From Simple Numbers to ScalingUp Cash. PRESENTED BY Greg Crabtree, CPA

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1 From Simple Numbers to ScalingUp Cash PRESENTED BY Greg Crabtree, CPA

2 Simple Numbers PROFIT + PURPOSE = IMPACT Slides at: SimpleNumbers.me/slides Greg Crabtree Greg.Crabtree@crbcpa.net

3 Applying the Cash Decision Ques6ons to: Scale Up Cash Profitability The Wealth Building Capacity of your business Scaling Up Cash Presented by: Greg Crabtree, CPA, Author of Simple Numbers, Straight Talk, Big Profits and contributor to Scaling Up (Chapter 13)

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6 Cash Decision Ques6ons 1. The business is structured and operated as if it were being sold tomorrow to maximize market value. 2. Profitability is running at 3x industry average. 3. Cash flow is a high priority i.e. we re focused on con6nually improving the business model to generate more cash as the business scales.

7 Cash Decision Ques6ons 4. We receive 6mely and accurate repor6ng of key data for our daily, weekly, monthly, and quarterly mee6ng rhythms. 5. We know profitability, gross margin, and revenue by customer, project, loca6on, line of business, team and/or employee where applicable

8 Cash Decision Ques6ons 6. Individual line items on the P&L and Balance Sheet have people specifically accountable for each. 7. We have a rolling forecast looking forward 12 to 18 months updated at least monthly. 8. We have 3x to 10x the cash reserves compared to our compe6tors.

9 CASH DECISION #1 THE BUSINESS IS STRUCTURED AND OPERATED AS IF IT WERE BEING SOLD TOMORROW TO MAXIMIZE MARKET VALUE.

10 Understanding ROIC ROIC (Return on Invested Capital) Annual Pre-tax Profit divided by your investment Your Investment Cash and property you contribute Sweat Equity Does not include terminal value on a sale

11 Typical Self Funded Entrepreneur Startup

12 The Power of Compounding

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16 ROIC Takeaways Economy is growing much faster than we think Private Companies now dominate the economy Cash is not the inhibitor to grow. The main inhibitors are: Unable to build capacity Not confident in growth Desire to consume profits instead of growth

17 Running a Ready to Sell Business Effec6ve Business Structure (legal and tax) to either keep or sell Opera6onal excellence with documented processes that being followed Knowing and monitoring what drives market value for your business Regularly scrub internal financials for deal adjustments

18 3 Essen6al Business Value Data Points Economic Value What is the business worth to you on a cash flow/roe basis without selling Current Market Value similar businesses in size and industry are selling for Replacement Return needed if you sold at Market Value

19 Economic Value See Chapter 9 of Simple Numbers, Straight Talk, Big Profits by Greg Crabtree Developed to manage shareholder or management buyout concepts based on aler tax cash flow and a reasonable 6me frame for purchase 5 years to buyout a 50% owner, 10 to 14 years depending on interest rate for a 100% sale Formula 3 6mes Net Income Plus Equity

20 Current Market Value Can be a mul6ple of EBITDA (aler deal adjustments) (5 is generally considered neutral) Can be a mul6plier of Revenue, Gross Margin or Value per qualified customer If you are carrying debt, you generally have to payoff debt from proceeds or adjust price if they keep the debt

21 Replacement Return Needed Calculate Net Aler Tax Proceeds (use an average 25% tax rate for illustra6on) Divide Net Income (aler deal adjustments) by the Net Aler Tax proceeds If replacement return needed is above 15%, reconsider whether selling is the best decision or are you at a point in life where you will not need to consume more than the annual earnings of the replacement investment

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25 3 Business Value Plays Run to harvest Profitable, cash flow genera6ng Only sell when you are ready to re6re or start another more profitable business Harvest un6l Premium Sale Profitable, cash flow genera6ng Only sell if you can get a significant premium (usually 10x Ebitda) Build to Sell Cash flow neutral to nega6ve Building a business of volume for a strip sale Be certain of market demand and valua6on

26 CASH DECISION #2 PROFITABILITY IS RUNNING AT 3X INDUSTRY AVERAGE.

27 Profitability Keys Have your P&L speak truth by elimina6ng distor6ons Owners Comp at Market Wage you get paid a salary for what you do and a return on what you own Owner Occupied Real Estate at market rent Separate Non Opera6ng Expenses below Net Opera6ng Income

28 Profitability Keys HaSet Profit Targets on your True Top Line Companies with Gross Margin below 40% should use Gross Margin as the True Top Line Labor Produc6vity is the #1 Key to Profitability Op6mized Management Labor produc6vity sets the stage for Direct Labor to be efficient Use Salary Cap concept to match labor to produc6vity required

29 Profitability Keys - Con6nued Be careful comparing to industry data that has not been normalized for distor6ons Compare your performance to businesses with similar models that may not be in the same industry (contrac6ng, staffing, retail, manufacturing, etc) Isolate expense spending that is for future years and consider displaying it below Net Opera6ng Income to not distort current opera6onal performance.

30 4 Primary Business Models Services Product Sale Product Sale + Services Manufacturing

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32 Repor6ng Best Prac6ce

33 Repor6ng Best Prac6ce

34 Repor6ng Best Prac6ce

35 CASH DECISION #3 CASH FLOW IS A HIGH PRIORITY I.E. WE RE FOCUSED ON CONTINUALLY IMPROVING THE BUSINESS MODEL TO GENERATE MORE CASH AS THE BUSINESS SCALES.

36 Cash Flow Keys Understand the 6me lag between profit and cash flow U6lize Alan Miltz s Power of One and Cash Flow Story tools or custom projec6on model 5 Compe6ng Forces for Cash Flow R&D or reinvestment for growth Taxes Debt Service Core Capitaliza6on Profit Distribu6ons

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38 Five Compe6ng Forces for Cash 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)

39 CASH DECISION #4 WE RECEIVE TIMELY AND ACCURATE REPORTING OF KEY DATA FOR OUR DAILY, WEEKLY, MONTHLY, AND QUARTERLY MEETING RHYTHMS.

40 Repor6ng Rhythms Break free from the Calendar! Embrace the weekly accoun6ng rhythm Adopt Rolling 12 data as the performance measurement Gold Standard Good data fast is beser than perfect data late Accoun6ng does not have to be done by Accountants, imbed accoun6ng into opera6onal processes where the greatest knowledge of the transac6on is closest to the transac6on

41 Recommended Reports Daily Cash and Line of Credit Balances Weekly 2 Week Cash Flow Forecast Revenue, Gross Margin, Direct Labor & Contribu6on Margin (Report shows, week, trailing 4 week, trailing 13 week and trailing 52 week data) along with any other key ac6vity metrics

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43 Recommended Reports Monthly Full Financial Model (Balance Sheet, P&L & Cash Flow and business segments) Start with Rolling 12 P&L, move to Rolling 3 P&L and then to Monthly P&L to avoid short term data bias Specifically reforecast next 3 months and use trends to forecast out to 12 to 18 months Review other key ra6os and model cash flow trends

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45 Recommended Reports Quarterly Review specialty segment reports By Customer By Project By Product (GMROI for inventoried goods) Any other segment that requires extra effort to create and is not totally automated Closer review of longer term forecast

46 CASH DECISION #5 WE KNOW PROFITABILITY, GROSS MARGIN, AND REVENUE BY CUSTOMER, PROJECT, LOCATION, LINE OF BUSINESS, TEAM AND/OR EMPLOYEE WHERE APPLICABLE

47 Profit Cube Effec6ve Segment Repor6ng Keep segment repor6ng simple by tracking Revenue Direct Costs Gross Margin (Revenue minus Direct Costs) Direct Labor Contribu6on Margin (Gross Margin minus Direct Labor) Direct LER (Gross Margin divided by Direct Labor)

48 Profit Cube Effec6ve Segment Repor6ng - Con6nued Recommend to avoid alloca6ng Overhead or Payroll Taxes and Benefits Focus on Contribu6on Margin by segment and compare Direct LER to search for which pasern is the most efficient with labor but also yields higher Contribu6on Margin $ High Rates of performance are no good if you cannot get enough volume, conversely, volume is no good if it is at a bad rate

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50 Margin by Customer

51 LER by Customer

52 LER by Crew

53 LER by Employee

54 CASH DECISION #6 INDIVIDUAL LINE ITEMS ON THE P&L AND BALANCE SHEET HAVE PEOPLE SPECIFICALLY ACCOUNTABLE FOR EACH.

55 Line Accountability Balance Sheet All the dead bodies are on the balance sheet Avoid immaterial adjus6ng for prepaid expenses and accruals unless they are material Use book deprecia6on instead of tax for management statements Consider Related Party Receivables as a reduc6on of equity instead of an asset since they are not likely to be repaid any6me soon

56 Line Accountability P&L Assign responsibility at the rolled up level (Simple Numbers format) Responsibility will be to review past performance as well at forecaster (avoid budget thinking ) Rolling 12 trend is most authorita6ve data Keep total model in perspec6ve No costs are truly fixed and no costs are truly variable Be mindful of cost characteris6cs and search for unproduc6ve costs that produce lisle to no value

57 CASH DECISION #7 WE HAVE A ROLLING FORECAST LOOKING FORWARD 12 TO 18 MONTHS UPDATED AT LEAST MONTHLY.

58 Art of Forecas6ng A man who aims at nothing hits it with amazing accuracy Rolling 12 data is usually able to predict 3 to six months out just from trend paserns Top Down method Determine expected revenue Predict costs needed to support ac6vity

59 Art of Forecas6ng Bosom Up Method Iden6fy Management Labor Mul6ply Management Labor by mler target to get the Contribu6on Margin target Iden6fy dler rate targeted to calculate Direct Labor (CM / (dler-1)) Sum of Direct Labor and Contribu6on Margin is Gross Margin Target Divide Gross Margin by GM% to es6mate Revenue

60 Step #1 Management Labor 6mes mler = Contribu6on Margin

61 Step #2 Contribu6on Margin / (dler-1) = Direct Labor

62 Step #3 Contribu6on Margin + Direct Labor = Gross margin

63 Step #4 GM / GM% = Revenue

64 Landscape Thinking Model

65 CASH DECISION #8 WE HAVE 3X TO 10X THE CASH RESERVES COMPARED TO OUR COMPETITORS.

66 Core Capital Target When is my business fully capitalized? When you have: 2 months of opera6ng expenses (including direct labor) in cash (essen6ally, anything you do not have terms on) Nothing drawn on a line of credit (would include lines that have been termed out) Current taxes have been set aside and are not in the cash reserve number All other BS ra6os are secondary if you hit this level of cash

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68 Core Capital Target & ROE If you achieve the 2 months cash and have 10% net profit You should have a minimum of a 50% Return on equity year over year without selling the business. Most businesses have 75% to 100% that do not require heavy capitaliza6on You can achieve a higher ROE with debt, but you are taking added risk to do it