We had the opportunity to interview Greg Crabtree, author of Simple Numbers, Straight Talk, Big Profits! today. Greg is an amazing business coach. If you have a 17 minutes, watch the video interview and master your cash flow.
Here's the transcript:
Eddy: This is Eddy Hood at Ignite Spot Outsourced Accounting. I'm really excited, today we have Greg Crabtree with us. He's one of my favorite authors. If you didn't know, he wrote a book called Simple Numbers, Straight Talk, Big Profits! We like it so much, we actually give it to everyone of our new clients that come on. So thanks for writing the book first of all-
Greg: I appreciate it. Thanks for recommending it.
Eddy: Yeah, it's a great book. If you guys haven't read it yet, the reason we give it out as a gift is because it really does take a complex subject and break it down in a simple way that any entrepreneur can take and use to better their business. So we're excited to have Greg with us today.
Eddy: Well Greg, I've got a couple of questions here. We try and keep these short, 10 to 15 minutes at most. If we don't get to all of my questions, that's alright. First, in the book, you talk a lot about getting profitable through managing your labor, labor productivity, labor cap, and those kinds of things. Can you talk to us about why you approach a business that way?
Greg: Well it all started with an idea that we kept looking at. You know, we were doing just general consulting. I've always been a student of business and I was fortunate to have clients that were quite successful in their businesses. As we went back and looked at what caused that change, we came up with this common theme. We have a singular way that we see the world in a P&L.
Greg: I was in a speech last week in Arizona and there was 130 people in the room. I said "All of you could take your pen out and put it on the table, and none of them would look the same. Why is that? We're creating the tower of Babel in accounting where nobody is speaking the same language. We have to come up with a singular way of seeing the data so that we can create comparabilities."
Greg: As I was doing that research, we hit upon the idea that the missing component was the fact that labor, when you isolate it, has a number in the P&L that it's held accountable to; whether it's direct labor that's held accountable to gross margin or it's management labor that's held accountable to contribution margin. Once we came up with that, it gave us a vision of the movement of a company's performance. It became the comparison of a good performer in an industry segment versus a poor performer. And then as we started focusing on it, we started seeing all of these comparable examples in the market place.
Greg: In the book, I talk about the salary cap concept in the NFL. All 32 teams pay the exact same wages, so why is it that the New England Patriots are so much more successful than the Oakland Raiders? It's because they do a better job of getting productivity for every dollar of labor spent.
Greg: I'm on a one-man mission to forever eliminate the concept of the FTE or Full-Time Employee. It's one of the stupidest things we ever came up with. I've never seen two people that act the same, should be paid the same - and here we are trying to homogenize a person, but they're all special and unique. But what's really the same is a dollar of labor. Every dollar that I spend has to be productive in that way. We found that when we extracted the labor component from the cost component and we pulled direct labor down as a sub-total beyond gross margin, most of the cost of goods sold that wasn't labor was just a pass through, or a term that I've started using as of late is "bait".
Greg: In reality, if you look at a construction company that is $20 million dollars and he's got $5 million dollars in materials and $12 million in sub-contractors, he's really a $2.8 million construction services manager, not a $20 million dollar business. We've got a large client that is in the distribution business and I said You're not a $60 million dollar distributor, you're a $9 million dollar inventory services business. It hurts your ego at first to think of gross margin, but if you focus on gross margin as the true top line of the business, you start to have this clarity of the true economic point of your business. As you start to apply labor against that, you start to see if your direct labor is getting more efficient or less efficient as you grow.
Greg: We're doing a project for a trade association, and we had 7 companies that we broke down data for and were presenting at the conference this week. And just looking at dynamics, once we have a simple and repeatable construct for seeing the data, it makes it very easy to present and compare the productivity aspects of it. Instead of searching for the billable hour, we realized that we have all of this unique data that's from privately held companies. I can't share it publically, but I can certainly do research on it to figure out why some companies succeed and others fail.
Eddy: I think a problem that a lot of businesses run into is the owners pay. At what point does the owner ramp up his or her pay? How do they know when to take a sufficient salary?
Greg: In the start up phase of a business, everybody is familiar with the term "sweat equity". We actually go to the effort to calculate it. Because ultimately as much as every business owner thinks that they are special, I've got news for you, you can be replaced - and there are some that can be improved upon. So don't get too high on your horse saying I'm unique, I'm special. Well yeah, you're kind of special, but there are 8 billion people in the world so they can find a replacement. And so the idea is that we create this distortive element of people, and there are a couple of reasons why. Part of the reason is that you're lying to yourself about the true profitability of the business.
Greg: The second is that you're playing some kind of tax game. Ahh, I don't want to pay payroll taxes on that. I'll just take a distribution if I'm an S-corporation and not pay the payroll taxes. We've just contended that in the grand scheme of things, if you want to build a wealth building business, payroll taxes are a rounding error. Quit trying to play the edges of the game and go after the real brass ring which is to run a profitable business. Our perfect game plan is to have you pay yourself a market-based wage and live of the net after-tax income because that's what you're being paid for the job that you're doing. Anything that the business produces in profitability, you take that as a dividend. You're going to take a distribution out of the business to pay taxes if you're and S or an LLC. You'll pay corporate taxes if you're a C-corp. But we want you to treat that company as a business that's required by its investors to produce a profit and pay a dividend.
Greg: When you have that separation, what you start to realize is, well if my business isn't profitable I'm either not a good manager or I'm not in a good industry and do I want to keep going? We've actually found very few cases where that is the case. It comes down to understanding here's what I'm getting paid for the job I'm doing, and then here's my return on investment. If we can convince you on that model, I will guarantee you that if you have a fully capitalized business, which is two months operating expenses in cash and no debt, that business will have an equity balance that is sufficient to produce a 50% return on equity at 10% profit.
Greg: Now you tell me, how many people would not want to invest money in a business that will produce a 50% return on equity. That's not what the public markets are doing.
Eddy: Just to break this down, what were are saying is that if you're a business owner, step number one is to work on your cost of goods sold structure and make sure that you're accounting for your labor correctly. Number two, figure out what your market rate wage should be. What should you as a business owner make? What's a fair salary? Don't over-inflate it because of your ego. Maybe go to salary.com to figure out that wage point. So you would take that wage as a paycheck and pay payroll taxes on that. And then run your business profitably so that at the end of the year you can take a percentage of the profits as a draw.
Greg: That's right. The idea is that we want you to mimic taxation so that the business should always be making a distribution to cover the taxes it causes. This is the thing that causes a privately held business to have a lumpy cash flow because they're not setting aside the taxes as they earn them on a quarter to quarter basis. We recommend setting up a tax savings account. Don't send it to the IRS until you absolutely have to, but don't incur a penalty. And then when it's time to pay it, there's no drama.
Eddy: Yeah, we do the same thing. We tell our clients every week or every month to set aside funds in a separate account to cover their taxes.
Eddy: Lets actually talk about that lumpy cash flow for a minute. Obviously if you're not saving for taxes, that causes a problem. You think you're doing well and then all of the sudden you've got a $50,000 tax bill and that messes everything up. What else is messing up cash flow for small business owners?
Greg: The classic scenario is the person that has some ability to borrow money to fund their business, and what they fail to understand is that you can only repay debt with after-tax profits. When you borrow money when you're not making money, you've excelerated the death rate of the business. You've got to get that thing profitable, because the only thing that is going to make the bank happy is if you repay it. One of the things that just drives me nuts is when someone has $100,000 in profits at the end of the year and their aaccountant tells them to buy some equipment. Stop that. Why would you spend a dollar to save 40 cents in tax? Plus they make it worse by borrowing the money. So they didn't even spend real money to get the deductions. They may have pushed they tax bracket into the twenties or teens, but to repay the debt they got to be in the 40% bracket to generate enough cash flow to retire the debt and get out of the hole. It's a cycle that we preach against with all of our might.
Greg: When I put this in the book, I felt like I would get some push back but I've only gotten one negative comment and it was from another CPA. I guess he felt threatened. At the end of the day, the number one indicator of wealth creation is the size of the check that you write to the IRS. If you didn't write a big check to the IRS, you either didn't make any money or you cheated and both are bad. I'm giving you permission to go and be profitable, set aside the tax and pay it, and then keep going. We've seen these amazing turn-arounds in companies that were trying to be minimalists all the time. There's so much untapped economic potential in privately held businesses because of their lack of understanding of the profit matrix.
Eddy: I do want to talk about one last thing before we end. In the book you talk about budgeting and forecasting and you make the comment of getting rid of the budget and focusing on forecasting. Why don't you tell us about your philosophy there.
Greg: It comes from a quote that I heard. I don't even know who to ascribe it to. It says "A man who aims at nothing, hits it with amazing accuracy." A budget by it's nature is irrelevant within one to two months of the year. I learned this by going to the two-day plant tour at Springfield Manufacturing with Jack Stacks. If you haven't read the book, The Great Game of Business, It's an amazing company, and that's where in that two-day visit I saw a floor mechanic in their engine factory that could explain a balance sheet, P&L, and cash flow and forecast it better than any accountant that I have ever met. He had never had a single accounting class in his life. That is the discipline that they deploy. They actually re-forecast weekly. That's probably a little noisy for most folks but it certainly helped them become a very stable and successful business. We believe that you should always be looking ahead at least once a month. We build custom models for our clients to look at those forecasts in a simplistic fashion. We're not trying to forecast line items, we forecasting based on our P&L construct. But I have got to forecast the P&L to then be able to forecast the balance sheet so that we know when the cash shows up. I'm telling you, profit and cash are on two different trains. They eventually get to the same station, but at different times.
Eddy: We do the same thing. As we forecast for our clients, it can get convoluted because some people want to forecast office supplies month by month. What I care about is the wealth of the business. Are you going to get wealthy because of this? Will your customers get wealthy? What about the shareholders?
Greg: That's the secret to our format because there are only eight lines of data. There's revenue, direct costs, direct labor and those are the 3 business engine lines. And then there are 5 buckets of expenses: facilities, marketing, management labor, payroll taxes, and the catch all is other operating expenses. It has the most line items. It will go up and down on a monthly basis, but you put that on a rolling 12 basis and it's smooth.
The final words of the interview were focused in thanking Greg for his time with us. I hope you enjoyed this interview. There were quite a few concepts talked about here, so if you have any questions fire away in the comment section below.
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