System Six of six. The one that tells you whether the other five worked, and the one a buyer checks before he believes a word you’ve said.
I read a story in the paper that made my blood boil.
A granite company. Beautiful work. People raved about their countertops. The quality was genuinely top-notch.
They were going broke.
The owner admitted to the reporter that he didn’t understand the financial side. Billing. Cash flow. Meeting payroll. Arranging financing. The pressure was crushing him.
Fortunately an interior decorator who used them regularly did understand those things. She put in some capital, took over the management side, and brought order to the chaos. Now she handles the books and the marketing so the technicians can do what they love.
The article said they’d doubled their billings in a year.
Here’s what the article didn’t mention.
The bottom line. Because doubling sales doesn’t always translate into more profit.
Being good at the work doesn’t qualify you to own the business
The skill sets aren’t the same.
In fact, being a great technician can actively hurt you as an owner. Because if you’re working in your business all day, you don’t have time to work on it.
You know how most owners decide whether things are going well?
They look at the bank balance.
Here’s the dirty little secret about the bank balance. Sometimes that money is there because you haven’t paid your bills yet.
In sports there are measurements to gauge performance. In business there are measurements to gauge success. You need them both, and you need them on a schedule.
Start with the number nobody wants to run
Five minutes. Real numbers, not the ones in your head.
Weeks of cash
A. Cash in the bank today
B. Accounts payable today
C. Payroll due in the next 30 days
D. Everything else due in the next 30 days
E. A minus B minus C minus D. What you actually have.
F. What it costs to run this business for one week. Then E divided by F. That’s your weeks of cash.
If you didn’t know that number before today, you’ve been flying blind. Most owners are, and most of them don’t find out until the week it matters.
Never lose track of the goal
The goal of any business is simple. To make money for the owner.
You might love what you do. Great. But be honest: the business exists for one main reason, and that’s to make money for you.
The goal should be even higher. To make a LOT of money for you.
Think about it. You’re taking all the risk. Employees. Rent. Expenses. Liability. You could have a job with a fraction of that exposure.
So the goal isn’t to create a job for yourself, although I meet plenty of owners who seem to think it is.
The goal is to create a business that generates a cash flow stream.
And here’s the kicker. A business that can be valued on a cash flow stream that doesn’t require you to participate is worth many times more than one where the cash flow depends on you selling your time.
How much more? Try ten times cash flow instead of two to three.
That’s the difference between building wealth and building a job.
The measurement calendar
Measurements have to be regular. Weekly, monthly, quarterly, annually. Here’s what goes where.
Weekly. A flash report somebody else builds: last week’s sales, collections, bank deposits, checks written, cash on hand, cash needed next week, accounts receivable, accounts payable, and weekly profit based on cash. Plus leads, presentations made, and deals closed, so you can watch your closing ratio move.
Monthly. Bank reconciliation and an income statement. Every single month, so you can see how you did.
Quarterly. Year-to-date financials, receivables and payables, lines of credit, and the balance sheet. In July and October, tax projections with your tax planner. In March, a complete insurance review: property, casualty, life, disability, health.
Annually. A company meeting, a complete financial review, a budget, and a five-year plan.
Note the phrase in the weekly line. Somebody else builds it.
If you’re the one assembling the flash report, you’ve made yourself the reporting system, which is the same mistake as being the sales system or the delivery system. Somebody else builds it. You read it.
Sales is not profit
The granite company doubled billings and still had a problem.
Revenue is the number owners brag about at lunch. Profit is the number that pays you. Cash is the number that keeps the doors open. They move independently, and a business can grow itself straight into insolvency by winning work it can’t fund.
If you only track one of the three, track cash.
The number a buyer actually starts from
Not revenue. Not the net income on your tax return.
A buyer starts from owner earnings: what the business produces for whoever owns it, after normalizing for the things you run through it that a new owner wouldn’t.
Your salary, if it’s above or below what it would cost to replace you. The vehicle. The travel that’s really personal. The family member on payroll who doesn’t work there. One-time expenses that won’t repeat.
Those adjustments are legitimate. Buyers expect them. But every one of them has to be provable, because you’ll be asked to prove it.
Here’s the part that costs owners money. An add-back you can’t document isn’t an add-back. It’s a number the buyer strikes, and every dollar he strikes gets multiplied by whatever multiple you’re negotiating. A $40,000 adjustment you can’t support isn’t a $40,000 problem. At five times, it’s a $200,000 problem.
Two times versus ten
Take your owner earnings. Multiply by two. That’s roughly where a business lands when the cash flow depends on the owner.
Now multiply the same number by ten. That’s the neighborhood when it doesn’t. The spread between those two numbers is what the six systems are worth to you, and it’s usually the largest financial event of an owner’s life.
One honest caveat, because I’d rather you hear it from me than from a buyer. That’s an estimate for your own planning. Real multiples turn on industry, size, growth rate, deal structure, customer mix, and what one specific buyer wants on one specific day.
Through a buyer’s eyes
Buyers don’t discount bad numbers as hard as they discount numbers they can’t verify.
Somewhere between the letter of intent and the closing, a buyer runs a quality of earnings review. An accountant sits down with your books and tries to prove your profit is real. Not that it’s good. That it’s real.
If it holds up, you close on the terms you agreed.
If it doesn’t, one of three things happens. The price comes down. The holdback goes up. Or the buyer decides you’re not the kind of person he wants to be in business with, and walks, and you’ve burned four months and your best window.
Most owners put the books off until the year they want to sell.
That’s exactly one year too late. A buyer wants three years of clean books, and you cannot go back and create last year.
Which is the real argument for starting this system now, whether or not you’re selling. Clean books cost you a bookkeeper. Dirty books cost you a multiple.
Frequently Asked Questions
What financial reports should a small business owner review weekly?
A one-page flash report: sales, collections, deposits, checks written, cash on hand, cash needed next week, receivables, payables, and profit based on cash. Plus leads, presentations, and deals closed. Somebody other than you should build it.
What is a quality of earnings review?
An accountant working for the buyer sits down with your books between the letter of intent and closing and tries to verify that the profit you claimed is real and repeatable. It’s where unsupported add-backs die.
What are owner add-backs?
Expenses the business carries that a new owner wouldn’t, added back to show true earning power. An above-market owner salary, personal vehicles or travel, family on payroll who don’t work, and genuine one-time costs. Each one has to be documented to survive.
Why is a business worth ten times cash flow instead of two?
Because the cash flow doesn’t require the owner. A stream that keeps running when you stop is an investment. A stream that stops when you stop is a job, and nobody pays investment multiples for a job.
How many years of clean books does a buyer want?
Three. Which is why the year you decide to sell is the wrong year to start, and why this system pays whether or not a sale is anywhere on your horizon.
I have a bookkeeper. Isn’t that enough?
A bookkeeper records what happened. A measurement system tells you what to do about it, on a schedule, in a format you actually read. Most owners have the first and not the second.
What if I don’t understand financial statements?
Then you’re the granite company, and you have two options. Learn enough to read them, or bring in somebody who already can. Both work. Doing neither is what puts profitable businesses out of business.
One Hour. One Price.
Sixty minutes on the phone. Bring your last three years of financials if you have them.
I’ll tell you what a buyer’s accountant would do with them, and what I’d clean up first.
It costs $1,000.
Most business owners get one shot at their exit. One. The cheapest hour you’ll spend on it.
The material on this page is general information about how businesses are built and valued. It isn’t legal advice or tax advice, and reading it doesn’t make me your lawyer. Every business is different, and the details are where the money is.