Many entrepreneurs have behaviors that stand in the way of performance greatness. My passion is presenting them data in a “Simple Numbers” way, empowering them to make more savvy decisions. Recently, I’ve been telling this story to drive the point home:
Bob has $100,000 that he’s looking to invest. He runs into Jim at a party, and they get to talking about investment opportunities. Jim says, “What if I offered you 50% interest on a 1 year CD?” Bob at first wonders if this is too good to be true, but Jim has never steered him wrong before, so he takes him up on the offer. A year later, Jim calls him back. “Hey, Bob, good news! Your CD has matured and I have your $150,000. Now, the IRS will need $20,000 for the tax on the interest, so let me know if you want to reinvest the $130,000 or if you want to spend some of it on a car or a big vacation or something.” Bob immediately says, “Of course I want to reinvest it all again!”
Bob’s investment story is exactly like you and your business, except when your business makes the profit, you immediately think of some way to spend it instead of reinvesting it into the business until the business has no more growth potential (which rarely happens!).
Here is the “Simple Numbers” math. You have a business that is doing $2 million in revenue. At 10% profit it makes $200,000 profit. Based on our research, the average amount of equity you need to be fully capitalized for this business would be around $400,000. The last time I checked my math, $200,000 of net income divided by $400,000 of equity is 50%. I am talking about the real return of value while still owning the business, not a hypothetical value if you sold it (that would be more!). The profit of $200,000 is also AFTER you have taken a market based wage for the “job” you do in the business.
I understand the demands of life and how anxious you are to enjoy some of the fruits of the business, but if you truly believed in the certainty of a 50% return (or more!) would you change your consumption habits to keep reinvesting? I think you would.
If you can drive to 15% profit, the return goes up even higher to 75% or 100%. We recently had a client who made a nice exit that was doing $5,250,000 in net income on $5 million of equity. No debt, plenty of cash, plenty of inventory, and over 100% return on equity. They were in the perfect position of demanding over 10x profits for the sales price (and all sales proceeds up front with no earn out) because anything less would have not been worth it to find a replacement investment. They had pricing power!
Perform your own calculation of return on investment. Just use net income in place of the income and equity in place of the investment. Equity is simply all assets minus all liabilities. Oh yes, that is over on the balance sheet, that statement most of you may not look at. Forget the multiple accounts the accountants put down there in the equity section of the balance sheet and just focus on the total equity number. Equity is 4 basic things; you put money in, you take money out, you add profit, you have losses. That’s it.
Hopefully, you have a return of over 50%. If you have a lot of debt, you may have a high percentage but if the dollars are wimpy, you have work to do to increase net income. If your return is lower than 50% but your net income is above 10%, you are potentially keeping too much cash in your business and putting it at risk of an attack on the business. This is not very common, but we do see it on occasion. For most of you, you are just taking out all of your profit in distributions and starving your cow!
Our clients have experienced magical success by committing to 10% or better profit, only distributing the cash needed to cover taxes, and leaving the rest in the business until it has nothing drawn on the line of credit.
Try it, I think you will like the results!
Want to learn more about the simple number style?
Get the 4 Keys to Unlock Your Business Potential when you watch Greg's On Demand Seminar, called Simple Numbers, Straight Talk, Big Profits! Or get his book at www.SimpleNumbers.me.