The Lost Art of Profit

Today’s small business environment has been polluted by the coronation of the “entrepreneur.” The “entrepreneur” is the business owner who takes their concept and through new age promotion has created a larger than life business that he then sells for millions. This is so wrong on so many levels and it does not apply to virtually anyone you will ever know—including yourself.

FACT: Most small businesses will never be sold for more than their asset value.

FACT: The rich IPO’s are concentrated in technology—if you aren’t a computer or internet wiz, or a biotech engineer forget it.

FACT: The vast majority of jobs in our country are not in sexy start-ups—they are in boring, old small businesses.

When our fathers started a business they started a business doing something that they understood. They understood plumbing, carpentry, farming, electrical—they understood how to make or service something. They started with no money and did the work themselves. They grew slowly taking the money that they made to support their family and to put back into the business. Earning a profit was not optional—if they didn’t make money they didn’t eat. They enlisted their family into the businesses—sometimes of pride and sometimes of necessity. Their off-spring learned the business and it became the father’s dream and objective to build the business so that it could be passed on to their children. Even if they were very successful they probably still leaned to live below their means. They knew that there was a business cycle and that they had to have a strong company with nominal debt so that they could survive the downturns that naturally occur. Although they lack the business tools that are now, in a more complicated world are essential, they learned to understand their cash flow and learned to control their money and operations so that a profit was produced. Without the aid of a computer they made a good living for their family.

But this wasn’t good enough for the 21st century owner. This was old-fashioned. Basic business practices be gone—we no longer have to wait for our riches, we can get them now. You don’t need to build a business over time—just create a model and sell it off! Profit doesn’t matter anymore—just drive sales (or internet hits). Unfortunately, for some this worked; for most it doesn’t. The rules haven’t really changed—we must still earn a profit for a business to work. But this lesson has been abandoned in favor of get rich quick schemes. Time to go back to the basics.

There are six responsibilities of the small business owner. First you must earn a minimum-mandatory profit. In a meeting with a small business owner in July of 2011, this person who I will not name argued this point! “I am an S Corp—we don’t want to make money!” Amazing. One of the obstacles that we face today is how accountants have convinced people to run their business by tax principles—to the point that they don’t even know what “profit” is. And for those who get past their tax accounting, they still don’t have a plan in place to produce their profit—they really don’t understand how a small business owner earns their money. They want to earn it from their job rather than from their business. They don’t understand the difference between profit and cash flow and they really don’t have financial control of their company.

The second responsibility of the owner is to create cost controls to assure the production of that profit and the third is to create an organizational structure of employees that is responsible for the enforcement of those cost controls. You have to have a financial plan designed to produce your desirable, pre-determined result—a budget. Duh. An owner without a budget won’t be an owner for long. Most owners do it intuitively—like the last generation—and therefore are doomed to owning a job. It is from your budget that accountability and incentives within your organizational structure are created. If you own a company you are delegating the responsibility for portions of your budget to your employees and then holding them accountable for it (and rewarding them for exceeding it). This cannot be done until the owner fulfills their first three responsibilities.

The fourth responsibility is to sell—internally and externally. You must sell to your customers and you must sell to your employees. Climbers, campers and quitters alike must be sold on the benefit of doing their job—producing the minimum, mandatory profit. And then—the fifth responsibility—you must keep what you make. Tax and risk management must be regularly addressed. As the old adage goes, “it’s not what you make it’s what you keep that matters.” Lastly you must have fun. Don’t underestimate this one. Most successful owners don’t believe that they go to work—they are having fun.

There is help available for small business owners are ready to “get back to basics” and re-focus on profit. For those who do not, some will survive on hope and luck; and even for those who do there is no guarantee but decide which road you would rather travel.

How do you use your Budget?

Colonel Savage, upon observing the workers of the Union Pacific RR in 1868, “Verily, men earn their money like horses and spend it like asses.”

What you can afford and when you can afford it

One of the first questions that we ask a business owner is, “How do you use your budget?”   This is usually met with a blank stare and some temporizing questions like, “what do you mean?”  The fact is that most owners of small businesses simply do not have a meaningful, effective budget.  They really cannot  tell me what they can afford or when they can afford it. A Company’s budget establishes what they can afford—their cash flow establishes when they will be able to afford it. The budget is merely the company’s financial plan to obtain their desired result. It is obviously central to a company’s success and a basic business tool yet the owner does not even have one. The budget is the financial model that the business must achieve in order to get your results.

A “budget” is a financial plan designed to produce a pre-determined result. It is the owner’s most important management tool.

Example:

Sales                                                              100%

COGS

Materials                                                      30%

Labor                                                          30%

Other                                                          10%

Total COGS                                                      70%

Gross Profit                                                      30%

Overhead                                                         20%

Net Profit                                                          10%

Note that it is critical that the budget be in percentages and not dollars. Only the Federal Government can budget dollars because they are not restricted to what comes in—you are. Your job is to hit two numbers—the 70% Gross Profit and the 20% Overhead. If these two numbers hit, you will hit your profit.

What needs to be done beyond the general percentages is to tie down those numbers, create systems for the constant revision of those numbers and create focus throughout the entire organization on hitting those numbers.

Since the owner’s job is to hit two numbers–gross profit and overhead.  If you hit those two numbers you win the game–and yet many owners don’t understand that significance.  Once that is understood we add the assumption that the owner is not perfect—that he will not hit those two numbers. Therefore we create a Profit Plan for the business assuming that he will only do half of his job. The company develops a budget for, in this case, 5% of sales and pre-determines how that will be spent on new assets, retirement of debt, retention of cash and taxes. This way the business knows what they are doing in these categories over then next twelve months and they can be relatively certain of achieving it since it is based only on half of the profit that they should be doing. If the owner does his job and produces the 10% profit that he should, then he is entitled to that difference as his bonus. In taking it he does not compromise the company as their needs have been accounted for in the first 5%.  This is how a neopreneur business owner makes his money. You receive a salary for working in the company but your real money comes from doing your job—hitting those two numbers.  You can do whatever you like with that money—you have already covered your cost of production, your overhead and have fully funded your Profit Plan.

To make your job easier, we delegate the responsibilities for hitting the numbers that are in this budget—fractionalization.  We can have a production person responsible for production labor, a purchaser responsible for material costs, and an administration person responsible for overhead (although we generally have to take administrative—or at least owner’s compensation—out of the delegated overhead number).  If the person who is responsible for holding the direct labor to 30% is able to do his job better and holds it to 28%, he has produced an additional 2% profit. This is beyond the budgeted profit and becomes the basis for an incentive. One-half percent is paid to the person who produced it; one-half percent to the owner for managing him so effectively and one percent is paid to the company for additional assets, debt retirement, cash retention and taxes. This formula is carried through to the other key profit variables.

In this example, the amount of the profit plan, when divided by .05 gives you the company’s required sales for break even. Not even a sales plan can be developed without a budget.

In our Annual Physical we break down your financial statements and create a budget.  We have software available to our members to utilize those numbers against their financials and we work with our clients to keep them on track.  To find out more about budgeting, log in (first register if you have not) and do a search for “budget.”  You will find numerous other posts on this topic.

Are you making over $250,000 per year?

Editorial

The unfortunate truth is that few small business owners are, ever have, or ever will. The small business owner that some talk about “protecting from a tax increase” is not the owner-operated sub $5 million company that represents the vast majority of real small businesses. As is referenced in other posts in this blog, the term entrepreneur has been hijacked by venture capitalists whose predominate focus are high tech and health care. No electrical contractor, no plumber, no landscape company, no trophy company, no sub-contractor is going to be approached by a venture capitalist to be taken public and create millions of dollars of income. Not going to happen. That is why we have coined the term neopreneur. The Fremont Group is dedicated to helping the neopreneur; not the entrepreneur—between bankers and government they have plenty of help already.

You as a neopreneur have to run your business for a profit—the profit is your income. A generation ago a father started a business, worked hard, put the profit back into the company to build a business that would provide him an income and be passed on to his children. Today the children who start a business think that they are going to build up the sales volume and make their fortune by selling it. We have a generation that never learned how to make a profit. Our mission is the bring profit back as the focus in the real small businesses and to do so and thrive requires that the government help.

The next time you hear that we can’t raise taxes on the rich because it will hurt small business take a look at your past three tax returns. What will hurt you is not a tax on high incomes, rather what hurts you is the eroding middle class. For most small businesses the middle class is essential as a customer base. If they aren’t buying, you aren’t selling. Of course there are exceptions but as a general rule, you are the middle class, not the rich. We all aspire to be rich but as this recession has shown the first objective must be to survive. I urge you to reject the “we can’t afford to be a great country” approach and support the “we are a great country and we simply have to properly finance it” approach. To do otherwise will do nothing but prolong the lack of demand that you have seen over the past three years.

This is our opinion—your comments are welcome.

Budgeting for Neopreneurs—the Small Business Owners who comprise the clients of The Fremont Group

Colonel Savage, upon observing the workers of the Union Pacific RR in 1868, “Verily, men earn their money like horses and spend it like asses.”

What you can afford and when you can afford it

The owner cannot really tell me what they can afford or when they can afford it. A Company’s budget establishes what they can afford—their cash flow establishes when they will be able to afford it. The budget is merely the company’s financial plan to obtain their desired result. It is obviously central to a company’s success and a basic business tool yet the owner does not even have one. The budget is the financial model that the business must achieve in order to get your results.

A “budget” is a financial plan designed to produce a pre-determined result. It is the owner’s most important management tool.

Example:

Sales                                                              100%

COGS

Materials                                                      30%

Labor                                                          30%

Other                                                          10%

Total COGS                                                      70%

Gross Profit                                                      30%

Overhead                                                         20%

Net Profit                                                          10%

Note that it is critical that the budget be in percentages and not dollars. Only the Federal Government can budget dollars because they are not restricted to what comes in—you are. Your job is to hit two numbers—the 70% Gross Profit and the 20% Overhead. If these two numbers hit, you will hit your profit.

What consulting can do for you is to tie down those numbers, create systems for the constant revision of those numbers and create focus throughout the entire organization on hitting those numbers.

Since the owner’s job is to hit those two numbers we start with the assumption that the owner is no good—that he will not hit those two numbers. Therefore we create a Profit Plan for the business assuming that he will only do half of his job. The company develops a budget for, in this case, 5% of sales and pre-determines how that will be spent on new assets, retirement of debt, retention of cash and taxes. This way the business knows what they are doing in these categories over then next twelve months and they can be relatively certain of achieving it since it is based only on half of the profit that they should be doing. If the owner does his job and produces the 10% profit that he should, then he is entitled to that difference as his bonus. In taking it he does not compromise the company as their needs have been accounted for in the first 5%.  This is how a neopreneur business owner makes his money. You receive a salary for working in the company but your real money comes from doing your job—hitting those two numbers.  You can do whatever you like with that money—you have already covered your cost of production, your overhead and have fully funded your Profit Plan.

To make your job easier, we delegate the responsibilities for hitting the numbers that are in this budget—fractionalization.  We can have a production person responsible for production labor, a purchaser responsible for material costs, and an administration person responsible for overhead (although we generally have to take administrative—or at least owner’s compensation—out of the delegated overhead number).  If the person who is responsible for holding the direct labor to 30% is able to do his job better and holds it to 28%, he has produced an additional 2% profit. This is beyond the budgeted profit and becomes the basis for an incentive. One-half percent is paid to the person who produced it; one-half percent to the owner for managing him so effectively and one percent is paid to the company for additional assets, debt retirement, cash retention and taxes. This formula is carried through to the other key profit variables.

In this example, the amount of the profit plan, when divided by .05 gives you the company’s required sales for break even. Not even a sales plan can be developed without a budget.

Building a bottom-line successful company during a recession

(Article was edited)
“…it was Monty’s open-mindedness which was the key to his success.”

Back in 2003, business was easy for Monty Kosloski, owner of Friend’s Plumbing. The housing boom was in full swing, people were spending money freely and Monty was growing his business by double-digit percentages every year.  But instead of just letting the rising tide of the economy lift his boat, Monty had the foresight to bring in help to build a strong foundation for his business. Monty realized that for him to grow, expand and survive over the long run, he needed to put in place the methods, systems, controls and incentives that are the hallmark of a wellrun company.

Like so many neopreneurs, Monty spent more time working in the business than working on the business. While building a successful business, Monty found himself overwhelmed by all the hats that he was wearing. As the owner, he thought he should be involved in every decision and answer all his employees’ questions to keep the business running on the course he had directed for it. However, this simple management structure in which everything went through Monty left him overworked. His key employees were being under-utilized and he felt overwhelmed by the lack of structure in his business. To Monty, delegation was a foreign word from a foreign management language.

In spite of being involved in every decision, Monty knew that he was leaking profits in his plumbing business because of the lack of organization and efficiency. However, he didn’t know exactly where he was losing money or how to fix it. Just as homeowners needed a professional like Monty to fix their plumbing issues, Monty knew he needed to bring in expert to help fix his profit leaks rather than trying to fix them himself.

Monty became excited about the prospects of making more money. However, he did not fully understand how the impact of putting organization into place in his business was going to dramatically change his company for the better.  From day one, they began to change the culture of Friend’s Plumbing, and Monty was involved in every decision. In fact, his open-mindedness was the key to his success. Without Monty’s commitment to alter the way he managed his business, there would be no hope for changing the broader operations of Friend’s Plumbing with all his employees. “Once I made that decision to move forward on day one, consultants presence was an incredible lift to my people,” he said.

Immediately, they went to each individual to take some responsibilities off Monty’s back. While making the organizational changes for Friend’s Plumbing, they worked very carefully to ensure that every employee was comfortable with the changes being made. “Even though they said some of the same things I said, it made more sense [to the employees] when he said it,” Monty said. One of the effects was that everybody in the company “got more excited—the way they drove, the way dressed, they way they did everything” he continued.

“From programs on computers, cash flow, raising prices 50 cents—it was a combination of hundreds of things” that brought about the overall changes to Friend’s Plumbing, Monty said. Books were changed and new systems were put in place from cash flow to cost controls to productivity-based incentives, which could be used over and over again to ensure the modifications to the company operations became lasting. “After that first week, we changed and have never been the same since,” Monty said proudly. Moreover, it gave him the opportunity to regain control over his business, with everyone in the company pulling together as a team with a new direction.

“Probably one of the most important things they did for me was to set up a financial tracking system, which is more than just the bottom line you get from the accountant,” Monty said. “It’s a daily thing—you can’t look at just one or two factors with the economy the way it is. I now have all the tools I need as we go along.”   Monty said that a variety of new financial and operational reports that gave him the ability to manage all the critical variables necessary for his success. “I think what it allowed me to do was track, not only on a weekly basis, but also on a daily basis,” he said. “Looking back, it has allowed me to notice something on the horizon—something going to go bad.”  Monty said it was a simple formula that could be adjusted on a regular basis according to his needs—daily, weekly and monthly. Monty indicated that one of his fears about changing was the “fear of the unknown, and falling back into old habits … not anymore,” he said with confidence. “The systems keep me on track.”

To improve productivity at Friend’s Plumbing, they developed productivity-based incentive plans to generate more revenue and profits, which could then be shared with employees. “One of the things about our business is that it’s a service business where we have a lot of opportunities to sell products,” Monty said.  Monty had sold service agreements in the past, but had stopped. “Hourly wages went up; incentives and Christmas bonuses increased,” Monty said. In addition, there was money to share with the administrative staff in the office and the dispatchers. “Money does drive people,” Monty said.

In organizing his business and creating an engine for growth through productivity-based incentives, Friend’s Plumbing grew from having six to seven vans on the road to currently having 25 vehicles. Monty said the key to gaining the maximum benefit out of a consulting experience is to be open-minded. “[The business owner] must be willing to make the changes, otherwise you won’t benefit,” he said. “If you do everything, you will make more money. Your people will make more money.”  The difference in his company before and after was dramatic. “It’s the total attitude,” Monty explains. “The employees are conscientious about how they look and how they treat everyone. The incentives and spiffs [have created] a different company. Everyone is more relaxed. Managers are now empowered to do their job, and everyone accepted that. Fortunately, I had good people to fill the positions outlined.” “Now they have the authority to make decisions,” he explains. “And that’s good for me to be out of the office. I can sell more. I don’t feel I am working as hard in the business as I am working on the business.”

Learning how to transform from being one of the workers in the business to becoming the master strategist of the enterprise is one of the fundamental changes. However, the business owner has to be open-minded and willing to change and accept the new way of doing business. Additionally, as Monty’s experience has shown, the results will mean greater success for the business owner. “It works,” Monty said. “We are different. We are a lot different for the better.”

Back in 2003, Monty was not concerned about surviving. He was concerned about getting his arms around a fast growing plumbing business where he was overstressed and overworked. Unfortunately, many neopreneurs believe these factors are simply the price one has to pay when owning a business. “When they came here in 2003, it was almost easy at times,” Monty said. “But last year in 2008, we had 10 percent less sales than the year before. Yet, it was the most profitable year I ever had. That’s kind of scary. So, as I look into this year, and we actually had two very bad months—January and February were very bad—but the changes that I was able to implement by going into my cost control system, and understanding my expenses and my profit and all the things that I have in how I am going to create a bottomline successful company, I am so optimistic about this year. I think this could be possibly better than last year, and sales may go down 10 percent. But I am going to survive. That’s the key—I have the tools to make the changes.” Monty has always had all the tools he needed to fix a plumbing problem. But he didn’t have the tools he needed to run his business successfully in both good economic times and bad, nor did he know what he truly needed.

Looking back on his experience, Monty has this advice for other business owners. “Once you have made the judgment call, you realize it’s something you have to do,” he said. “If you don’t make that move now, you will regret it. They are the experts. These people have the answers. We are definitely a more controlled, structured organization, and we now have more of an insight into all of our problems. Prior to this, our employees did not present themselves correctly. The organization of this company has totally changed. Everything seems to be better when you are successful; and, in order to be successful, you have to have a good system. That’s what they did for me.” As Monty looks at his business today, succeeding in the middle of the worst economic recession since the Great Depression, he credits consultants for helping him not only survive the tough times, but also to thrive in spite of them. In a moment of sober reflection about his decision to bring in consultants to build a stronger foundation for his business when the tide was rising during the construction boom, Monty said, “I probably wouldn’t be here today if I had not brought them in.”

Entrepreneur vs Neopreneur

Venture capitalists and the money markets have created a class of business owners that they like to call entrepreneurs.  In their quest to capitalize on the ideas of others they have glamorized this concept and, in some cases while enriching themselves, have made a few of these chosen people wealthy.  In doing so they have created a generation of business owners who contribute nothing to society—they create companies to sell them.

A generation ago businesses were formed to provide a good or service that was valued by society.  The owner started this business with the long-term goal of building wealth through conservative management, earning a profit through effective management, reinvestment of those profits into the business and by investing in loyal employees who produced that profit.  They would build the business and pass it along to a second generation.  These people were entrepreneurs before the term had been coined, however the term was hijacked by the money changers.  These people weren’t glamorous enough for them and didn’t provide anyone but bankers with the ability to make money off them.  Everything that is old is new again—we now call these people neopreneurs.

The lost art of neopreneurship isn’t sexy; it doesn’t make you rich quick and is often subject to ridicule.  This is the result of the conscious effort to deglamorize the art of building a solid business because it does not serve the needs of the money community.

There are reasons that the art of building a business through the generation of profit has been lost.  Until about 1980 the top personal tax rate was between 70 and 90%.  The tax code gave little incentive to take large salaries and bonuses out of businesses as it would become subject to very high taxation.  After 1980 the top tax rate was halved and instead of reinvesting profit back into business it became popular to take this money out of businesses and direct it to personal income.  Of course this depletion of corporate resources resulted in companies with higher debt and at greater risk to a fluctuating economy leaving millions without jobs.  We are not here to advocate a return to higher taxes, rather we are here to advocate a return to the conservative, effective management of companies.  Neopreneurship is the transformation of a company from the reliance upon people and institutions who desire to profit from your work and deplete your resources and to transform the owner of a small business from someone who owns a job to someone who owns a business.

(Note—the terms neopreneur and neopreneurship are copyright terms developed by The Fremont Group think tank and implemented through The Fremont Group Institute of Neopreneurship.)

Neopreneurship©

The Fremont Group is introducing to the business community the term “neopreneurship.©” The small business owner has been squeezed into oblivion. The term entrepreneur no longer applies to someone who is working all day, trying to build a business and make a profit, rather it has been hijacked by venture capitalists and the high-tech industry. We are going to focus on the “new” entrepreneur—that which was old is new again—the person running his own business for a profit not for the purpose of selling out in an IPO.

Starting in late March we will be launching The Fremont Group Institute of Neopreneurship™ aimed at the true heart of American Business—the little guy!