Episode Transcript
[00:00:00] Speaker A: 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.
What up?
[00:00:16] Speaker B: How's it going?
[00:00:18] Speaker A: We are going to be diving into the five year forecast and then the valuation target.
This is milestone number 12 in module four.
And I thought, Kim, we should start with what your thought process is of why a five year forecast is important and then I will wrap it together with the IBD point of it as well. But you have spent so many years talking about forecasting, so why do you think forecasting is important and what does it mean?
[00:00:53] Speaker B: Sure, I'm trying to think of the best way to word it. You are not going to achieve your goal if you don't set a goal, I guess is the way that I look at it, and that's why forecasting to me is so important, is that you need to know where you're headed. So that way, I mean, it's kind of like when I'm driving, I'm looking further down the road, I'm not looking directly in front of me. I want to know what corners are coming up and what traffic is going on and so on and so forth. So a forecast to me is just like that. It's from a business perspective, you're driving your business vehicle and you're looking further on down the road to know where you're headed. Does that align with your goals? And if not, maybe you take that off ramp and you hop on to a different road to get there faster or something. Right. So it's just, it helps give you the tools you need to build the roadmap to achieve where it is you want to go.
[00:01:41] Speaker A: How do you differentiate what you're thinking about as a front forecast compared to someone that's listening in and has a vto, you know, from the EOS scorecard. And like I want to be 40
[00:01:55] Speaker B: million, it has to be grounded in reality.
[00:01:59] Speaker A: So what does that mean? How, how would you differentiate, like goals compared to a forecast?
[00:02:05] Speaker B: A forecast is based on data, not desire.
It's the way that I would look at it in very simple terms is that it's based on inputs that generates an outcome that you may or may not appreciate.
But at least it sets the reality bar so that way you can change the inputs and see what you need to change in order to eventually try to get closer to the desire.
[00:02:29] Speaker A: Love it.
Love it. How do you. Any thoughts about how to frame up the question So I don't just start word vomiting.
[00:02:38] Speaker B: Well, you have. Well in IBD there is a very step process and we've talked before about top down, bottom up approaches, we've talked about the financial model and how that helps you see outwards. So I would say like, I would just start with where the module start or the milestone starts. Right. What is the first step to building out a forecast? I have ideas in my head, but curious, yours. What do you see as the first step?
[00:03:10] Speaker A: The valuation target at a point in time in the future which is typically five years old.
So when we have a goal like you know, like the 30, 40 million or whatever revenue number puts, you know, people put on there, what I'm trying to think about, how to formulate my thoughts, Kim, and I want your help because you and I have been deep into AI, deep into the financial model, how IBDS modules tie into the financials. And you know, they're like when I think about a five year target.
So it's, you know, the milestone is called the five year forecast evaluation gap. I mean like what is the actual target in five years?
And that's that destination that you were talking about.
But what I think most people miss, which this milestone is trying to accomplish, is what specifically is it?
[00:04:04] Speaker B: Right?
[00:04:05] Speaker A: Like there, there's an actual mathematical outcome that we're driving towards, not subjectivity. We're not, we're not trying to be subjective of like where are you going? Like, it's like specifically what does the income statement, the balance sheet and the cash flow statement look like in five years?
Because that actually will, that, that's the only way, Kim, we can see what will the growth rates be or need to be over the next five years. Are we going to grow too fast so we eat up all of our cash and we go broke?
How does that growth impact the owner's distributions?
Working capital, our need for debt, our need for capital reinvestment?
We actually can't see any of those answers unless we have the three dimensional target.
And I call it three dimensional because one dimensional is the revenue, two dimensional is some variation of profit. But we need to actually see all three financial statements in five years.
Otherwise we cannot see our constraints of cash flow and growth and how we're actually going to grow.
And then when we see that, then we can see our trade offs. So to your point, like do we cut over here and then do we go a different route and go faster? Do we change our product mix and our revenue mix? Do we change our margin mix? Do we change our people like we don't know any of those answers unless we can see in the five year forecast, like what that's going to be and what I'm going to even double click on that even one more time.
It's not just the one valuation of all three statements. We want to actually see all three statements. So that's the way we actually see total clarity is all three financial statements in the future.
But most people will say, well, we just want to look at the normalized EBITDA and the multiple.
Well, normalized EBITDA is not like. And there's a lot of different ways we can or rabbit holes. My mind's going, but normalized EBITDA and a multiple is a valuation metric. That's lens number two. But there are three ways to think about evaluation. Three lenses that we have in module two, which is the discounted cash flow, which is actual cash flow, like real money, and then the risk of that cash flow called the dcf.
Normalized EBITDA does not take into consideration debt or taxes or any of that shit. So I've got clients where if we don't sell this business, there is no plan B because they're looking at Lens 2 with the normalized E, but then the multiple and it's like, well, you can have 2 million, $3 million in normalized E but not a pot to piss in for cash.
So there's no plan B. You can't go, I'm just going to wait a couple years.
And then the third lens is the transaction value, which is if you were to sell this with the market value, normally I save it to multiple 60% cash at closing net debt. Keep your cash, keep your cash, pay off the debt. What does that all mean to you? In five years, that's where it's the scorecard.
Then the Lens 2 builds on top of that and we want to be able to clearly articulate all that stuff, otherwise we're just totally guessing.
And so yeah, go for it.
[00:07:24] Speaker B: No, that's right. I was going to add to it that for those listening in, I think one of the aha moments that I had when you and I first started talking about this going back to desire, gut, all of that versus fact is that everything that you just talked about is achievable and it is off of actual data. It is not the I wrote down on my VTO that I want to be at 40 million.
Like everything that you just talked about in the three statement model allows you to make those informed decisions off of actual data. Your business norms, business Performance averages.
So like your user journey conversions, all the things like, it's grounded in data. It's not just a. I'm going to pick a number and then I'm going to manipulate the rest of the data to getting me there.
[00:08:12] Speaker A: I would agree with that.
But I think we want to bifurcate two parts of this milestone, which is one is the actual valuation and the three financial models, or not three mentioned models, three statements. We want to see the whole picture of the company in five years.
And then there's the three lenses of value that we can think about. The discounted cash flow, the market multiple and then the transaction value of the deal structure. What would that look like in year five? That becomes the peg.
And then in between there is a infinite amount of choices of how to get there.
And I think that's where it's really important because then we're starting to reconcile the choices against someone's goals. So for example, let's, I'm just gonna make these numbers up, but let's say we have a $10 million company, we want to get to 40 million in year five. It's like, okay, well if the person says, I need a half a million dollars in distributions and I don't want to work anymore, it's like, okay, well how are we going to grow there? Well, let's say the, you know, the company's margins on one of their product lines, that's the main product line is 10%. You start to kind of like back into. And you're like, okay, does that mean you can't do that? No, but what it means is like, well, you might have to divert your product mix, might have to acquire a company.
All of that's going to bump into that cash flow need. Like you're not going to be able to pull a half a million dollars in distributions out while growing that fast.
So then that's why it's like this trade off of cash flow in time now or wealth tomorrow. Because we could, I like 100% believe that we could probably create.
We could not only go from 10 to 40 million, but we could probably triple the value of the company. Question is, how much debt do you have and how does that impact your time and your cash flow goals?
I don't give a shit whether you do that or not. But it's like the whole Willy Wonka gal. It's like, I want it now, I want all of it now. It's like, well, that's not how it works. And to your point about the data, we can Just have a mathematical connection between today that point A and that point B to C.
What is it going to require for a level of effort to get there? And the effort is quantified in time, cash flow and wealth. And how does that impact your goals? So I really do believe anything's possible.
It just matters like what does that journey mean to what you want.
[00:10:39] Speaker B: I like that a lot. And actually what just to pull out some and highlight something that you said the in order to reach said goal, if it is like we'll say 10 million to 40 million, say that's a BHAG kind of a goal, you have to do something different. You can't continue to do everything the same way that you've been doing it, expecting it to change the results somehow. And I think that's a key piece that I've seen a handful, I won't say a lot, but a handful of business owners that say well I want to grow by X amount over the next five years. And it's something like a four totally ridiculous ibhag. And the question always was okay, great, what are you going to do differently that you're. That's going to change your. Because right now your results are X, Y and Z and the data is suggesting you're only going to be at 20 million five years from now. And so to your point, often it does require some sort of cash investment. So that way they can acquisitions.
[00:11:34] Speaker A: You're just doing something differently to your point. And like and I'll even give most people credit to say like most of us don't know how we're going to get there. That's the work that we want to do. We got Claude, we got the IBD material between advisors and peer groups and Claude and material like we can figure out the spectrum of house.
I think what, what's what differentiates our community and the owners that we're working with with other people is like I don't like hearing I want to do something more than a couple times.
Just what do you, what do you like moving forward every day? Like we're gonna just do yeah or
[00:12:15] Speaker B: get off the pot.
[00:12:15] Speaker A: Like I like that's fine. Like. And we don't if we don't know how that's. That's what we're on the, on the journey for. It's the willingness to do things differently, the willingness to shake up the routine. The willingness to have I'll put it this way, the willingness to once the goal is clear and someone. This is what I think is so fun about goal Setting versus like, I mean like the whole financial industrial complex is all like fear based. Like estate planning before you die and like insurance and like, you know, like you're going to like all of this is about like fear.
I like we're going to take the goal and make the goal so exciting that the dopamine pulls you towards the goal instead of fear based. And so what can happen then is the willingness to work really hard and invest your time or forego cash flow today because you can see the line of sight to that plan B. So it's really just the willingness to like do the goal setting, understand the paths that it takes to get there and then actually start working towards the how. Because the how might not be. We're not one. We don't know necessarily which is okay. But we're constantly iterating and tightening up the feedback loop. And the cool part about all of this is with the, with the numbers that we've been walking through with the financial model because it's a closed loop system, because it's math and because it's objective. Like the answers of whether you should do this, that or that it become like it's knowable, you know what I mean? Like this is not like some mystical thing that you have to go like get on the bat phone call to like call someone to get like some magical answer about whether you should or shouldn't do something. It literally is just take your ideas, plot those out in the income statement from revenue, cost of goods, SG&A plug, plug all this stuff in in your balance sheet and cash flow statement. You're like how does this do to me? Or what does this do to me?
[00:14:13] Speaker B: When you were saying all that I was envisioning plug it into Claude and talk to Claude.
[00:14:18] Speaker A: Well let's, let's, yeah but let's, let's double click on that because the.
Claude is going to be like yes you should.
But if Claude doesn't know your goal how. I mean I think that this is what most people are getting wrong with AI like if Claude doesn't know the first principle goals and my first principle, what I mean is it's based in specific physics and math.
Like we have like physics, biology and math. There are just things like the, I mean unless you're colorblind, like the grass is green, right? There's double entry accounting. You throw a bowling ball off a roof, it falls and a bridge either works or doesn't. A rocket either blows up or doesn't. And like that's what I mean by first Principle. And the reassuring thing for me is with the financial model, I don't have to wonder, is it Kim's opinion, Is it Claude's opinion? Is it GPT's opinion, is it Gemini's opinion? It's like, no, like Claude, you know, I'll walk you through it. And this will probably tie into some of the five year forecasting stuff that we want to get into is when I was redoing all of the numbers for advanced solutions in the five year forecast for the financial model. Kim, as I was building it all up for our trainings in the coaching program, I would like to so the story I want to tell.
So okay, I'm going to pause for a second. Is this when I say pause, just like before, I just start rambling. What, what my goal is and you keep me on track is I want to walk through what I did and what level of thinking I was going through with Claude and it could have been an investment banker for I give a shit. But the experience is the same. I was walking through the thought process on the business operations and how it was bumping up against the constraint of the cash flow goes in the valuation. Does that make sense? So this is the level of thinking that we want to do and the reason that Claude and AI can be so powerful is because I don't have to wonder if it's right or not.
Does that make sense before I just start going down a rabbit hole?
[00:16:29] Speaker B: I think so. Because you don't have to wonder if it's right or not because you've already built up the.
The model.
[00:16:36] Speaker A: Yeah. So yeah, okay, good clarification point. I think it's a good liftoff point.
I have the financial model and maybe I should pull it up right now. But let me explain it first and then I'll pull it up and I'll kind of walk through with you and you can kind of see if you're seeing the story in the numbers. So we have five years, so five columns.
Every column is all three statements financially connected together.
And then all five columns are mathematically connected together.
And then the point B is the valuation. That's the pot that pops out of the year five, three statements.
So in the cash flow statement, which is the bottom of the five columns, cash position, so the bank account and the bottom, the bottom cell of all five of those cash flow.
Five of those columns in the cash flow statement.
And then right up from there is the change in cash. But like really close up is the ownership distributions because that's the last thing. And Right above that is tax distributions. And then we have CapEx and we have like. So like we're starting, when I say bottom up it's from, okay Kim, you want 25 grand a month.
Okay, so in Advanced Solutions we have, it's 150 grand in distributions, year one, 150, year two. And then I think it then goes to 2, 75, 400, 540. So there's this ramp up as the company grows that there's more cash for distributions.
But also I have very specific directions for my goals of what we want the net debt to be. So net debt in the valuations is you get to keep your cash and pay off your debt when you sell a company.
So you take the multiple times normalized EBITDA and then keep your cash, pay off your debt.
Well we now understand what the goal is of how much cash and how much debt. So Advanced Solutions goes from $1 million in debt and no cash, effectively year one to a million dollars in debt, year five with 2 million in cash.
So the net debt goes from negative, it's a million in debt to a million in surplus cash over five years.
And the debt changed, it went from some like shitty, like high interest rate debt to more long term conventional SBA loans. So to show like you can have good debt and it'll help with your cash flow. So let me go back. So at the bottom up when I'm saying when I'm working with anybody or Claude or anybody, it's like okay, the goal is 1501-001502-75400, 540.
That's the goal for the cash flow. We now have the net debt and the target valuation. We go from 1.5 and normalized EBITDA to 3 million.
Okay, so we got our, we got our bookends point A and point B, 1.5 to 3 million the net debt. So 1.5 on it was a 4.5 multiple to 3 million at 6.67.
And that we did that through a sustainable, predictable, transferable cash flow implementing the IBD roadmap. So like you're starting to see the puzzle come into clear view.
How do we get there?
[00:20:02] Speaker B: Right?
[00:20:02] Speaker A: That's the question.
Well in Advanced Solutions I built it based off of some loose ideas with my old company.
So we were copying it services and managed print and stuff like that. So I don't care. The story is what's fascinating to me. So we have five revenue lines, equipment, projects, reoccurring service, one, two and then consumables. Well, equipment's declining in margins.
They're copiers.
We were selling them below cost, which is why we're getting into managed IT services, which is why we were doing like. I mean, every single company I've ever worked with has some sort of story like this. This is getting pressure. We're trying to find the blue ocean. We're trying to like SWAT analysis, like, yeah, got it. Everybody's in the same boat. You're trying to figure out where you can make more money.
Understood.
How do we want that makeup to change over time? And this be, this is going to help us into module five with you of like the ideal client profile, the customer journey, all these different things that we're going to unpack with you.
But we had this journey over five years. Well, I started working with Claude, like, how do we do this? What's our forecast? And then it would go just build out a bunch of shit. And I'm like, claude, what the F? We have $3 million less cash in year three. You're right, Ryan, good call.
[00:21:25] Speaker B: Affirmation. Affirmation. Yeah.
[00:21:26] Speaker A: And then, but, but what would happen is it would ignore my point.
I would say, what the F. Claude or GPT or gem, it doesn't matter. Like, remember, this is the financial model and you know, Claude's got the plugin in the financial model too. So like I kept hitting it and I kept looking, I'm like, nope, it's off. Nope, it's off. And I was using cash and the cash flow and the different pegs of the perimeter.
And it took, I don't know, a day or two.
And it was like, we refined the reference revenue targets, the revenue makeup over the, you know, over the couple years, the margins and what we need to do the margin payroll and how like, you know, business development reps versus, like account managers versus, like we like how much we had for the client acquisition cost. Because like we have a framework to say we have to work within this so I get my cash and I get my valuation.
And not once did it. Just remember that and then go with it. I had to keep going back and be like, wrong, wrong, wrong. And like kept spot checking it.
And the first principle constraints of math and double entry accounting and then the closed loop system became that puzzle framework.
And then I just kept having to beat it into submission. Like, you cannot change the distributions, you cannot change the net debt. We're going from 1.5 in EBITDA to 3 million.
Go reference a strategic plan. Go reference all of the all the material that I'm giving you. And like here's the story that we're trying to do. And like we were looking at modifying the different margins, modifying the different sgna. But like in that took lots of iterative work.
Had I gone to Claude and be like I want to do 40 million in revenue, like let's do it.
[00:23:16] Speaker B: Good job.
[00:23:17] Speaker A: And then like, wait a second, I've got 80 million in debt.
[00:23:21] Speaker B: Yeah.
[00:23:23] Speaker A: I'm gonna stop and pause. Like I want your reactions to just that process. I mean, how do you.
Yeah. What are your, what are your thoughts about that?
[00:23:31] Speaker B: I think it's an important part doing all the iterations. I think people are like, the people that are using AI are so seem to be very trusting. Like the people that are all in. Into using it are very trusting. And so I think it's important to understand A, you need your own framework and B, you need to be smart yourself. Like you still need to be the human. It's a good tool, but it's not the brain. And so I think that's.
[00:23:57] Speaker A: Let me, let me tweak a little bit of what I would. How I would word that is.
AI is unbelievable with understanding first principles.
So it is way smarter than me, but it does not know my goals.
And I have to keep repeating the constraints. Like you 150, 150, 275, 3 or 400, 540. That's the distribution that I want. Do not deviate from that. We need this cash position, we need this valuation reference this document. Reference this document. And when it does that, it's able to work within the constraints and so that back. Back to like there's a thousand or infinite amount of ways we can get to the goal.
And that's what AI is unbelievable for.
It's not good at the start and it's not good at the stop. But like the 98% in between is unbelievable. And same thing with like, if we were to build a bridge. I do not know the engineering that it takes to build a bridge, but I can knowing how to ask questions of like we have to follow the laws of physics and how load bearing. I don't know shit but about building a bridge, but I feel like by making sure we're following those first principles, I would need someone that's an engineer to spot check that.
[00:25:24] Speaker B: Right.
[00:25:24] Speaker A: Same thing if it's a rocket or a plane. But AI can become so powerful because it understands all of that. Because, because it's not scouring Reddit for people's opinions about how to build a bridge. You know, it just knows that like this is the truth.
So it would just would tweak the goals.
It can't help but the brain in between there. I think it's unbelievable.
[00:25:52] Speaker B: And I like how you reworded that. So then back to the five year forecast and where. So we talked, I asked in the beginning, where is a good place to start? And so would you say that the good place to start then is setting said goals? Like you were just explaining in your case study, you had to sit there and set what those goals were.
[00:26:13] Speaker A: That's why the owner scorecard is module one. Like the owner's goals. It has to be, it has to start there. Like, you know, I think, I don't know if it was a podcast or if it was one of our training sessions where as a coach, like what I've been doing for years now, people would, by definition, as a coach, they would come to me and say, I don't know if I should do this, that or that.
Okay, what's your goals? I don't know.
It's the whole cat in the hat. Well, if, you know, Allison, Alice says, where should I go? And he goes, where do you want to go? And she goes, I don't know. He goes, well, then any route will do.
It's like, I don't know.
So we have to start with those goals first.
That's the bottom up. That's the perimeter. That's what the owner scorecard for the five years is.
Then we nest all of these ideas inside of that and it's absolutely okay to change our goal.
You know what I mean? If I were to look at like, you know, that scenario planning be like, okay, I can't get to the valuation unless I take less cash.
So if I go down to and I maintain 250 instead of going up to 400, then 540, I could hire those key people.
And then I know I could like buy my time back and then get to the valuation. Like, that's totally cool to change your mind. But what we're doing is we're starting with the bottom up. To answer your question directly, we're starting from the owner scorecard. You know, people listening and I'm constantly doing this rectangle. It's like, it's the puzzle outline, the, the perimeter that we have to put together.
Then we start doing those scenarios inside of that.
[00:28:01] Speaker B: Okay, that makes a lot of sense. What are so the scenarios?
How do you.
I mean, I see that as part of building out your Five year forecast. Right.
[00:28:11] Speaker A: Like let's start with you. Let's. I'm going to flip it. Like what? Like let's assume that we did what I just described, then what you and I are promoting or promoting for our clients and what they should do is do top down and then we're, and then we're reconciling, we're syncing both of these parts up.
So you then start with a top down. So let's talk through like what you would do for five years. You know, you and Alan, your dad and we did that five year forecasting workshop a couple months ago. Walk through like how you, what you think the top down approach should be and how it should be approached instead of just that straight line do. We're doing what we're doing constantly. I think you already covered why we need to shift that thought process. But how would you start?
[00:29:03] Speaker B: Well, I was always focused on the revenue side of things. So I wasn't looking at valuations or profitability or any of those things.
[00:29:10] Speaker A: I was just let's assume that all like let's say this advanced solutions, we did this.
Like I've got all of the owner scorecard stuff put together. So then how would you start the.
Just, you can just focus on the revenue.
[00:29:26] Speaker B: Well, and I think it's helpful to, to do this exercise in just the revenue after you have the framework that you were just talking about too because it allows you to see how close are you to point B with the analysis that's been done and then that starts to form. What are those scenarios you got to start considering, considering are they big leaps or just little gains along the way? And so it's just a lot of data collection and gathering. It's looking at your user journey. What are your conversion rates. It's looking at the economics around you, like demand for your products, your market position. Is there heavy new competition coming into the market that you need to be aware of? So it's just, it's a lot of data gathering where you put it all together and you can see the external factors and then the internal, like I mentioned the conversion rates. What are your average close rates? What are your average deal size by product type, stuff like that. And so you just look at your business norms. How much new business do you typically close? What is your retention rate typically rate? Rates of change? Looking at your rates, you change find out where you are in the cycle. So it's just collecting all the data and then projecting that forward year after year after year for the five years to see okay. Based on business as usual and these external factors that are, that are going to impact me in one way or another, this is where we land in comparison to that point B that we were just discussing. And then that allows you to see what gap exists and it lets you know how big of changes you're going to have to make. Or not like an acquisition or maybe it's just a new product launch because you're.
[00:30:58] Speaker A: So let's use some of the advanced solutions numbers and then we will pull up the model just to reconcile this storytelling with the actual numbers. So we're going from 10 million to 20 million over five years.
We got five different product lines.
When do you start with the business cycles?
Like, like as you. Because you, you listed off a bunch of great stuff that we're going to be covering in detail when we do your module on the podcast for you know, forecasting and, and everything that has to do with predictable revenue. But for now, like how, what order would you do those things? And when you say lots of data gathering because your question from the CRO is to say what kind of effort and what kind of realistic journey is it from 10 to 20 million, is that a fair way to put it? Like, so what order do you start synthesizing this data in?
[00:31:50] Speaker B: Yeah, I think it's more of a time, an ongoing timeline. So like your rates of change should be looked at every month because as you understand them better month after month it'll be better to inform you when you get to your ready for budget planning season.
The in depth analysis of competitive environment, market trends, demand, all of that. It's usually an annual thing and it's a few months before you're ready to set a budget.
So that way you can have the forecast done before you get into budget planning season. The internal conversion rates, those should be tracked on a monthly basis just so that way you can see any anomalies that are going on, know your seasonality and all of that. So I would say the internal metrics are monthly and external metrics would be an annual occurrence.
[00:32:36] Speaker A: Because the purpose of what you just said is if we. So last week we did the annual budgeting, which is monthly three statement model which would start at the, you know, call it Q4. Lock that in by the, you know, December 15th for the next year. What we're trying to do is show that it doesn't stop there.
What we want to do is have a rolling five year that's on top of that annual and then that point B. So like we're constantly Rolling the whole thing forward with every year that goes by because that point B and then that gap will allow us to understand our trade offs of distributions versus reinvestment. So it's not just one year because if we stop at one year we really have no, it's just not sufficient enough. I mean the discounted cash flow goes five years. So the only way we can actually track that is to actually have five years out. But then when you say that you're doing all this stuff every month and you've got this best practice as a CRO, when you look at, when you zoom out and you look at the five year, I'm kind of like picturing the cycles that you and ITR used to do is like, okay, where's our business and where's our clients inside that cycle? So we're not just looking at a 5% growth rate for five years, right? So that's like where my mind goes, okay, so that we, we map that first and then we start looking at our products and service lines going, how do we fill and how do we buck that trend within side of the natural force of that cycle. Is that a fair, what do you thought a fair way to putting it or what do you think?
[00:34:11] Speaker B: No. 100% and buck the trend is a very common term in my world with being a CRO and saying, okay, how am I going to change that? Right? Because it's the business that's the business as usual. When you're looking over the five years and you're seeing your cycles, this is where the economy is taking you. If you continue to do business as usual based on a whole bunch of factors and so then it's all right, how do we change that business as usual? By doing something different. And then that's where that gets baked more into your one year outlook. Those the how to like the new things that you're going to do. So to your point, we do need the five year view as business as usual. So you can say, how do I change it? And then in your one year, that's typically where you have, I'm going to hire this key player or this headhunter or whatever the case may be. And so that's where you start to see those numbers show up in your one year.
[00:35:02] Speaker A: Got it.
Let me, I'm going to pull this up. I think it might be useful. All right, so where's my mouse? You can see this, right?
[00:35:11] Speaker B: Yeah.
[00:35:12] Speaker A: So I just wanted to, you know, people can go to YouTube or Spotify, they both have the videos and I'll talk through it. So if you're just looking at it or if you're just listening, you can hear it. So, Kim, this is what I was.
This is what we walked through in our workshop a while back.
See, I can zoom in that. Good. Okay, so we have our income statement first we have our five revenue lines. That gets us to our total revenue over the course of the next five years. We start at 27 here. There's a budget tab. I'm sorry, a budget column that's over to the left. I don't want to scroll too much, but we're just.
Like I said, there's five columns and this revenue line, you as the CRO would be responsible for that. So all of that work that you just described would be inside here.
And you can see how revenue. I'll come back and I'll show some of the value drivers here in a second. But starts with revenue. Then we go down to cost of goods and what the COO would have to do based on what you thought. So after you did all that stuff, we'd say, okay, well, how are given the revenue makeup and the trends over the next five years, what is the operations going to need to look like from the cost of goods and the service get us right?
[00:36:31] Speaker B: Do you mind? I want to jump in there just for a quick second, too. That's where a really big disconnect happens a lot, too, between the CRO and the COO or sales hat and the production side of the business. Because I might be able to say, all right, revenue wise, I'm confident if we invest all this money, we're going to get these outcomes. And then it's oftentimes our production team is going to push back and say, well, there's no way we can handle that scenario. And so you've said it many times, and just highlighting it now for this episode is that that's why the COO and CRO have to work together. It's not in silos, and they're each coming up with their own numbers. It has to be in conjunction with
[00:37:09] Speaker A: each other, 100% and the people listening in. If you're a owner and CEO, you're the one that's helping synthesize this. So that way those two people talk like that. You like the person that owns the company and the person that runs the company is responsible for all this stuff, like making sure that all the dots connect. And the beauty of what we've been talking about in this miniseries is that there's a model that allows you to See everything, how they all interconnect. And I've got a client right now where like we're short techs, we can't figure out where to find them. So we're trying to figure out how to sell more stuff that doesn't require as many people. And that's, that's a common theme that we're hearing a lot in varying industries and companies.
And so that's why it has to start with revenue. And I'll come back and walk through the story and how we started thinking about this and this is all high level Kim. This is not like this is the story. Right. We want to have the general trends. We're not doing like we're not doing ground, you know, ground up based budgeting for everything. We want to have some of the assumptions and I'll show you how we have the ability to do that and sgna, overhead, opex, whatever you want to call it. You can see here in the orange I've got highlights of things that we want to do. Back to goals. So I've got, hey, here's when I want to hire the cfo. We're going to go from a fractional to a full time, you know and that's in 27, in 30. 20, 30. We want to hire the CEO. Okay. And then in here we not only hired the cfo.
I'm sorry, we had the CRO. Yeah, there's a couple. You showing you when we can put the executives in there.
Some of them might have been mislabeled there but you're showing like hey in I want to buy my time back and when can I afford these people? And I'm going to have a fractional firm until I can afford the full time person company bonus pool that's going to grow over years. We did a whole miniseries on that. Executive compensation for the annual is right there.
The consulting and advisory right here is showing that hey, we had to ramp that up in order to afford the fractional so we could then hire the full time people normalized. EBITDA in 26 is 1.5. We're going to the 300 grand. We've got the normalization events here which are the recruiters and they're the ERP implementation and whatever the random other stuff is that we are talking about. So we now have the income statement covered, the balance sheet. We can then project out the balance sheet with days sales outstanding receivable or days sales outstanding, inventory outstanding and payables outstanding to then drive the whole balance sheet forward to connect it to the income statement.
That gets us down to the statement of cash flow. We can see how our working capital changes over time. Accounts payable, receivable. And we can come down to cash flow provided by operating activities. And this is the CEOs KPI.
And then we can see if there's any cash flow from investing activities that we need to do, any capex that we need.
And then. So this is any of that capex that. I mean, there's a lot of stuff that could require that. And debt, equity, do we finance it? Do we pay cash? I don't know. These are all just levers. Kim, that wig, as I'm walking through this, we just have the levers visible going.
And I'll show how this all ties out to cash, cash flow from financing activities. This is all of our debt. Right? So you can see that we're starting to pay down debt. And then we start to change the debt makeup over time. We can see our taxes that we're going to owe. And then look at that. 150, 275, 400, 540.
And then the cash at the end of the year. So, like, when I was saying that I literally had plugged this button, the cloud button, I was like.
And then like, these would change and I'm like, wrong.
And so it was just playing with all these numbers and I couldn't have had more fun because I have been doing this now for a couple decades and I've never been able to get the feedback on my idea that fast in my entire life. Kim.
Like, should I do this? How about this? How about this? How about this? How about this?
[00:41:18] Speaker B: How about this?
[00:41:18] Speaker A: And I was like, yes, no, yes, no, yes, no, yes, no, like, and it, and it started with, so over here we have these drivers to show we're going to kind of have equipment sales be flat.
So this is the story that I ended up working on with Claude. Like, okay, the equipment sales is going to be flat.
Project work is lumpy. But we're going to use project work to fill in when we have cycles. That's where you've. You and I have talked where, like, didn't you used to do that? Like when you'd be in different cycles, you did different marketing campaigns to sell different things. You want to speak to that real quick?
[00:41:56] Speaker B: Sure, yeah. It's seeing it in advance of the cycles, just so that way you know when to launch the marketing campaign. But yes, if you see different product lines are going through different cycles at different points, which they all usually do, that informs Your marketing strategy of what you want to focus on and when
[00:42:14] Speaker A: and the project work here is, yes, it's not reoccurring, but it's nice to mute some of that volatility.
[00:42:20] Speaker B: Yeah.
[00:42:22] Speaker A: Reoccurring service one and two here again, I just labeled those, but it could have. In my world, it was managed it versus, you know, print services. We want to keep ramping up.
And you'll see in the, in the margins like these are really, I don't have that on this sheet, but we have the margin attributes of each of these service lines because we're matching the cost of goods with the revenue.
So we want to ramp up the growth rate of the reoccurring services. And we come down to cost of goods and we're able to show like, okay, if we're going to do all that stuff, what are we going to need for cost of goods? And this is a percentage of revenue. You can see over here the different drivers, percentage of line of business, assumed growth rate. So we just, we have different levers that we can pull.
And then down here we can see the growth rates based on the people we're planning on hiring.
[00:43:15] Speaker B: Right.
[00:43:16] Speaker A: There's the salesperson, the CRO promoted from sales manager, plus the bonus.
[00:43:20] Speaker B: Right.
[00:43:21] Speaker A: The bonus pool here is that trickle down, that cascading effect of the company bonus pool compared to the executive compensation.
We can see then the different consulting firms and fractional leaders that we might need.
And I don't know if I had another.
The income statement becomes the levers that we want to pull, Kim, because the balance sheet and the cash flow statement, the cash flow statement just being the difference of the balance sheet over each of these years.
The balance sheet is going to tell us, and that's where we are explaining what our goals are for that cash flow. Right. So we're telling our CFO or Claude or whoever, these are our goals. And then the income statement become the levers. Right? So the income statement becomes the operational landscape of all the levers we can pull. And we're just constantly going back and going like, okay, so, okay, well I want to hire a fractional CFO for 7,500 bucks for the first 18 months. Then I'm going to have enough cash to be able to hire someone for 2, 225 base plus the comp plan. And then you come down here and go, oh, I don't like that cash position. How about if I do that?
[00:44:38] Speaker B: You know what I mean?
[00:44:39] Speaker A: Like, that's what I mean. You just keep going back and Forth but almost every business that I know, Kim stays right here in the income statement and they have no idea this bottom level ownership goal like the connection between the two and that right there is what is so such a bummer for everybody because the my back. Yep. So that's why everybody's guessing is because they're looking at a one dimensional plan without any understanding that it has like I'm really curious because you have now been what I would probably call indoctrinated by this over the last 12 to 18 months. But do you see how like you cannot come up with the goal, you cannot get to your answers unless you do this 100%.
[00:45:40] Speaker B: 100. The very first time you showed me this I was like oh.
Because it would have made would have been life changing in my previous roles because when I as a CRO would do all the work that I said that I would I was doing with the forecasting and the da da da da da I would come up with a number owner might say well my Point B is $15 million different than that. I'm like okay great. But to get there you're going to need to invest XYZ so that way we can reach said goals. And it was always well we can't invest that because I also still need this cash over here for this instead. So I think that's a fundamental perspective that you're bringing to the table with having this insight is there is a trade off. You can't have both all the time. Like some sometimes it works out but there are there like there is a trade off in the goal setting the cash your wealth in the future and how you're going to get there and how quickly you're going to get there.
[00:46:39] Speaker A: Like you might get more cash today or more wealth tomorrow.
[00:46:42] Speaker B: Right.
[00:46:42] Speaker A: And the more wealth tomorrow becomes possible when you can see the through line of how the investment creates the, the the sustainable cash flow and the multiple expansion. And before I know we've only got like five minutes here but I wanted to show the the owner scorecard here. We actually got that tied in for the time cash flow wealth. But I wanted to show this page here.
I built this in like 5 minutes with the content in Claude and like what we have here is the discounted cash flow. So in the reason we can't actually get the discounted cash flow for year five is because it takes five years to do the present value. So if people heard a bunch of Charlie Brown stuff there, don't worry about it. Let's go right to the market Multiple.
Look at this, Kim. We can go from, so this is your 26 through 2030.
We're going from one and this is pulling from the five year forecast, Kim. So we got 1.5 in normalized EBITDA and we go to 3 million. We go from 4.52 to 6.67. And that's based on the weighted average cost of capital, which is the inverse of the multiple and the blend of equity and debt and the company specific risk that is all based on how sustainable predictable transfer of the cash flow is. So the whole point is over those five years and we're not just doing straight line growth, we're hiring the people, putting the systems in, putting the comp plans in, because all of that enhances the transferability of that cash flow, gets us to our enterprise value, 7.1 to 20 million.
We have cash accumulation. Look at that. We go from the 300 to the 2 million.
We have the debt.
That trend that, that evolves over time, we have the net debt.
That sign is wrong. We'll have to go back and look at that.
Oh yeah, that works. Because we go from $6.1 million valuation to 21 and that's the equity value because we have the market multiple times the normalized ebitda. Keep your cash, pay off your debt and that's what the equity value is.
And so every single year we can seek him, we can literally track our valuation and we would be able to see in that five year forecast, it literally changes these numbers.
So I'm like, oh well that didn't work.
I took way more cash out. But now I only can get to a $15 million valuation.
And then that lens two is just that market multiple. But we go here to lens three, the transaction value.
What we have going on here is that it starts with that equity value from right above.
And then we have to pay bankers and attorneys and advisors fees and then we have the equity after those fees and then the cash at closing. So up here, what I like to do is we have it based on 60% cash at closing. So if you did 80, it would change all those numbers.
Transaction fees, 5% capital gains, 25% and a working capital target point is we have the levers. What I like to be able to do, Kim, is say like, you know what?
60% cash at closing is a reasonable number to plan around because ESOP private equity firm. I mean there's internal transfer. It's just like, hey, this is something that can be planned around based on the reasonable market multiple. So our Cash at closing is that blue line there. It goes from 3.5 million to 12 million, less your taxes. Here's your net proceeds, 2.6 million to 9 million at closing, mind you.
[00:50:25] Speaker B: Right.
[00:50:25] Speaker A: Everything else will be contingent rolled equity, earn out seller's note. That's going to be meaningful. But I'm trying to show in Lens 3 that we want to look at the knowable, confident number, cash at closing.
So we have this convergence of lens 1 and 2, which is. Lens 1 is the discounted cash flow, which is if you keep the business and you're reaping the rewards of those distributions or you sell the business. That's the hurdle rate of like, should I keep the business, should I reinvest in the business or should I sell it as an owner? Because you could take the money out of your business and put it into the stock market, gold, bitcoin, real estate. And you want to know the difference of those two.
So the convergence of lens one and three is when we hit escape velocity, we have hit our cash flow freedom. We've literally become free with total optionality of keep the business or sell the business. And look it, it literally has a yes or no.
[00:51:23] Speaker B: And then what's like, I was color coded too. Yeah.
[00:51:25] Speaker A: And that's Claude. I want it to be red.
And like, we have here the, the gap. What's the actual gap? Based on the owner scorecard of the cash flow that we want and the net worth, because we have outside investments. So we have this entire framework and we can constantly just go back and be like, did it work? Did it not work? And we have the ability to play around with the, with the journey that we want to go on.
And it's the only way that I know to be able to actually help us answer the question of should I do A, B or C and how does that impact what I want? And we can just keep doing this iterative approach that'll give us lens, that'll give us such clarity of like, how to actually keep on track or off track. And then the rest of the modules in IBD is all about how do we make sure we do that.
That's why this is module four, because you know the first three modules about building the owner's plan, building the playbook, coming up with your goals, understanding valuations. Because if people don't know the jargon I was explaining, it has to be done in order to actually own your destiny. Like, we have to understand how valuations work, otherwise we're outsourcing our freedom to other people.
So they can hold the answers for us. And I don't want that for people. We need to be able to, like, pick up the phone from someone that wants to buy our company and have a mature conversation with them without learning on the fly.
[00:53:04] Speaker B: I love all of that. It's the perfect tool for owners. And I think it's amazing. I think it's refreshingly simple while seeming complex all at the same time. Right. Like, it might feel overwhelming, but we've seen so many people that didn't know any of these things being able to speak this language and understanding it now. So it is just a matter of an educational process that's. And it's not a painful one. It's relatively. It's more simple than I think people would think.
[00:53:32] Speaker A: That's the whole point of the training program, right? That's our little plug, you know, reach out to us about the boardroom blueprint. Because I'm convinced that the differentiator going forward is education.
Because now with 200 bucks a month, I got rid of, like, all of these advisors. So it's like, I mean, we still need the domain experts, right? So I think we're having this convergence of, like, the people who are actually smart and actually experienced in their domain are going to be so freaking scarce and so valuable because everyone else that's just doers that don't know how the system works.
Claude. Can already do all that stuff. What I want is to be able to, like, work with people to say, is it like just having that education allows us to ask the questions and to know whether it's right or wrong. Same experience that we want. When we're talking to a buyer and they're like, well, how about this? What about that? You know, and like, you can actually have a fluid conversation. Whether it's a buyer, an investment banker, a commercial banker, or Claude, it's all the same type of experience that we want, which has to do with do we actually understand what we want and how this stuff works? And then we've got the tools in front of us.
[00:54:36] Speaker B: Yep, agreed. Love every part of it.
[00:54:39] Speaker A: And you have to go, so.
[00:54:42] Speaker B: Oh, I didn't realize that we were past time.
[00:54:44] Speaker A: All right, so reach out to us on the board and blueprint. We got one certain in August. Otherwise we got. We're. We're going to be kicking off your module next.
[00:54:53] Speaker B: Gonna be fun times. I'm excited.
[00:55:05] Speaker A: This episode is brought to you by Kastos Productions.
