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 Roland Solo today. I am going to continue the conversation we've had over the last few weeks and I want to dive into today to help you understand what story is the margins of your business telling you and then how do you make sure that you maintain your margins and continue to align your strategies with your ownership goals. So I'm going to actually be pulling up some materials. So if you're listening to this while you're running or in your car, please don't get in an accident. I'm going to walk you through verbally what I'm actually doing, but also if you wanted to pull up Spotify or YouTube, the video is also there. So to level set us, before I pull up the actual ongoing financial model, the three statement model, to actually show you the charts and the graphs and the KPIs that I'm looking at to make decisions. So when I say make decisions, I'm going to actually be using the case study that I built out. I'm going to be referencing my old business where we had multiple product and service lines and we had different things going on with different products and service lines. When I say different things, meaning different margins, different trends. And I wanted to make sure that we had sustainable cash flow. So what I've got here on my iPad, if you are listening in, I have just got the three statements. I've got a little sheet up to show you how they all interplay together. And I think this is so important for just a level set to make sure we understand how important the margins are.
[00:01:36] So when we have three financial statements, they're all connected together through the mathematical interplay between that income statement, the balance sheet and the cash flow statement. So in the income statement we've got our revenue, gross margins and normalized EBITDA as a proxy for cash flow. And the income statement interplays with the balance sheet because we have receivables, payables and inventory, also known as working capital.
[00:01:59] And so that working capital we know is going to impact cash.
[00:02:05] And when we look at the cash flow statement, which is my favorite statement, because that is the mathematical difference between the balance sheet over two periods of time. So we have the balance sheet in July 31st and then the balance sheet in August 31st. And the cash flow statement is just telling us the story of what happened to did receivables go up or down? Did payables go up or down? Did inventory go up or down? How did we pay our debt taxes and then reinvestment and owner's distribution. So at the end of the day we want to be looking at distributions and taking money out of the company versus reinvestment.
[00:02:40] So I go to this next page where to show how the five year plan is absolutely crucial to get context.
[00:02:49] So that way you understand when you're sitting there and looking at one of your revenue lines or your lines of business and you're looking at your margins, you're going, okay, should I increase prices to my customers? Should I continue to maintain these small margins because I've got another product or service line I'm reinvesting into.
[00:03:06] The only way we can get any context in any of this is the five year plan. So as you can see up on top here, I've got five years of the, I mean, and I'm literally, I'll pull up this sheet in a second. We've got five potential columns of the three statements. The five year valuation target, where we will have the normalized ebitda, the multiple, and then the whole net proceeds. To say, okay, this is the target doesn't mean that we actually want to sell. But if this is the target and the constraint for the valuation, that'll help us put into perspective owners, distributions, working capital debt, taxes, etc.
[00:03:41] This is absolutely a must to be able to get context. To sit in a boardroom on a quarterly basis and say, okay, we have a product or service line that it's eroding your margins. What do we do about it? Do we go to our clients? Do we increase prices? Do we, I mean all these different trade offs that we have to make every day. And in the boardroom we want to have context.
[00:04:04] This right here, this sheet that I'm walking through is how the three statement financial model, the ongoing file. God bless you, Pat. That is the name of the, the file because it's just ongoing. We are constantly looking at the future in relationship to today with the constraints. Some words I've been using lately, if you're familiar with them, it's. This is, these are first principles. This is a closed loop system. So every decision related to your operations, which is your income statement versus your ownership goals, which is your cash flow statement in the balance sheet and your valuation target, it's all closed loop. Meaning that it's, we can't have leakage. We. Every single decision ripples into one of the other aspects. And we want to understand what that ripple effect is. So this is why I wanted to show you this before jumping into the financial model, because this is exactly how the financial model is structured. And so again, I'm going to do my best to continue talking through this in a way that makes sense. So that way, if you are listening in, it will hopefully make sense to you. All right, now here's what I've got. I've got the financial model up.
[00:05:11] This financial model is what I am always talking about. I've got podcast out a few, you know, a few months ago, like the only financial model you'll ever need. I'm constantly updating it for whatever it's worth. This is just the badass thing that is new. Is this Claude plugin? Claude Inner. I said recently, like, Claude being this plugin is like inserting Pat into a spreadsheet. He's like genie in the genie in the bottle. He's in his heaven spot. Okay, here's what I wanted to do. And I'm going to pull up right away the the dashboards.
[00:05:46] So I'm pulling up the COO dashboard. So I've got a lot here. I'm not going to be covering all of the financial model because the question today is what's going on with our margins and what do we need to do about them?
[00:06:00] So the COO is responsible for margins in my world. So we have the CRO. And actually I'll just pull this up again just so I'm going to flip over if, you know, the people keep hearing me talk about the typical org chart. So what we have here is the board responsible the valuation and cash flow goals.
[00:06:21] CEO is responsible for company, for performance, like the whole operations. The CEO's job is to build a business that accomplishes ownership goals. And then the CRO is all about the revenue and being responsible for the revenue. The COO is gross margins and then the CFO is cash flow and the financial model. So I pulled up the COO chart and the KPI tab on the financial model because that's what they're responsible for.
[00:06:52] All right, so when I got here is a.
[00:06:58] I will, I will take my time going through this because and I will talk through this is like when I look at like what is going on with our margins, I want to first and under, first to understand is what are our gross margins and what's going on with them in relationship to gross profit. So gross profit being the dollar amount and gross margins being the percentage and the, the trap that I see so many people in. And I'll talk about traps and I'll talk about the best practices and where to find the data and what it looks like to clean up your data to get the right data. So one of the traps I see people fall into is they're looking at their gross profit constantly and not the gross margin because you can have growing gross profit, but eroding gross margin. So you could have the dollar amounts growing, but you could have the margins and the percentages shrinking. So what I'm showing here is a chart where we have the line graph of the monthly gross margin, which is a blended gross margin because we've got multiple product and service lines here. And I'm going to walk you through why that's so important to break those down. But before we do it, like the way I think about this is just like double clicking. If we're sitting in a monthly meeting with our CEO and you're the CEO, it's like, well, how are we doing? Like, you're responsible for gross profit, gross margins, how are we doing? So we would pull up this chart first and say, okay, well what's this chart telling us? Well, the chart is showing us that we're seasonal because we have this up and down bar chart of the gross profit and it's slowly going up and up over time as each year goes. And so then we're also looking at the gross profit margin line and it's also going in relationship to the ups and downs. But you can, it's harder to see, like, okay, what's is the trending going up or down? And like, what's the rate of change?
[00:08:53] That would be the question I would have and I think everybody would want to have that question. And if you have multiple product and service lines, the question would be, is like, well, why.
[00:09:02] So up here on the top, what I have is the margin status per product and service line. So this company and I, this is not my exact old industry because I don't want to, I don't want to state any facts about my old industry of the copy or the IT and the software services, but I'm using the different lines of businesses as an example. So I'm not saying that these are the margins that were in the old industry, but there are similar stories that I can tell. And the story is what we're trying to identify is like what's going on. So we have equipment, project work and then reoccurring services one and two and then consumable. So My old world was like copiers, managed it, software automation, like document management. And then we would have project work, whether it was project IT work or software work. And then we have consumables, multiple lines of business with different margins. So what I want to know if I'm sitting here as a CEO and the CEO or if I'm on a monthly owner ownership meeting, I'm like, okay, well what's going on with their margins? Are they trending up or down? And so what we can see here is that equipment, the current gross margin is 35%, current project work is 43%.
[00:10:12] The average of the reoccurring services is 55. And then the consumables is 25 or 24.9.
[00:10:19] So if you're listening in versus watching, you can just. They're different, right? So the question we would have is what should we do more of and why and where has it been, where is it and where is it trending towards? Those are all very legitimate questions and I think everyone has those questions and they are the right questions.
[00:10:40] What we want to do to answer that is to break out the margins per product and service line so we can see the trend.
[00:10:48] What I'm showing up here first and I'm going to come back to this is the three month average, the rolling average. And this is that rates of change that Kim Clark and Alan Bullio are always talking about. And then there's the three months over the 12 months rate of change which just shows a different level of visibility to that rate of change. To see are the margins compressing at an accelerating rate or are they growing at an accelerating rate? And the quick version of this is the equipment is accelerating downwards. So we have a accelerating downwards of a 3:12 rate of change at almost negative 12%, meaning we have major compress the equipment. My God, was that my old business? Like when my dad started the business in copiers, they were making a shitload of margin and by the end we were selling it below cost.
[00:11:40] And then the project work is a slight decline rate of change of negative 5.5 and the reoccurring service has an expanding margin of 4%. Okay, I just want to give you that quick little overview and then I'm going to kind of jump back for a second. Talk about, okay, how do I want to look at this data?
[00:11:57] Because I'm hoping that as I explained to you what I like to look for, you can resonate with it and then you can start to think about how do you get the data.
[00:12:05] So before I Break down the different product and service lines and the stories that those different service lines are telling us is the only way we can be confident.
[00:12:17] In the data that I'm looking at right here, which is the gross profit and gross margin chart, is if we are measuring our gross profit and margin in a way we believe.
[00:12:30] Here are the things that can go wrong where we don't believe the gross margin because that is like it's such an important data point and a KPI we want to maintain as inflation comes, as we've got supply chain issues, I mean, there's a lot going on and there's going to continue to be a lot going on. So the gross margins, those percentages, we believe those. If we believe the costs that are matching the revenue. So I'm gonna give a couple examples from my old business. And I have a ton of clients that I'm working with where we have had to clean this up because I got a professional services company right now that I'm working with where the last 18 months, lots of cleanup. They had no idea what the gross margins are because we did not have the costs matching the revenue.
[00:13:19] My old industry. So I'll give you an example. On the equipment side, the equipment had.
[00:13:26] We had to have all of the. Well, I'm sorry, there was equipment which is selling the copiers. There was service, which is the actual service contracts, and then there was IT services. So the question is, well, in order to dissect and understand the margins of each of those product and service lines, what costs are necessary to deliver that product and service?
[00:13:47] I. It sounds so simple. You would think it sounds so simple. However, it is a sob to get the actual data onto the income statement in a meaningful way that matches the revenue in that month. What I mean by that is whatever it costs to deliver that product or service, you need to account for.
[00:14:09] So in the copier world, the technicians, we had like 24 technicians and the cars, the insurance, the people, meaning the payroll, all of that stuff was actually in the cost. So that way, if I, for example, made $100,000 that month on a, on a service contract, I would have.
[00:14:32] I'm sorry, not a contract. Because that's a different way of analyzing which as a good note, you can analyze per client or per contract. Often in your ERP system like ours was e Automate or it could be netsuite or Oracle or SAP.
[00:14:44] I'm looking at in the revenue and the. Or in the income statement, the revenue against the cost of goods. So we can see the gross profit and the gross margins. So I had to have all of those people, those cars and everything in my cost of goods.
[00:15:01] And then that had to reconcile against and connect to the revenue. That's called the matching principle in accounting. So that way I know that if it's, for example, right here we've got, let's say we were shooting for 40% gross margins that if it's a hundred thousand dollars in revenue that month, we have 40,000 or $60,000 of cost of goods.
[00:15:21] And the IT services was. So it was completely different, but it was the same. We had it all in the same business, but we had to have the right data because in the IT services world the payroll and all of the people for the IT10 IT engineers was inside of SGA which is also called overhead or opex.
[00:15:40] And we would then take the time spent in the time tracking system would bill against the revenue contracts. So there's two different ways of measuring gross margins.
[00:15:53] You have to understand your industry standard.
[00:15:57] What's important for you to understand for yourself, like what are your preferences. So we can believe that 40% gross margin. So then we can start to get to the point where we can make choices around do we do more or less of a product or service and do we increase or decrease our pricing? We won't know until we have real information.
[00:16:17] Couple other gotchas are revenue recognition.
[00:16:21] So making sure that if you are a construction company and you or any kind of any kind of service where you have a project, let's say it's a hundred thousand dollar project and it takes four months, you would have percent complete or milestone billing where let's say it's perfectly even over four months. It would, you would recognize 25 grand a month, every month for four months. And you would then recognize the percent complete or the progress of your expenses against that project every month against that 25 grand. So you would have revenue and your cost of goods matching that every single month.
[00:17:03] Which is completely different potentially than the cash flow of like you got half of the deposit up front and then maybe you're buying and selling different parts of the project or whether it's, I mean payroll could be inventory that comes and goes and that's why it's a balance. Those are balance sheets, sheet adjustments.
[00:17:23] If you're already, if your ears are bleeding, I'm sorry, like I learned all this because I just wanted to know where are we making money? What should we do more of? So this is just so important because in order to make a big huge decision, we want to have Correct data. So revenue recognition, milestone or progress billing to help us with revenue recognition.
[00:17:46] We cannot be on cash basis. Like, if you're on cash basis, I'll quote Pat, it's a lemonade stand. And I've got a client where, I mean, like, it's a $20 million lemonade stand. They make a lot of money. But, like, you can't. We can't see any of the operations on cash basis because we want to understand operationally how are we doing with our products and services every month. So accrual basis allows us to actually spread that revenue and that cost of goods to match every single month. So we can look at a chart like this to go, hey, in December, what'd we do? We did 38% gross margins, and we had. What do we got here for the. And gross profit we had, call it almost 500 grand.
[00:18:31] How are we supposed to know that if we don't believe the data? So then there's the whole. I mean, we had a. I have a client who's probably listening in.
[00:18:40] We had negative gross margins because we had revenue recognition problems. They had to go out and buy like $150,000 net suite module to do that. And then you have to adjust business processes internally. All of that to be said, it's so freaking worth going through the effort. So we can look at a chart like this and be like, I believe it. I might not like the picture, but I believe the data that I am seeing, which is I see our gross profit, the dollar amount, and I see our gross margins, and I believe it. And this is just at the blended level at the whole company.
[00:19:12] And then if we believe the data, then we can say, okay, well, what does that blend consist of? So you can see here now where we are looking at the gross margin by line of business.
[00:19:31] This is very important to then go one layer deeper to say, if we have a multiple lines of business, business, what is the gross margin per product and service line? In this example, we have equipment, project work, reoccurring service one, reoccurring service two, and consumable. So there are five lines of business that have wildly different gross margins.
[00:19:58] Strategic planning is where we would figure out where and what should we do more of or less of. And I'm just going to keep using my old business as an example. Not to say that this is exactly how my. My old story in history went, but you're going to get a story from it.
[00:20:13] So you can see here, once we double click, there we go. Okay, well, the equipment used to be 60%.
[00:20:20] Oh, we got all zeros here on the.
[00:20:23] On the dates. I'm going to show you the Claude here thing. This is going to be so cool. Okay, but first I'm going to show you that we got 60% gross margins way back at the. At the start, which is actually 2023. And it's been eroding over time to the point where now we are sitting at, like, 35% gross margins. And so I'm actually, if you're. If you're checking this out, I'm gonna. I'm gonna pull up Claude to show you how freaking awesome this is. So, Claude, we have no real dates on the gross margin by product line graph on the COO charts tab. Can you help me, please? All right, so while that's doing its work, what we're trying to do is say, okay, well, the equipment is going from 60% down to about 35%. Well, that's not good. Right?
[00:21:18] Well, if we look here at the orange and the green lines, those are the different reoccurring services. So I am trying to show that the IT services were high gross margin. We had gross. We had managed print services, and they were going from roughly 40% as we were, you know, figuring things out to the point where we're now closer to 55 to 60% gross margins. And that's the course over 2023, all the way down to 2026.
[00:21:47] And so the trend is. It's going up.
[00:21:51] Oh, wow. It did not fix it.
[00:21:55] We're gonna back out of that. All right, well, failure on cloud here for a second, that didn't work.
[00:22:03] I wanted the dates of the bottom axis.
[00:22:10] And so the services are going up because we're getting more efficient. And then what we can see is there's a lumpy project work where there could be intentional choices of when and how to pick up projects at certain margins based on utilization of, like, when a company or like, when your team might be, you know, less busy and you're willing to take on certain jobs. And so you're trying to figure out how to balance all these things. Because if, at the end of the day, if you, as the owner, want 40, 50 grand a month and free cash flow after working capital debt and taxes, the ideal way to figure that out is to manage your revenue forecast within your gross profit and gross margins. So that way you have the ability to have predictable cash flow. That's the whole point. The more sustainable, predictable, transferable your cash flow is, the more the company's worth and the more you can have sustainable distributions.
[00:23:02] So what we're looking at, this gross margin by product line is a lot of different stories that we're telling here. And a couple other stories that I think my, my group found useful this week on our call was, I mean the equipment, I mean we lost a job or a very large school where they sold the project at 300 grand below our cost.
[00:23:25] And I was like, holy what. Like screw this business. Well, when you have management services at 55% more margin like you can, you can, you could argue it's the whole razor, razor blade. And but our, like what I found out is our competitor, they were paying cash with order discounts. We did not have the cash to do that. So they're getting 5% discounts with cash with order. They had rebates from the manufacturer. So they were able to, that was probably their cost.
[00:23:53] They were able to do that and then pick up the 60 month service contracts.
[00:23:59] And if you're adding IT services or document management on top of that, you want to get that foot in the door. You could do that for any different. Like you know, the, a whole lost leader product service line. I mean, you know, so many people like well let's get rid of this line of business. Well, it's like, well we had 3,000 customers. Like that's a great client base to sell other things into.
[00:24:20] And you go, what else should we sell to them? Well that's where you know, strategic planning comes into play of like at services or document management. Like we, when we had the Minnesota Wild, like we bundled in all these products and services on a 60 month contract with bank financing, with equipment services, you know, all these different things, which is very sustainable.
[00:24:42] This just gives us a lens to say okay, what is going on? What do we like? What do we not like? What are our customers buying and what do they want from us?
[00:24:52] When I go to one more double click in, let's see here.
[00:24:59] All right, so I, I got that fixed. So we got the dates down here and the gross margin by product and service line. And what you can see here is I'm, I'm going to go back up over to the individual ones. But you can see then as we in 2026 and I'm going to actually pull up the budget, the three statement budget and show you how we start to make intentional decisions about where we're going to spend our time and effort. But you can see here that we're focusing in on now there's a couple different colors because I reformatted it with Claude. But the, we're trending up with the service. We're going to manage the decline of the equipment, but we still need it because we need that. Our customers need the equipment based on our strategic plan. And then we're managing the pro, the projects within a, within a range of margins that we want to keep. And now we go over to the individual breakdowns and what I'm showing here is there's this threshold that, and I'll, I'm actually going to pull this over so you can see this because this is where we start to make some really cool decisions on. Okay, now I'm not going to do that. Okay. So bear with me here. So I've got the, we got the equipment. What we're showing here is that you can see the equipment decline. So equipment is going from 60% down to around 35%. And I've got, I've got these guidelines of these two different bar charts that go from the left to the right along with the chart. And what we have is the ability to see what the target and the floor is for equipment. So we have a target of 42%, but the floor is 38%. So we are currently below the floor because what we can see is we can see the trend dropping below that 38 because we are currently at 35%. So the question is like, okay, we're now having this trigger and like we, we should have a conversation in our board meeting, like what's going on here? Like is this maintaining or like are we accelerating this decline? And, and based on the rates of change over the three months, we have a slight pick back up. So we are 0.5%. So we're kind of coming out of that dip. But over the last 12 months we're still down as a rate of change of almost 12%.
[00:27:18] I'm not coming to any conclusions here. What I'm trying to show is that there's conversations to be had and your, your business and your boardroom conversations and the CEO and the COO should be having conversations around what are we going to be doing with this and what, like, what is the long term viability? Well, if we need that equipment to then sell the reoccurring services that are going up.
[00:27:40] That's a logical, logical conclusion. So we can see in the reoccurring services. So what if you're listening in, we go from the left, which is January 23rd, to the right, which is April 26th. That's all of the current state. And we have a trend upwards to the Right. So we go from around 43. I'm sorry, 38%, something like that. What do we got here? And all the way up to around that 58% going up back up to the top left. So the reoccurring service is. Yeah, the around 55%.
[00:28:09] And our target is 52 and our floor is 45. So we're above and we're growing and it's accelerating in growth.
[00:28:16] And then the project work and the consumables both have guidelines too for the floor and the, the target cool part is for project work too. This allows us to, you know, when I think about like the decisions that could be made after this, if we have like a slow summer month and we have the fixed cost of the payroll, like, let's get these people to work. And the, the, the KPIs I would be looking at is utilization of the, you know, there's utilization of how busy are they? So you'd be looking at different people's time tracking, say, okay, what have they been doing and are they busy? And then one of my clients has got a great metric that I like, which is billing efficiency, which is payroll by it based on billable hours. So what's the ratio of billable hours based on payroll?
[00:29:01] But that's different than utilization because in utilization the question is like, what are they doing?
[00:29:05] And so I say all that because the answers that we're looking for is like, hey, if we're slow in the summer months, maybe we can deploy our team and take a lower bid job. But we're, it's better than nothing.
[00:29:18] So we start to have just way better discussions around should we increase prices, which we know have are tough conversations with our customers, should we keep product or service lines. That's where strategic planning comes into play because we need to understand how we're driving the revenue of the business.
[00:29:39] And then looking at the margins, because when I think about the conversations that we had last week with Alex at the group workshop, if inflation's coming, which I mean, payroll is going to be, it's got a leg effect of like 18 months from some of the supply chain stuff that's coming. But like diesel, I mean, there's a lot of other different supply chains that are going to be hit. Your customers could be potentially hit. There's all these different ramifications. And even outside of that, I was telling you my story about my business that was 15 years ago, like these are best practices to make good decisions regardless of what's going on. Because maintaining your margins allow you to then, I mean, have consistent distributions and build a valuable business that you can prove.
[00:30:26] So there's a lot of different ways to start slicing and dicing this data if you have accurate information.
[00:30:32] And now what I'm going to do is I'm going to go over to the on track year to date tab, which what I'm showing here is, I mean this is some of the best in class ways of looking at your financial information.
[00:30:47] And because we have the three statements all tied together.
[00:30:52] But when you're just looking at numbers, it's very difficult to see that story even if you have all financial, all three statements tied together. But what we have here on our income statement is all of our revenue lines broken out. You can see year to date versus actual and then you can see year to date versus budget. Because those are two ways that I would like to look at the information. Said, okay, what do we do? Well, equipment sales, this, this April is 750 grand versus last April, which is 708. So the difference is 41,000 bucks.
[00:31:28] So if we're just looking at the growth of the revenue, we're like, oh, that's good.
[00:31:33] But as you, you and I just talked about, we have declining margins and accelerating declining margins and equipment sales. And so if we looked at this year versus last year, we're up by 5.9%.
[00:31:47] But according to the budget that we built out, the budget was 891.
[00:31:53] The actual was 740. So we're $141,000 short, which is 15.9% off.
[00:32:00] And what I have here in column M is like I have the ability to look at last year versus this year, this year versus budget. And then I want to look at what's the, what's the total budget for the year and then what's the gap to, to bridge my target and then how much do I need per month to catch back up.
[00:32:19] So we're able to look at this by breaking out our revenue lines and matching them with the cost of goods lines. You can see here we got the cost of goods tied to each of those so that again, they're matching it so we can see those gross margins. And what that allows us to do over here, which I love this, and I'm going to walk it, walk you through that if you're listening in is we have this analysis to say, okay, based on what we have done so far, how much of the gross profit is a result of increased or decreased revenue or increase or decrease of profit. Because everything can get all blurred together. Say, yeah, we're up, or yeah, we're down. It's like, no. So here's my analysis. So if I look at the first box this year versus last year. So April of 2025, we year to date. So this is April. So the first four months, we had done 2.6 million bucks. And this year, April year to date for revenue, we've done $3.3 million. So we're up about 670 grand.
[00:33:25] And the gross margins last year were 35.6.
[00:33:29] This year it's 30, 36. So we're up, gross margin wise, 0.4.
[00:33:35] The gross profit dollar amounts went from $948,000 to $1.1 million. So we're up a quarter million dollars in gross profit.
[00:33:46] So back to the story. Yay. If we look at that like, yay. Well, okay, that's year to date versus last year, and that's blended. And we already talked about the accelerating trend downwards of equipment.
[00:34:00] Like, we need to be able to see those things that I just said. And. And we just walked through in order to not just blindly be excited about this year compared to last year, which is just so stupid when we think about it. And then the. The next box down.
[00:34:16] Oh, I'm sorry. Before I go down, before I keep going. So when I Look at that 250 grand, the question is, what's the change? So the gross profit. Let me say this again. The gross profit is up 250grand year to date compared to last year. So we're at 1.198 million compared to 948,000.
[00:34:38] That's a quarter million bucks. But the reason that 250 grand in gross profit exists is because most of that came from revenue growth, which is 238 grand versus the 11 grand that came from the margin growth because the margins went from 35.6 to 36. So 0.4% gross.
[00:35:01] Gross margin increase.
[00:35:02] I'm sorry if this is blurring all together. And again, go back to Spotify or YouTube if you want to watch the video and. Or plug the transcript into Claude, however you want to engage with this information. This is just so important.
[00:35:15] So what I'm looking at is we sold more shit last this year than last year, and we sold more shit at a slightly higher margin, and it's all blended together that resulted in a $250,000 increase in gross profit dollar amounts.
[00:35:32] But what I now know because of the previous few tabs is we're still declining in equipment, and we had other Product and service lines, the reoccurring service lines that picked that up and picked that slack up. So we better do more of all of this. And our sales compensation plan should be aligned towards our goals. This should be something that is expected because our strategic plan expected this.
[00:35:55] And if any of this caught us off guard, we have to figure how to pivot in our quarterly meeting to figure out what are we gonna do about this.
[00:36:02] A different way to then look at that same information year to date. So here we are. We're looking at April's numbers, and I want to look at year to date versus the budget that I put into place for 26.
[00:36:15] So the budget is a three statement budget for all three statements that was done in December. And we're going on track or off track for all three statements.
[00:36:26] And we just got done with our April book, so now we're looking at. Okay, well, our budget was $3 million for year to date for total revenue. The actual was 3.3.
[00:36:41] So we have 246 grand more in revenue than we anticipated.
[00:36:47] However, our gross margins that we anticipated and our budget was 37.5 and our gross margins actual was 36%. So we're down 1.6% in gross margin. And remember, this is the blended of all five product lines, which is why we have to separate those. Because the, the first question you would probably have is like, well, why are we down? And what was down? Those are the perfect questions.
[00:37:17] So then the, the gross profit total.
[00:37:21] So 3.086 at 37.5, which is the budget. Our budget for gross profit was 1.15, and our actual was 1.198 million.
[00:37:34] So we actually are up 39%, 39 grand in gross profit, but we're down 1.6 in a, in a compressed gross margin. So we thought we were going to hit 37.5% gross margins, but we're actually only at 36.
[00:37:53] Well, the question would be, is like, well, why are we up 39 grand in gross profit? Then we sold more at lower margins, and so we beat the revenue by 92 grand.
[00:38:08] But then we had margin compression and lost 52 grand, which resulted in the $39,000 gross profit.
[00:38:17] I am hoping that you're, you're tracking because this is like, if I wish I would had this data 15 years ago. And I know my clients have this. And it is so fun because it is an absolute bitch to get the actual information. I mean, I, I am not belittling how much misery it can get to accrual based financials. Get your revenue recognition and all your processes to make sure your cost of goods matches your revenue. It sucks.
[00:38:47] It's change management, it's people, it's systems, it's processes. But like we can't do this if we don't have the correct information.
[00:38:57] Then we can start going how well we do to compare to last year? How will we, how well did we do compared to the budget?
[00:39:04] How much was resulting from revenue growth versus or revenue decrease or margin expansion versus Margaret margin compression. And then I'm going to go back to the other tab, say okay great.
[00:39:15] Then we start double clicking and going okay. We start looking at charts and this is where, that's why I started here going okay, well what's the visuals of the gross profit versus gross margin then by the lines of business and then our targets based on floor based on targets we start to just double click in a bunch of different ways so we can stay on track. And what I'm going to show here, so this is the again I'm, I'm back to the on track year to date tab. I was just showing the income statement with those little boxes next to it. But I'm gonna go all the way down where we can look at the normalized EBITDA as adjusted last year versus this year and this year versus budget. We're down, we're down 85 grand in our adjusted EBITDA even though we sold more stuff.
[00:40:03] So we're up 300 grand in revenue, but we're down 85 grand in revenue, normalized EBITDA.
[00:40:09] And we're actually, I'm going to keep going through the balance sheet and then it's connected to the cash flow statement.
[00:40:15] So we can then look at then how does the change in sales impact our accounts receivable, inventory and payable. So that's why I've got those highlighted here.
[00:40:27] And then we have the ability to go all the way down. Cash flow provided by operating activities and this line 180 here. The cash flow provided by operant activities is the CEO's metric because the CEO should be responsible for revenue, gross margins and normalized EBITDA and working capital. This should be the CEO's target.
[00:40:47] So we can see how well we are doing there and we are actually ahead.
[00:40:55] This is why understanding how to read these financials is so important because like to go back to what I've said, we're ahead on revenue, we have margin compression, we have more gross profit. But where's it come from? Well we had some product Service lines that picked up for the decline in the equipment. And we have more cash flow from operating activities because we could probably go through and I'm not going to do it on the call here. Whether it's things tied to payables, receivables, inventory, different normalized events, we have a higher net income. So we get all these numbers are different ways of looking at the truth to understand the story of what's going on with your margins and what are you going to do about it?
[00:41:34] I go all the way down here. These are my favorite lines.
[00:41:37] Do we have the ability to estimate and look at our taxes? So we have the ability to look what are the taxes that we should have been paying and our estimated taxes and can we take our distributions?
[00:41:51] So last year, so last year we took out 103 grand so far and this year we've got a hundred grand so far and we have been accumulating cash. So we actually have a higher amount of cash than we thought. So we budgeted for 268 grand, but we actually have 560 grand.
[00:42:08] So think about that. We have reduced our margin because of margin compression. We sold more stuff.
[00:42:14] We have higher cash flow from operating activities, resulted in more cash. Question is, do you take a larger distribution or do you feel like you want to reinvest that money back into figuring out how to overcome the margin compression or double down on the product and service line that's growing?
[00:42:33] That's totally a, a judgment call for owners. Not the, not the CEO but the owner because that will impact the five year plan and the. How fast can you get? Not how fast, but. Well, yeah, how fast can you get to your goal? What's your confidence level that you get that you're going to get to your goal?
[00:42:53] And the way we do that is through this five year forecast you can see here.
[00:42:59] So we're able to then take that budget and then expand that out so you can then have a five year budget. And I'm actually going to quickly show this. When I say five year budget, well, it's like, well, what are we going to do? And actually if you're listening in or if you, if you can see this, I keep saying that, sorry, whatever it is, you, you know, you know what to do now we want to make decisions based on the things that we were just seeing. So if for equipment, what I'm showing over the next five years is that we're going to flatline, that we're not going to grow too much in that and it's okay if we actually decline, what we're going to do is we're going to focus on maintaining the project work in the right season and to overcome some of that seasonality and we're going to double down on one of the services. So in this example here, I was showing that we actually buy a company in year 2028 because it's good margins. And so we can then strategize around what we're going to do with the service and product lines over the next five years.
[00:44:07] And what that allows us to see over the next five years is that our gross margins go from that 34, 35% up to 45% over the next five years because of that acquisition and because we quit focusing on equipment and because we drove the sales compensation plans towards the higher gross margin work, because that was part of our strategic plan.
[00:44:33] And we can then see, I'm gonna go all the way down to our distributions over the next five years. We can see our taxes over the next five years and we go from a negative cash balance in 2027, which that essentially just means that we've tapped our line of credit and we accumulate around 2.9 million bucks by the end of 2031.
[00:44:54] And we can springboard that all the way off to the valuation target, which is 20 right here, I've got it on 2030. We could put it to 2031 if we wanted to. But this include because we've got the whole budget tied to the five year tied to the valuation, we can see that in 2030 we've got a $3 million normalized EBITDA as a mid range multiple we've got 5.
[00:45:19] So in the, on the spreadsheet we've got a 4 or 5 and a 6 range of multiples. On 3 million bucks, that gives us an enterprise value range of 12.2 to $18 million. It's got all of our debt included because it's all of the financials tied together.
[00:45:36] And then we've got a cash accumulation. So our equity value goes from $13 million to 19. Because when we sell a company, it is cash free, debt free, with a normalized level of working capital.
[00:45:49] This doesn't mean we have to sell the business or want to sell the business. This says, what are the decisions today and how are they going to impact my long term valuation? Because if you start sucking cash out of the company and can't actually achieve your growth targets, the valuation will have to be adjusted.
[00:46:10] We can take that equity value and make some assumptions on net proceeds. So net Proceeds would go from 8.6 to, to a $12 million. That's the range based on the 4 to a 6. If we applied the 35% tax. And again, asset versus stock sale, that's a big question. There's a lot of questions around here. So there's just some assumptions for planning.
[00:46:31] So we have in the mid multiple range. So I'm just going to go through this again. $3 million roughly for the normalized EBITDA times of five puts us at around 15 million bucks. We have around 1.125 in debt.
[00:46:47] 2.1 in cash leaves us at $16.3 million in equity valuation with a 30% tax.
[00:46:56] We have $10.6 million net proceeds. If our desired target was 10 million bucks, we have a surplus of 600 grand.
[00:47:05] Based on a range, based on a range of planning.
[00:47:10] The big huge caveat I'm going to add to this is we have to, I, I, my, my best practice is I was just, I just did this twice over this last week is I like to plan around 60 cash at closing because that will help us with, you know, you could do an esop, a private equity sale, internal transfer. I mean you could do some serious like higher probability planning, around 60% cash at closing.
[00:47:34] Well that means that we're not getting financially free cash at closing. So there's a whole nother session we'll have to do at some point on the deal structures.
[00:47:45] My takeaway for everybody is your net proceeds cash at closing should hit your financial targets. Otherwise you're going to have that contingency be tied to someone else being your boss.
[00:47:59] And the whole point of all this is we can go back to the COO monthly charts and be like, okay, what's going on with the gross margins?
[00:48:12] What are we selling more of or less of? And what are the margins trending? Well, the, the equipment's trending downwards, the services are trending upwards. How does that reconcile with our strategic plan? How does that reconcile with our sales compensation plan? Who are like our sales reps? What are they selling more of and less of? And why? And then how does that tie into our budget? On track, off track? For me as the owner, I would want to know how does it impact my ability to take my distributions? How does that impact our ability to hit our long term goal for the next five years? And do we need to change our five year plan based on the things that we're seeing? Do we need to go back and update our strategic plan because we want to do less equipment and we Want to do more services so we can maintain and hold the margins from 35 to 45% and increase them.
[00:49:07] Another thing, other things that this can help me decide is like, hey, if inflation's really hitting and I want to increase my salaries of all my people by 10%, I could go in here and I could see the salary and wage growth. I could plug in 10%.
[00:49:23] And I know the back of the napkin math. I would still have enough cash.
[00:49:28] And if I did that, it would increase my confidence that I would hit my goals. So we're just like literally just pulling these levers to see how do we increase the ability that we're gonna hit our goals. So in this five year forecast, we think we're gonna have around 3 million bucks in cash.
[00:49:43] Question is, do we believe that?
[00:49:46] And if we don't, we need to go back and start toggling these levers. Well, we want to increase the gross margin. So how do we do that? We need to analyze our customer base. We need to analyze our product and service base. We need to maybe, you know, look at our cost structure. There's just all these questions that I am confident that you know how to answer.
[00:50:05] If you had the data. Well, I shouldn't even say know how to answer it. I'm confident you have the right questions. I think the answers is what we're looking for. And then what you do about it is a whole series of questions. That takes planning, takes collaboration, takes, you know, a lot of, a lot of thought if you're still paying attention.
[00:50:25] Congratulations, you have a peer inside of my brain. My point behind this, and I'm moving this over, is I really hope that we can empower you by getting you data.
[00:50:41] We gotta know what you want, like what are your owner's goals? Your owner's goals have to be the constraints.
[00:50:49] The owner's goals are your constraints. Your cash flow goals and your valuation goals are the constraints. Then we need to understand what levers you need to pull in the operations and what the just trade offs are of all this stuff. And then that can allow you to then stay on track or off track and have quarterly board meetings to say, okay, what's going on and making sure that you've got your owner's hat on in the board meeting. If you're the CEO, put your CEO's hat on, looking at the income statement, KPIs, and then the working capital. And then if you're any of those other executives from the CRO, COO and CFO, you can put those hats on look at the KPIs and then start asking yourself, what are we doing? Where have we come from? Where are we at, where are we going? And what are the trade offs to stay on track or off track?
[00:51:35] Because you know, at the end of the day, if it results in you having to analyze your customers and do a price increase of 10%, you know, the trade offs, like if we don't do this, then I have a risk. I mean, like we don't want to be in the nonprofit business.
[00:51:51] You can flip to a 5o C3 if you want. But this is about maintaining your margins, building a healthy culture, building a healthy company and finding the right products and services with the right customers that value you because you're delivering value.
[00:52:04] I hope everybody enjoyed this. If you are interested, go to the website.
[00:52:09] We are kicking off a June boardroom blueprint. So it's a 90 day program where we actually build out a financial model. You get a business valuation, you have the ability to. So I got it up here on the screen here. We'll get an owner's plan three statement model, five year forecast owner's valuation and it's 7,500 bucks. It's going up to ten grand later on this year. So kind of just. That's not some marketing gimmick. It's just because we're trying to continue to get the ball rolling. We've had a bunch of people signing up and it's fun watching this go. And month one, we're going through ownership goals. Month two, it's understanding valuations. Month three, you're installing the operating system and all the while you're having our team build out the model and the valuation.
[00:52:54] And you're, you're really roughly expecting two hours, three hours a week. It's asynchronous because you're gonna be able to actually go through and you can see here you can get into the learning management system where you're diving into multiples, normalize, EBITDA, all this stuff. Each video is around 15, 20 minutes. It's me going through a bunch of videos.
[00:53:19] I don't know why it's not loaded. A bunch of drawings. So that way you understand all this stuff. And every single Monday we've got open office hours and Tuesday we've got trainings.
[00:53:30] Go to ryantansom.com check it out. It's on the coaching tab. And I hope you enjoyed this. You got any questions? Drop a comment on YouTube. If you are looking for any additional information that I can help you with. Talk to you later.
[00:53:46] Foreign.
[00:53:52] This episode is brought to you by Castos Productions.
