Episode Transcript
[00:00:00] Welcome to the Independence by Design podcast, where we discuss what it means to be a business owner and ways to get unstuck from the day to day so we can design a business that gives us a life of independence.
[00:00:15] What's up, everybody? I am very excited. I am going to try something new. This is a solo podcast. I was on my run for this morning and I was thinking about what most of my coaching clients and the people that I have presented to recently would like to know. And it is how do I clarify my ownership goals and how do I get visibility into my numbers? And so one of the biggest things that I've found a challenge with is showing people what I know to be true and possible, which is a financial model that was created by my dear friend, Pat Hobby, who's been on the podcast, my old business partner and dear friend, and he brainwashed me because this is the way I see the world now. And anything that is short of this financial ongoing statement is just guessing in my mind. So I wanted to show you what it looks like, how it can be used to make informed decisions, how it can be used to back into your valuation, target your owner's distributions, look at work, working capital debt, how it could be used for budgeting, how it could be used for comp plans, how it could be. I'm not going to get into all of it right now, but like, I just wanted to just start putting it all out there so the people listening in, you can follow along. I'm hoping that this is still a good experience. I'm going to try and be conscious of the fact that you could be listening in. Otherwise, go on to Spotify or YouTube to check out the video. I just want to show you what's possible so you can start envisioning what can be done and what is possible and how to start having conversations with your finances. You're like, why don't you have this? And then how to start bringing in the planning and all your ideas into this.
[00:01:51] So what I want to start with is why your ownership goals are so damn important. So I got on the spread on the sheet right now, or the screen is, we need to understand your goals for time, cash flow and wealth. And if you want to go from 60 hours down to 50 hours over the next five years, we're going to be able to show in this financial model how you're going to be able to then buy back your time by inserting in a salary and the income statement while still maintaining your cash flow. So cash flow here we've got 400 grand and 600 grand. And the whole thought process here is that we're going to increase our income through distributions while decreasing our salary just for conceptual purposes. And we need to have a line of sight on our, on our wealth. So what does our overall net worth need to be and what do we want it to be? Call it in five years.
[00:02:43] And if we wanted our net worth to be worth 15 million bucks at 4% withdrawal, that can give us our 600 grand to give us our financial freedom number. So this is just kind of conceptually we have to put these constraints in to then build the operations and the financial model around our goals. And then we can start toggling together our goal. Say, hey, you know what, I could reduce my net worth goal. How does the valuation fit into that? I'm going to show you how that works as well.
[00:03:08] What is my, you know, how does, if I sell the business, would I have enough to retire and keep maintaining that income?
[00:03:14] All of this is possible. And it all lands in a spreadsheet. I just have to show it in the graphics because over the years people are like, oh, the spreadsheet's too much. Like, yeah, but at some point we just gotta get this shit done. So that way we can actually make decisions. And the high level decisions that we can make are so powerful of growth rates. How are we going to deal with employee payroll if we think that inflation is going to keep going? Do we want to increase the payroll above and beyond to recruit other people, bonus plans? I mean all of this stuff can be seen inside the numbers. So I'm pulling up now the spreadsheet. This is, and I'm just gonna be walking through this while I talk. And so again, like I, my goal is to make it a fun experience for you as you're, as you're listening in as well. So I'm starting all the way over on the right tab. Because this, the natural flow of this file is, is that we're going from the database, which is where all the information comes from. So I'll end there. And this is, this is the exact opposite how I think Pat things, I think from the top, like what's the valuation in year five?
[00:04:21] I want to be able to back into that where a lot of times people will start from the ground up. Both are right. But we want to triangulate those two. So the far right is what we call the valuation gap tab. And this is pulling all of the information from all of the financials that are built out from the five year Projections. So we have on a tab three columns and the first, the middle column is the, the base case of the valuation target that we want to have based on the projections. So let's say our normalized EBITDA is 4.3 million bucks.
[00:04:56] We can go down and say hey, what multiple do we think that that is going to hit? And you know, when you think about the multiples, you can go to Pepperdine Capital Market study, which is a great way investment bankers and brokers, there's a lot of different ways to back into that multiple. And what I like to think about the multiple as we're looking at this in the valuation gap page here is something that is regardless of the buyer, it's possible regardless of the buyer. So an ESOP or a private equity or third party sale or management buyout because effectively the debt and the, the cash flow can fund the debt of the company. So let's say it's a five multiple. What this will the tab will do is, is show a range of four to six. So we're just going a multiple up in a multiple down. So you just see a range and you don't have to pay a bunch of money for valuation because we're using our normalized EBITDA in the forecast. And I'm going to back into all of this, our normalized ebitda we're taking a multiple which gets us to our enterprise value. So on a 5 multiple it's $21.6 million.
[00:06:00] Then the next set of lines are our debt because when you sell a company it's cash free, debt free, which is called equity value with a normal level of working capital.
[00:06:10] So cash free, debt free means you have to pay off any line of credit, long term debt, any notes payable. So in this situation there's $341,000 and we have cash of $3.6 million. So that's cash after working capital. So that's accumulated above and beyond payables, receivables and inventory.
[00:06:30] We will be able to see that in the financials. But just to I'm going to keep recalibrating us normalized EBITDA times the multiple.
[00:06:38] Then we, we have to pay off our debt and we get to keep our cash. Which means the Equity valuation is $24.9 million and it's about 3 point. Well, it's $3.6 million more than the enterprise value here because we have more cash than debt. It could be the opposite. There's a lot of companies that have a negative equity. So you could have a large enterprise value and like, you know, if this was, you know, a fully leveraged private equity firm, this could be negative $2 million in equity value, even though the enterprise values 21 million bucks.
[00:07:11] So we get to the equity value of $24 million.
[00:07:15] Over here on this column, we've got this tax rate. So let's say you're in the beautiful state of Minnesota, plus the federal government. Let's say it's 35% blended tax, puts us at a net proceeds of $16 million.
[00:07:29] If our desired net proceeds is.
[00:07:32] I'm going to put $15 million, which came from that graphic that was showing.
[00:07:37] Oops, there we go. That puts us $1.2 million above and beyond our target. If we were to get a 4 multiple, we're $1.5 million short. If we were to get a 6 multiple, we'd be $4 million above. This is a great. Again, regardless of the buyer, you say, hey, in this situation, five multiple on $4.3 million, I wanted net to net $15 million. I was able to do that and I've got an extra $1.2 million. The chance of getting all cash at closing of a deal is very small. It's not impossible, but you can start playing around with, well, how much? I mean this, in this situation, to get the net proceeds at closing, you're having to get almost all of it cash at closing.
[00:08:21] If you were to reduce your desired net proceeds to $10 million, you're having about $6 million to play around with with rolled equity or earnouts.
[00:08:31] This comes down to playing around with your target for your valuation at year five.
[00:08:38] That has to be put into relationship of the rest of your net worth. So that way, if you want a $20 million net worth, like, okay, how does my company fit into this? But you're able to look and see in the future with some basic math and some assumptions, what the company would be worth.
[00:08:56] I think everybody's capable of doing this and even on the back of the napkin. But the challenge that I've seen and why I'm super excited to dive into this model.
[00:09:08] What is the proof supporting this? So when I sit on my clients board meetings, all I'm asking is what is the probability of us getting here and why? What is like, how does sales relate to this? How does margins and cost of goods, how does the investments in the overhead and working capital, how do all of the different assumptions play into factor, play a factor into us getting to 4.3 million in normalized ebitda with this multiple and that kind of cash. So I'm going to go to the left one more tab which is the out year projections.
[00:09:44] So the out your projections are years, call it two through five.
[00:09:50] Because the tab to the left of this or a couple to this, the left of this is going to be the annual budget. So what I have, what I believe is the, my favorite best practices is that annually you have a monthly ground up budget with all three statements and going to show you what that looks like. I did a great podcast with Pat, I don't know like a month or two ago about that. But and there's a budgeting tool that we walk through.
[00:10:17] So annually you have a monthly budget month by month by month, line by line by line for all three statements. But then years two through five, which we call the out year projections, we are going to give some higher level assumptions for years two through five. So what we have here is actually because of the date that I'm doing this in is 26, 27, 28, 29 and 30. So it's five years obviously as we round out and complete 25 and finish that monthly budget, that annual, annual monthly budget, we would then repeg this all and it would be 27 through 30.
[00:10:55] And so what on this tab I'm going to more closely and break down all three statements again. I know we've done that on one of the previous podcasts, but I think it's just so important to keep reiterating this stuff. And I'm going to walk through the three statements and then walk through how the higher level assumptions can be built because these are the five columns that are backing up the five year plan to get to the which is technically the six year plan to get to the end of 2030.
[00:11:25] Because then we're going to have then the broken down monthly per column for a year. So when we have this out your projections, each column is a full year.
[00:11:37] And I'm going to orient you here where we're going to start with column X which is called column one. And we have, and that's for the, the next year. And we would have. When I say next year, I'm sorry, I keep going back to this.
[00:11:52] Maybe, maybe I'm, I'm going to bounce back over to this monthly budget right here. If you can see this, this is what I mean by the monthly. So every single month is a column. So this is for Jan, for, so this is for all of 2025. So as I'm going through the rest of this, I'm assuming 2025 is the full year monthly budget, and then in the out years is 26 through 30. And those are just one column as a whole year, because we're still technically in 2025. So I apologize if I was confusing you on that.
[00:12:27] So when we look at what the. Each column being all three statements, we have equipment sales, which in this example is $5.8 million, and then we have four other lines of business. And this could be services, it could be consumables, it could be licensing. I mean, whatever your lines of business are, that gets December of 2026 revenue to $20 million. And then it goes to 22 million 22.6, 24.9 to $26.1 million.
[00:13:00] And those revenue growth rates on each line of business over each year is being driven off of these assumptions in this spreadsheet where we can go in and say equipment sales for December or I'm sorry, for 26 is going to be right here. It's 0%.
[00:13:21] We could toggle it to 5% in this, in the model right now we have zero. And then 7% for equipment sales in 27, 3% in 28, 10% in 2030 or 2029, and then 5% in 2030. This is where we could be layering on economic cycles like Kim Clark and Alan Bowley are always talking about. But we can do each year's growth rate for each line of business for five years. And it's able to then extrapolate that for those five years. And what we're able to, how we're able to do that is we're taking the annual budget and extrapolating the growth rates off of the annual budget. So that's why we have to have the annual budget, because it's the foundation that we put the scaffolding on. And so in the spreadsheet, as you can see here, you're able to see the growth rates for annual year 23, 24, and 25. So that way you're able to look at the past and go, what have we done in the past?
[00:14:25] What do we. What should we do in the future? And making some assumptions and some growth rates and some cycles.
[00:14:30] So that gets us to our revenue for the next five years based on all the levels of thinking. And I'm going to come back as I round out the final part of this podcast. And I don't know exactly how long it's going to be. You'll know by looking down at the, at the timing, but I'm going to Round out with how do you use this in a monthly ownership meeting and a quarterly board meeting and then an annual planning where we start stress testing these assumptions because these are the ideas that everybody wants to get to, but we don't have the foundation to do so because most people don't have a model like this. Then we go down, we can go to the cost of goods. We do the same thing where you got every single year for the next five years for cost of goods, making sure that you have to have the revenue recognition between your costs and your revenue per line of business.
[00:15:20] I mean, you have to have that. So we trust the margins. And once we trust those margins and we trust those that cost of goods matching with the revenue, we can go down. And then in this example, 26, we have $12 million in cost of goods, which leads us to $7.7 million in gross profit, which is a 37% gross margin that goes all the way out. You know, then it goes to 13.6, 14, 15.3 and 16.1.
[00:15:50] And we are holding our margins steady around 38% because it goes 37.6 to 38.1, 38.1, 38.4, 38.5. If we were seeing margin slippage, we would have to be dealing with that. But we have revenue now, we've got gross margin.
[00:16:07] And then there's sales, general administration, opex, overhead, whatever you want to call it to get to our net operating income.
[00:16:17] In this example, it's $2,500,000, 3,000,100%. $3,100%, $3,080,000, $4,000,000. And we're sitting at 12.3 growth, net operating margin, 14.4, 13.9, 15.3, 15.4. And we have every single line. So like we're. If you think about why I'm explaining this like this, it's just thinking someone has to go through and go, what are we going to do per year and per revenue line over the next five years, what is it going to cost to deliver that revenue per cost of good line matching up with the revenue? And then what is it going to take in the overhead to get there?
[00:17:02] And this is where you're looking at ERP implementations or if you're looking at recruiting costs, or if you're looking at, you know, insurance expense update or increases or you know, if you're going to do a voip transit or migration or like a website or I mean like all of that stuff, bonus programs, all of that stuff needs to be in here and you Just have to go through the discipline of putting it in and you could start with higher level assumptions.
[00:17:28] And my hope in this video is that like the data is so worth it that it becomes worth the misery of going through this because it's not fun, but it's worth it.
[00:17:42] The next is we have other income expense to get us to our net income which goes from $2.4 million to 3.8, goes from 11.9% net income to 14.9.
[00:17:58] And then we have EBITDA and then EBITDA adjusted which is that normalized ebitda. So in this model we have a normalizing adjustments budget. So it literally has a tab where you can go through and like let's say if you're putting in a half of the sga, you're grabbing and saying okay, you know sgna, where let's put pick one here, I don't know, let's say in the legal and you know, row 55.
[00:18:24] I mean all those are pretty normal right now you can pick one of these SGA lines and say, hey, that's going to go up by a lot.
[00:18:33] Well, why is that? It's because, you know, we're going to do an acquisition, we're going to have $1 million in integration costs. You can go over to that normalized EBITDA tab and then plug it in there. So that way the normalized EBITDA is accurate because when we're over in this value gap tab we need to make sure it's pulling in. So you see that 4.338 there it is.
[00:18:58] So like the normalized diva, just based on what we're planning on doing, that's some made up number we pulled out of our butt. So it's all the thinking that went into the next five years.
[00:19:09] The balance sheet I'm going to skip through because I want to see the cash flow statement and I'm going to stop sharing real quick here just to quickly orient ourselves on how the three statements interact together.
[00:19:24] So, or let me show you here. So the three statements, okay, we have the balance sheet, Tom, and let's say that that is okay. We got May 31 to May 31 to June 30. So May 31 to June 30, two balance sheets over two periods of time. Okay, well you start with the balance sheet.
[00:19:56] The income statement is what the operations did last month. And then the income statement then ends with a balance sheet. But we end with a balance sheet at the end of the next month and we might have accounts receivable accounts payable, inventory, maybe of customer deposits that are assets or liabilities on our balance sheet. But the cash flow statement is literally a mathematical difference of the balance sheet over two periods of time.
[00:20:41] So the cash flow statement tells the story of how everything, all the money flows in and out of the business. So as a board member, all I care about is the use of cash and what's the projected cash position. And so these statements flow in and out together.
[00:21:01] And so when we pull up, then the model again, when we go down to the cash flow statement, this is honestly like when I, I was in a board meeting a couple months ago and they finally have a, a model, a three statement model. I went in, I'm like, what's cash? And one of the board members that's been there for a long time, first thing you said, what's the cash position? It's like, it's so awesome. And so the cash flow statement starts with net income. So every single one of these columns again is all three financial statements. And then it starts with net income. So you remember the $2,400,000 and then 3.8. That's how the cash flow statement starts.
[00:21:43] Then we go through changes in working capital, which is that loop de loop and that graphic I'm always showing. Oops, that's not what I wanted to do.
[00:21:51] So you can see here that each year we can start forecasting out our receivables, payables and inventory by receivables. How fast are we collecting our receivables? 25 days or 40 days? 60 days. And I'm going to show you how we can see the impact on that in the monthly budget inventory. How fast are we turning our inventory and then pay for payables? How fast are we paying our payables? Where is that? Right here. Okay, so right here. So for people who watch or they're listening In, I have $142,000 that's negative in December 27 versus $115,000 that's positive in 26.
[00:22:34] It's negative because we have more receivables and it's negative for the next couple years because as we grow, we're accumulating more receivables than we had before.
[00:22:49] Inventory is negative every single year because we're accumulating more inventory. So we have. So if you think about it, the cash flow statement is just the balance sheet over two periods of time.
[00:23:01] And so what we're doing is we're saying, okay, inventory is $109,000 more than it was last year. And accounts receivables is $142,000 more than it was last year. So it's starting with net income, but then it's what's the use of cash?
[00:23:21] So we started with, so we have this use of cash, of payables, receivables and inventory. Where's payables? Payables?
[00:23:32] Payables is positive if we're pushing off payables, and payables is negative if we paid payables fast. So that's called the cash conversion cycle.
[00:23:41] And this changes in working capital, also known as working capital, because some depending on your business model, the faster you grow, the more cash it consumes in your operations as well as your working capital.
[00:23:55] It gets to this line right here is 180, which is called net cash flow provided by or used by operating activities.
[00:24:04] This line right here is the bridge between ownership and operations. So everything above this, everything in the income statement is all operations. That's the CEO. If you're the CEO and you're putting on the CEO, hat like the CEO is responsible for the entire income statement and the working capital.
[00:24:24] And then they present to the board, which is a lot of times you as well. Okay, well, how did the cash flow from operations and how did it do? Did you use and consume cash or did you generate cash? In this example, we go from $2.6 million to $4 million over the course of five years.
[00:24:43] That bridge. Because then once we get to that line, what effectively we're saying is we did all of these things in the income statement each year. We sold this stuff, we made this kind of margin because we sold this stuff at this margin. We had all this overhead, and then we had this working capital, and we generated 2.6 million in cash. And then in December 30, December of 2030, we generated 2 point or $4.04 million in cash.
[00:25:13] Now it becomes an ownership decision of what do you want to do with that money? That is true capital allocation. And so after the net cash flow provided by it or used by operating activity, we can then figure out the cash flow from investing activities. So if you had other assets that you were generating income from, whether you had come, you know, cash in a money market account that you're generating yield on, or if you had rent deposits, other assets that are outside of your normal operating entity would go there and then cash flow from financing activities. This is where you're using cash. This is your debt section.
[00:25:53] And you would have a line of credit line here long Term debt payment, all your different notes.
[00:26:02] And these are the same AM schedules, amortization schedules and debt schedules. So you would have it the asset or liability on your balance sheet and then the liability of the loan on your balance sheet would then have to have an amortization schedule to then be able to reconcile with. These are just the payments. So these are the payments of debt that you would have. And then the full debt schedule would have to be in that value gap tab where you're able to see the total debt that you have to pay off when you sell the company, if you're to sell the company.
[00:26:38] But when we look at the rest of the cashless statement, these are my couple favorite parts to be honest. Here's your distributions for pre estimated taxes.
[00:26:49] So we can separate. I mean there's too many people I see where they have distributions and dividends convoluted because you have to take most people, hopefully you're taking the distributions and dividends to pay your taxes tax bill and then whatever's left over is yours. You can separate the two and you can make these payments based on, I think we got, I don't remember what the tax calculation is, 25% or something like that. And then there's distributions discretionary, which are what do you want?
[00:27:22] That's a bad color. So the distributions are how much do you want to pull out of the company in order to meet your needs?
[00:27:32] So in this example in 2026, we pull out 975 grand and there was. We're essentially doing 50% distributions and 50% taxes, it looks like here. And so we can see in this example that this owner can collect anywhere from 975 grand to $1.5 million in 2030.
[00:27:54] And so that's pulling out $2 million up to $3.1 million.
[00:28:02] And you can go all the way down to see the cash at the end of the period. That's like literally if you use U.S. bank or Wells Fargo or Choice bank or.
[00:28:13] I mean it doesn't matter or it doesn't. Whatever bank you use, how much money do you have in your checking account at the end of each year?
[00:28:21] So at the end of the year, December 2030, we're forecasting out $3.6 million.
[00:28:29] Given everything that we're trying to do. And then the question is, well, do we believe that number?
[00:28:35] And the way I was, I was on a call with a client recently and we're like, okay, discounted cash flow. I mean, I'm going to be talking a lot about this Stuff as I continue to roll out a bunch of training stuff that I've been doing.
[00:28:47] Okay, well, do we believe that? Well, I don't know.
[00:28:50] Now we go up here and we say, well, what don't we believe?
[00:28:54] Well, I don't believe we can grow at 3%. Okay, why?
[00:28:59] Cost of goods. You know what? I don't think we can hold our 38% margin because inflation's happening. We're having to like, you know, the 4% inflation or 4% raises on people is not enough anymore. The living wages is. We're going to have. We want to out compete and steal people. We want to want to go up to 7% and we want to, you know, invest in more systems and processes to increase our multiple. Like we want to pay higher bonus programs. You know, all of these different uses of cash and investing. We can see the ripple effect over all three statements to then get us to do. We believe that $3.6 million and going back to the discounted cash flow, it's like, okay, I'm going to handicap that and say, hey, I would bet my life on it that we can generate $2 million in cash given everything that we got going on.
[00:29:51] We're quantifying the discounted cash flow, the discount rate, the headache. I mean, it's not perfect. Net present value of the terminal value and the distributions.
[00:30:00] So that's probably jargon for most people. But what I'm trying to show is that that's how investors think.
[00:30:06] Like, what is our ability to predict the future of all of the operations to get to 3.6 million bucks?
[00:30:16] This is totally possible. And then we start playing around with all of the assumptions of, you know, I was just on a call with the client. Well, hey, Great Depression, 2030 and the, you know, whatever industry.
[00:30:30] Well, how is it, you know, how is it, how do we think it's going to happen? What's AI going to do to our margins? Could we increase our margins? Because, I mean, could we?
[00:30:39] All of the strategic ideas that I know everyone has can be played with levers in here. Without this model, we are totally guessing. And we could see how that all ripples forward to the normalized ebitda. And then we have to continue to play around with the multiple. But I don't know, I just, when I look at this, I want every single business owner to have this. It's more fun for me to work with people when they have this. So if you're looking here, I'm back down to on the balance sheet when we can figure out how to forecast out the balance sheet. We can see here days sales outstanding. We can actually play around with the accounts receivable where you've got it 36 days in collections. Inventory is turning 50 days.
[00:31:30] Prepaids are 1.1% of revenue. And so you can play around with this stuff comp plans. Like if we were to.
[00:31:40] Oh my gosh, I could go so many different directions with this. I'm going to get to the annual budget here in a second. But I think we can just. Because it's all just about the three statement model. I was talking to someone recently, we've talked a lot about comp plans of someone should be in charge of revenue Person A so like first actually I'm going to do it. Yeah, I'm going to do this right now. And then I'll go down to the annual. So let's say this is person a person number one. Let's call them Bob.
[00:32:13] Bob is a salesperson and Bob's goal is to predict all of this stuff, all the revenue. Show me how we're going to get there. And so all the strategic thinking has to go in there. All of the customer journey, the leading indicators, conversion rates. From my conversations with Allison Bechdel as well as Kim Clark. I mean all of the Kim Clark and Allison Bechdel and all this stuff goes into show me sales director.
[00:32:44] I struggle with sales because it's revenue revenue officer how the marketing and sales and strategy efforts are going to get us the ideal client profile and we're going to have the ideal conversion rates with a client acquisition cost that's going to get me to 20 million bucks in December of 26. If someone can't answer that question, they don't know what they're doing or they haven't or they haven't been able to given the resources to get that information to you. Maybe they don't have the right tool, the right CRM or the right data tracking. Okay, well then the question should be do we want to put that on as a rock?
[00:33:22] Because we can't answer that question right now and we know we want to answer that question.
[00:33:27] So we need to have the data. So we need to invest in that ability to make the data. So I'm going to walk through and I'm going to go in a little bit more detail on how I think about this from an investor board level perspective.
[00:33:44] That is the question. So if we're sitting in front of a sales director say okay, every single line item here. So there are five revenue lines.
[00:33:53] I Would like to see a customer journey in a CRM that includes all of the marketing analytics and then all the sales analytics, if you have them, that result in conversion rates to get to these numbers.
[00:34:08] And I'm gonna flip over, I'm gonna stop sharing right here and show you a marketing funnel. Just show you what I mean by this.
[00:34:13] So this is what I mean by the sales and marketing journey.
[00:34:18] This is like what's totally possible to say. Okay, well, so if right here is that signed contract and this is gonna lead to that revenue, well, what do we gotta do to acquire that revenue? Well, you know what, we have to do some speaking, we have to do some. How many webinars do you have to do? Cold calls?
[00:34:42] Do we have to have website traffic to get to a lead magnet? Let's say all of that leads to the lead magnet, which is an email.
[00:34:50] And this is where Allison Bechtol's podcast and then Kim Clark's podcast come into play. And then that email and will get us to a sales call.
[00:35:00] So then intro call.
[00:35:04] Okay. And then, then there's proposals and there's follow ups and all that leads us to a signed contract.
[00:35:10] What is the conversion rate from email to intro to signed contract?
[00:35:17] And then how many people do we need at the top of the funnel and what are we going to do to track all this stuff to get 100 emails, to get 15 intros, to get five closes?
[00:35:31] What's the average order volume and what's the average order volume out of revenue, number one revenue number two, just put behind this.
[00:35:47] So this is what a sales director.
[00:35:51] God, I keep saying sales director, chief revenue officer, because you know, you could argue that this stuff is marketing and this stuff is sales. I don't give a shit. Like there's a lot of stuff you need to do with conversion rates to get the freaking order.
[00:36:06] Someone needs to be responsible for closing sales. And I need revenue predictably on my income statement every single month next year and then out years two through five, I need the higher level assumption of the total volume that we're going to do.
[00:36:21] And all of that has to be done within what's called the client acquisition cost. So call it CAC. In my old industry it was 20% of gross profit we could use to acquire that gross profit dollar. So $0.20 to the dollar that we could use to acquire the dollar in order based on the lifetime value of the customer. Well, we would take that client acquisition cost and then that would be the constraint around all the shit you can do. So. Well, we don't have enough money to pay.
[00:36:52] I mean, I sat down with someone last week and they had about $1.5 million trade show booth. Like, oh my God, like, well, but I guess it's worth it. So if you have a shoestring budget, making sure that you're in your, when you're doing your budgeting in your sga, how much is going for paid social ads? How much is going, how much is your paid outbound marketing for calls or if your website traffic is there, like for that email, are you paying blog writers or. I don't care.
[00:37:24] What I do care about from an investor perspective is there's a hundred emails that lead to 15 intros that lead to five closes and then each of that revenue dollar amounts land on the income statement every single month. And then the chief revenue officer is responsible for that number. So I'm going to quit sharing here and then go back to the spreadsheet. So then that leads to this bucket of the, like these buckets of the income statement.
[00:37:54] And we needed to understand how there's a customer journey with client acquisition costs for all these. And what I'm trying to get across is like it's not my opinion, like if we don't have that, we're guessing because like we're trying to figure out what the hell this company is worth in the future.
[00:38:16] And if we have that valuation in the future, you understand what your trade offs are today.
[00:38:21] And we can actually look at the discounted cash flow as well. And that's a whole another long conversation then. So this person, A number one, Bob, who's in responsible for revenue will get their bonus program tied to landing the predictable revenue on the income statement based on the customer journey and the client acquisition cost, the cost of goods. This gross margin right here, this should be person number two, which is Sally. Okay, we go. Okay. Sally, you are our operations, our operations, our chief operations officer.
[00:39:02] You're responsible for delivering our products or services at the margin that we need based on the sales that we think we're going to do.
[00:39:10] Okay, These margins is what we need. So we can't be lower than that. Otherwise we are then going to have less cash and we're going to have less equity valuation.
[00:39:23] And then person A, or I keep saying A or interchange A in number one. So person number one, Bob, and person number two, Sally, work with person number three, which would be person number three, which is call that person Ted.
[00:39:43] Ted is the cfo and the CFO is responsible for normalized EBITDA and working through this With Bob and Sally.
[00:39:57] And their job is to make sure that they're extracting the information about what type of costs Bob needs for the client acquisition, for sales and marketing and all that sort of stuff. And then with Sally for the operations to make sure that all the products and the inventory and then the margins and all the stuff that are necessary. I'm margins, products and inventory and all the cost of goods are able to get to the margins that we forecasted for.
[00:40:25] Those are the three buckets of the income statement. And they're the three executives that like, if it's me, I want to str. Strangle one person.
[00:40:33] Anybody that has like more people tied to this number, the monkeys are going to land on the CEO's back, which is probably you. And the CEO's job is to get the entire company performance to the valuation for the board who owns the company and for the owner.
[00:40:50] And I don't know, like, this brings me so much peace because when I jump once I had one of my clients where they finally had the three statement model out, I got it sent over to me from the cfo. You know, the first thing I did, I went right in to distributions.
[00:41:09] I was like, oh nice.
[00:41:11] We can get a call a million to million five over the next five years and we have cash.
[00:41:18] If we believe all the planning and all the thought process and everything that went into it. We can jump right in and check that out and go, okay, now we start asking questions to Bob, Sally and Ted about why they think that they're going to hit this. And we want, we're looking for rational answers.
[00:41:35] And there's a lot of different back, you know, ways we could manage leadership, which is okay if, if Bob says, you know what, I don't have the data.
[00:41:48] And like Bob walks through what he would do in the customer journey and said, well, but I don't have a CRM and we don't have salespeople that track this.
[00:41:55] Like, do we all agree that accumulating the data is really important for predictable revenue for a valuable company? Yes.
[00:42:04] Well, maybe quarter one rock for Bob is, I don't know, HubSpot, salesforce. I don't give a shit, Bob. But like, like you need to, we need to figure it out. We need to figure out how to integrate sales and marketing to get the conversion rates so you can show this. So there becomes this process of do we all agree, do we have the data? And if we don't have the data, what systems do we need?
[00:42:27] And then if we, if we get the system do we have the best practices and the, the people that are doing the processes to get the data into the system, to get it into then the accounting or into the conversion rates into the revenue, into the income statement. And so there becomes this like this domino effect of saying, okay, well, Bob's doing the right job right now. He's, he's doing what he should.
[00:42:52] And let's, let's say for three months he fails miserably on the CRM implementation. He starts complaining and complaining and complaining, complaining and not out for help. It's like, dude, this is a Bob problem.
[00:43:03] Or it's like, is it someone else problem? We can, we can better isolate the problems. And same thing with, you know, Sally on operations. It's like, okay, we're not hitting our margins. Why? So I could keep going on and on about this and I'm still focused in on this out your projection tab, which is the bigger picture.
[00:43:22] We're taking all of that level of thinking on the budget. And I've got an entire podcast with Pat Hobby. I'll put in the link below where we walk through the budgeting process of how to build up the budget. Budgeting for the revenue. I kind of talked about that a lot more just now. And then the operations and then the payroll and all that build up that budgeting process happens outside of this financial model. And then it's copied and pasted into this so you have a different budgeting file. Otherwise this file becomes so enormous it's ridiculous. But this monthly budget right here is, we start and we're going. And this is what our monthly meetings are like. On track, off track. And it's every single month for revenue, every single month for gross profit and gross margin, every single month for net income and normalized ebitda. And then we go right down to my favorite financial model.
[00:44:19] Financial statement is what did, what happened with the repayables, receivables and inventory.
[00:44:25] Cash flow from operating activities is 290. So I'll read the numbers for people here. So if we go in a monthly basis, so the whole year for 25 gets us to. Well, that's the balance sheet. The whole year gets us to $20,000,000 in revenue. Well, in December, specifically of 2025, it's $1,800,000 in revenue. And it's broken out between five different revenue buckets.
[00:44:52] On track, off track for December and for the whole year. And there's all these blue tabs down here in this financial model where the blue tabs are a lot of the, the CFO should be giving a presentation every month on what happened and what's the story. And then the, the sale, the chief revenue officer, the operating officer, revenue margins. And then the finance person should be explaining to the CEO and the owner what happened and why.
[00:45:20] And so on track, off track with total revenue. And if it's off track, the question would be why? Well, not enough top of the funnel. Why? Well, you know, the market's off business cycles. Okay, well, we had. So the top of the funnel is not where we want it to be, but we still had enough in the bottom of the funnel. So then now I'm concerned about Q1.
[00:45:38] I, I'm just, I am so convicted that people that are listening to this, if you're still listening in, you know what questions to ask.
[00:45:48] It's just you don't have the data organized in a way that make any freaking sense. And once you have the data, it's like, okay, ask a bunch of questions. The sales, same thing with the operations. Well, our margins are off and how is the year to date and then the monthly. And how does it relate to our budget?
[00:46:06] So this budget right here, this budget tab is the foundation for the out year. So we have to have a monthly thought through budget in order to have years two through five in order to have the valuation target.
[00:46:22] We cannot get this valuation gap tab if we don't have years two through five.
[00:46:34] If we don't have the monthly annual budget, we don't have anything to be able to continue building off of. And the whole budgeting is just very ground up. And again, go check out that podcast with Pat. I'm going to zoom out for a second, or not zoom out, but kind of orient us around the rest of the financial model. What are the different components? Because I've gone from the right to the left, which is end in mind, is the valuation out, your annual monthly budget and then these. So these yellow tabs and the blue tabs are what I call, and I think Pat calls them presentation tabs. So it's on the monthly, like hey, on track, off track. That's literally what everything becomes as we've wrapped up our budgeting and in December, now it's all, you know, all of 26. Every month is on track, off track for the monthlies.
[00:47:26] And then quarterly, it's looking at the bigger picture, looking at distributions, estimated taxes, capital allocation, and then we kick off budgeting again in October of next year. And it's just the cycle of running a business from the boardroom. The charts you can see here Once you have all of this data, you can chart revenue, gross profit. I mean, once you have the data, I mean, jack stacks. My favorite quote is like the income statements, the best KPI dashboard you can look at. Gross profit and gross margin dollars. You can see because that those are big differences. So you're not just looking at the dollar amounts, you're looking at the percentages in relationship to the dollar amounts. Because these are the stories that you want to be looking at, which is, okay, our dollar amounts are up, but the profit or the gross margins down. What's going on?
[00:48:16] SG&A dollars and percentage of total revenue. You can see SG&A is creeping up.
[00:48:21] What's going on?
[00:48:22] Net operating income and margins and dollars.
[00:48:25] Net income and EBITDA and normalized ebitda. I mean, you can start just charting off anything. Client acquisition costs, you can start doing, I mean bonus programs, I mean all that kind of stuff.
[00:48:37] There's an analytics and ratios tab. So the top starts with the cash conversion cycle, which is your day's sales outstanding, your receivables. How fast are you collecting your receivables?
[00:48:49] Days, inventory outstanding and payables.
[00:48:53] So that cash conversion cycle should be something that's talked about on the leadership team.
[00:48:58] And then the. This is awesome. Effective. One day of change in cash.
[00:49:04] So awesome. Like that kind of data is amazing. Gets you to your liquidity ratios. I think Pat's even put on this now a bunch of bank ratios. So like if you have bank covenants and stuff like that, like that, you have to hit. You can start easily adding those to this, to this model. You got your gross margins information for charts down here is pulling from all the other statements.
[00:49:26] Okay. If you're following along, you're, you're a saint. I just wanted to get this all out so people can pause. People can always constantly reference this, pass it to your CFO or leadership team. This is what's possible. The blue tabs here, income statement comparison, actual and current month versus last year, actual versus budget. So these blue tabs, without going like into crazy detail, I'm just like, when I look at this, if I know that we've got everything from the value gap all the way to today, it's how many ways can we triangulate the story?
[00:50:05] So like it's like year, you know, income statement comparison last year versus this year, this year to budget. So I'll say that again, knowing that we have every, all the plan and we've got all of the historicals, I want to look at this month compared to Last year and then this month, and then actual versus budget. So we had a budget for this month on track, off track. And then what was the difference from last year? So in this example, we were 10% up or.
[00:50:35] Yeah, we're 10% up this year and we are on track with the budget by 0.2% within the budget. And you can go through all the lines and all the. The income statement.
[00:50:48] And then there's all of the.
[00:50:51] So down here on this income statement comparison is taking every line item in the income statement and creating it as a percentage of revenue. It's called common size and allows you to see trends of how things are changing over time.
[00:51:07] We can have the same thing with the balance sheet comparison, actual this month versus last year, and then current month versus budget.
[00:51:17] Same thing. Year to date with cash flow statement, year to date, income statement over the last. I mean, there's just a lot of different, you know, fiscal year to date, all the different year to dates. And trailing 12 months.
[00:51:30] All of these different tabs are just different ways to say on track, off track with the budget based on what we were trying to do.
[00:51:39] Why are we offer on. What's the story telling us as I boat slide into home here? Because I am tired. You're probably tired of me too. Is these orange tabs are the database of the historicals. So you can see in this, this one, it's the three statements. This is why Pat, I think it was like 2017, you got to come up with a different name than the ongoing file. It's like, it's too literal and it's too perfect. It's just ongoing. Because every single month, this is. We've got from December 21, I've got clients where they've got all their numbers. Every single column is a year back to 2001.
[00:52:24] And we can get all the historicals because then we can start looking at all the different ways to analyze the data.
[00:52:31] The way to do that in this model is how Pat started originally was. I can't remember where it was. Oh, here. So in the three statements, monthly tab, you could plug in and hard code in all your data for years past. But what Pat's got, this crazy fantastic method is exporting your trial balance, which is your whole list of all of your GL codes in your trial balance, which you're exporting everything.
[00:53:05] But then every, you know, everybody's got a junk drawer. I mean, like, God, I. I had someone that had 800 codes. And like the sins of the past are all in the previous years.
[00:53:14] But what you can do here is you can see you have a bunch like so in here you got autos and trucks, machinery and equipment, furniture equipment, computer equipment, buildings. All of that is fixed costs or fixed asset costs. So you're calling it, it's called a roll up code.
[00:53:32] So that way you're taking what you want your income statement and balance sheet to look like and you're saying, you know what, I want only five revenue lines.
[00:53:45] I want these 10 cost of goods lines and I want these SG&A lines. So the export from the trial balance allows you to map to a roll up code that you and your finance director should be looking at saying okay, how do I actually want to read my financials? Like what story do I want to be able to look at?
[00:54:06] And so that way instead of messing around with NetSuite or Oracle or, or QuickBooks Online or whatever it might be, you're like actually just exporting from there and then you're, you're cleaning up all the information here and then once you have that rollout it does like a vlookup and it populates throughout the entire file. So that way every single month you're just copying and pasting. I think Pat said with one of his clients it takes them 15 minutes to update a company that or owner that's got five companies.
[00:54:37] This data is insane. Like I can't imagine making a big investment buying a company taking a distribution without this information.
[00:54:50] The ability to look at different decisions. So as I'm about done wrapping up here, if you wanted to understand, hey his you know what, so that like what I've got looking at, what I'm looking at here is I'm on the monthly budget which is every column is a month for this year. And then there's the value gap. So I'm sorry, not the value gap, the out year. So I'm going to go to the out year for a second.
[00:55:17] If you wanted to hire a CEO for 300 grand in 2027, you could come in to officers payroll and throw in the money here.
[00:55:33] I'm not gonna, I'm gonna mess up a bunch of formulas. But let's say we wanted this to 100 times 100.
[00:55:43] So yep. So you can see how it went from 380 something to 780.
[00:55:51] So if you.
[00:55:52] So that was in 2029. I did that. So it went from 380 to 780.
[00:55:57] It reduced, it increased our total SGNA, it then reduced our normalized EBITDA and then it actually goes all the way down and it reduced our cash. I don't remember exactly. I think it was 1.3.
[00:56:13] I mean, like, that's what everybody wants to know is like, if I do this thing, what will happen? So if it's hiring a person, if it's, you know, investing into the business or like, I mean, honest to God, like distributions, if you want to take a big distribution, I had someone like, hey, I want to take a big distribution. So, and this, these are already pretty healthy distributions of 1.2 million bucks.
[00:56:36] If you wanted $3 million or like, let's say you were averaging $150,000 in distributions, you wanted to pull 800 grand out for a house, I don't know, what's the impact of that? If my sales go down and my sales are soft because of the business cycle or I mean margins are compressing, I mean, AI is coming, you name the problem.
[00:56:58] We can get context behind this and put it into the hole to see the impact.
[00:57:07] The ability also to go to a bank and then ask them for an increase, a line of credit or if you wanted to like increase your ability to take on long term debt, which by the way, having long term debt as the dollar gets the base is not a bad thing. Like you want to go borrow money at cheaper so you can figure out how to reinvest into the equity of your company and grow the equity, you can see the payoff because you could look at the how that debt were to roll into your equity valuation. So now I'm on the value gap tab. You say, let's say you took out another million dollars in debt, but you think that you could grow that. So like, you know, if you had machinery, it's like, you know what, I'm going to finance half that or maybe 70% of that because I'm going to take the rest of the cash and increase some payroll or it puts more money towards sales. And I think I can grow the company and I can see the return.
[00:58:02] I mean, I don't know. I hope this has been helpful. I wanted to get this out of my head when I was running today. I've just had so many conversations.
[00:58:15] I'm gonna stop sharing so many conversations over this past, like few weeks of like, I just wish everybody had this because I want to play around with everybody on the fun big idea stuff. And we can't do that if we're stuck in the mud. You know, we got mud on the windshield and we're just hoping we don't hit like it's so Stressful. It's also the reason that, you know, it's also the reason that people want to sell their company.
[00:58:41] They don't want to, they don't feel confident to hire a replacement because they don't have the. It's all self reinforcing up or down because you don't feel comfortable hiring someone. You don't have the right KPIs. You don't understand how it's tied to a goal and you don't understand the banking situation. You just, it's all these things that you're scared of. So you're spiraling down, but if you have this, it spirals up.
[00:59:01] I mean you can go to your bank, you can look at the KPIs, you can look at that like what you want to do for sales and marketing, you can look at you. I mean it just, it becomes fun. And I also believe that it the hard shit in business. I got off a call with a client today. It's been rough. It's been a rough industry cycle right now.
[00:59:25] And we are very close to having this model down now.
[00:59:30] Hey, it's, next year's not going to be perfectly fine and dandy. However, if we have this information, we'll be able to handle it and contextualize the pain. Like, oh, we got this thing going on. Okay, plug it all in. How does it impact my distributions, my growth rate, my working capital? I can talk to my bank and say, okay, we're going to be fine. I mean just the ability to do that and model out worst case scenario or model out best case scenario and tie comp plans to it.
[00:59:57] If there's anything I want to say is this is math, it's accounting and it's discipline and thinking.
[01:00:05] There's nothing here that's monumental or revolutionary.
[01:00:10] And you know, if you came from a background like me, where I didn't have a background in finance or accounting, when I saw that this was possible, I was like, are you freaking serious?
[01:00:20] That means everybody I've been working with didn't know what the f they were doing because like why wouldn't I have had this? It's like, oh. And that, that was the only conclusion I could come to. And the more I have been doing this for 10 years since selling the business. It's, this is, it's as rare as going to sleep, eating well, exercising and just living healthy. I mean, it's just, it's not, it's, it's not a shock what we're supposed to do.
[01:00:51] It's just not a lot of people do this. And finding the right person in your finance lead is going to be a tough challenge. But I think it first starts with what you know is possible. And I hope I just gave you a glimmer of hope that this is what's possible. Reach out to me if you want this file. I'm happy to be sharing this with people. That's pat and I want to share the.
[01:01:14] Share the goodness with the world. I am going to be continuing to grow my coaching program. And that's where it's like, hey, I want to continue giving more and more free content out there. And then people want accountability, they want community, they want more additional resources and tools and then the coaching programs for them. And that's always something that I'm going to continue to be growing and it's going to be a lot of fun stuff coming up in 26. So I hope you enjoyed this. You got any questions, reach out, let me know. I'll continue, I think doing more of these lessons learned and training podcasts, depending on the feedback that I get here.
[01:01:49] I appreciate you all and thanks for tuning in and share this with someone that you think would need it. See you.
