Calculate your tax liability each quarter whether you’re required to settle or not. Know whether you should use the safe harbor or pay-as-you-go approach to making tax payments. Be willing to change with each year as the right method is constantly evolving.
Set your market-based wage, have your taxes taken out of that wage, and fund your lifestyle with your net pay. Leave your distributions in business to first cover business taxes and then build wealth.
How to maximize your labor productivity
One of the most important KPIs for your business is your gross profit per labor. Aim for labor efficiency and make sure you’re getting the most out of your workforce.
Culture, productivity and profitability all live in harmony. One without the other two is like a table with a broken leg. It’s a disaster awaiting to strike.
Evaluate talent based on productivity and results, not on years of experience. Use performance appraisals to set honest expectations of your staff and given them authentic feedback. Identify top three or five skills you need for reach role in your business.
Avoid common incentive traps. Use incentive plans that guarantee sales and net profit. Forecast the financial impact of incentive plan payouts and have a fallback plan in case of market changes. Know what numbers you can share and defend, or just keep your books closed.
The three sources of capital: how to get money and effort to play nicely
Don’t fall prey to the idea that debt is capital. Save your own money whenever and wherever possible, and use it to start your business. If you look for outside capital, you must always watch out for the expectations of investors. If that’s not something you want, avoid taking their money.
Document your investors’ expectations and hire a professional lawyer to draft shareholder agreements. Put sweat equity into your business whenever possible. It’ll always give you a sense of return of investment. Whenever employees want to earn their way into the business, make sure they’re motivated by returns on their investment.
Reporting rhythms: the right data at the right time
Figure out your reporting rhythm and hold your team accountable to generate timely quality reports. It’s not the quantity, but the right data at the right time that matters.
Never take your eyes off your cash balance. Project your cash flow over a two-week period so you can plan for shortfalls. Monitor your labor productivity by watching your gross profit and your labor cost. Keep your P&L thin. Pay attention to what matters, usually seven or eight key lines of data. Never print a P&L without first making sure there’re no glaring errors.
Encomiums value: how to know what your business is worth to you
Knowing the economic value of your business gives you a baseline to make decisions about either selling or keeping your business. The fair market value of your business sets the baseline for decisions in 50/50 shareholder deals. As a rule of thumb, if you can buy out your partner for less than the economic value, you should take the deal. If you’re partner is offering more than the economic value, consider selling.
It’s not worth making a deal where the buyer can come back and seek damages from any possible overstatements. Set realistic expectations whiner you offer stock to key employees. Do the math on what our stock is really worth today and what you expect it to be worth if the employee leaves before the company is sold. Cash is cheap. Stock is expensive. Do not give away your stock without getting anything significant in return.
Skip the budget, learn to forecast
Use regular forecasts instead of budgets. Budgets are a license to spend. Forecasts are a permit to make profits. Keep your forecasts high.