The Moment a Good Business Starts Becoming a Great One | Ep 254

Speaker A: I've been inside hundreds of businesses at, uh, every stage and there's a specific moment that I've seen over and over again that's really hard to describe until you've witnessed it. It's the moment that a business goes from survival mode to kicking some serious butt. Revenue growth becomes more predictable, cash flow becomes more steady, and the owner goes from being reactive and putting out fires to being more proactive and cool headed. Today I want to describe what uh, that moment looks like in financial terms because for you it may be closer than you actually think. Now let's be real. Running a business is really hard and running a business that's not performing well really sucks. But probably one of the biggest things that causes stress for a business owner is a lack of visibility. So when you have no clue what's going on in your business and you don't have a clear grasp on your numbers, then literally you're just guessing. And I'm sure your stress levels are through the roof. And I know this because I've been there before. I remember when I had my first company here I was running a multi million dollar business and I was driving around in my truck all day trying to get work, trying to do work at a profitable level. I was managing crews, talking to customers, working, working on my business, working on my strategy. I was doing all this stuff wearing multiple hats and I had no clue what my numbers were. I mean, sure, I'd get my income statement and my balance sheet for my accountant every month, but when I looked at the income statement, all I saw was revenue and profit. I couldn't understand the levers in between. Same thing with the balance sheet. I look at my cash, I look at how much my customers owed me, but that's pretty much it. I didn't understand what the balance sheet m meant and how it connected to to the other financial statements and more importantly, how it connected to the operations of my business. But going back in time, if somebody were to ask me what was my revenue per hour, what was my margin on that revenue per hour, what was my free cash flow, how much of my profit was I converting to free cash flow, what was my return on invested capital and all these other things that a business owner should know, if somebody were to ask me those questions, I wouldn't have been able to answer them. Should I? Sure, I could have spitballed and said, yeah, we do about $150 per man hour. But I didn't know exactly. I didn't know precisely. And that's what creates A lot of anxiety and a lot of stress, and it causes a lot of business owners to lose a ton of money. Because when you don't know your numbers and you don't understand the levers in your business, you're literally just going out there getting work, getting, doing work and praying at the end of the year that there's some money left over. And if your business is doing really well right now, let's just say you have a lot of profit and your margins are great and you have cash in the bank and you're thinking, steve, I got this. Well, things can change on a dime because the economy could shift, your industry could get disrupted, you could lose a key client, you could lose a key employee. There are a number of things that can happen to your business. So the question is, if you're really profitable and you have a lot of cash flow right now, now is can you sustain that over an extended period of time? I was just meeting with a business owner a couple weeks ago and he's like, Steve, you know what the hardest thing about running my businesses right now? He's like, for the last decade and a half, everything has been upwards More revenue, more profit, their margins were getting fatter year by year. And everybody is just so energized and they were so excited during these time periods because everything they did just turned to gold. But now the economy has changed and more specifically, their industry has changed. So profit has been declining steadily because revenue is down. And so therefore running the business right now really sucks for this business owner. And so they brought me in to help them with their numbers. And they're very smart, very capable operators, just like I'm sure you are. But the thing that they struggle with are the right metrics to be paying attention to. And this requires you to know your numbers on multiple levels. So I can tell you that the business owner's anxiety and stress levels, even though we haven't solved everything for the business yet, they have dramatically shifted in the last few weeks because now there's visibility into the numbers, not just today, but over the last five years, we could see the trailing 12 months, the trends on everything, and it's all at our fingertips. So it's amazing when we're having our conversations because now we can speak with specificity instead of just guessing and saying, yeah, we think the average order value is this, the number of orders is this, or cash flow is that. We can literally look at the trends and we can know exactly what it takes to run his business from a labor perspective, from a Materials cost perspective, from a cash flow perspective. We know that stuff. We have a baseline to measure from, then we can set targets, we can start improving performance. And I could tell you, if you don't have financial visibility in your business, running a business is super hard. It's so much harder than it needs to be. You're going to be stressed out, you're going to be pulling your hair out, you're going to look like me, you're going to be bald. Maybe you don't want to be bald, maybe you're a good looking bald person, but nonetheless, you don't want to be pulling your hair out. But that's what happens when you don't have financial visibility. When you can fix it, you're on your way to the next step, right? So there's five conditions really that I'm going to get into. That was the first one, there's four other that are really important. And once these conditions are met, maybe your business won't be perfect, because I've never come across a perfect business. But running it is going to be so much easier and this is all going to be a breath of fresh air. So. So, number two, it comes down to your constraint. When you can identify your constraint with specificity and you could back it up with the numbers, then everything becomes so much more simple because you know where to focus, but you can't identify your constraint. Or I should say, it's really hard to identify your constraint if you don't have financial visibility. So see how these build on top of each other when it comes to your constraint, this is the number one thing that's holding back your business from achieving its full potential and achieving its full financial potential, I should say. So when it comes to strategy, our whole foundation is built on solving constraints. That's what I wrote about in this book. This is my newest book. It's called Strategy, and we just released it. Uh, back in the day. I kept everything close to my chest. I didn't share my methodologies, I didn't share my frameworks. But now I'm putting it out there. It's all in this book. But the theory of constraints is what rules the whole strategy framework, and it can rule your business. When you get really good at identifying your constraint and then putting an extraordinary amount of resources or a disproportionate amount of resources behind solving that constraint, your chances of solving that constraint increase. And when you solve that constraint, then guess what? You unlock the next wave of growth in your business. That could be revenue growth. It could Be margin growth, it could be cash flow growth. For years. For years in the past. When I was first starting out in business, I would grow my business until I hit a constraint. And that constraint could have been demand based, meaning I didn't have enough demand, enough leads for my business. So therefore we couldn't grow. We stayed stuck at a certain revenue level. Or the constraint could have been supply based. So I didn't have the right employees in the right positions to handle the workload. So let me stick with this demand based example. So there were times in my business when we couldn't get more leads and our sales and marketing engine was just all messed up. So therefore we just stayed stuck at a certain revenue level until I solve that problem. Until I solved getting more leads, guess what? We stayed stuck at that revenue. But what I would do instead is I would go focus on all these other things instead of fixing that one constraint. And guess what? We say it's stuck. Then finally I was like, wow, we need to solve for this constraint. I, uh, solved the constraint and then we had unlock growth and then we'd grow and then we'd run into a supply constraint. So I didn't have enough employees to handle the growth, so therefore I had to solve that constraint. But I would mess around, I'd have all these meetings, I'd do other projects and I'd do everything except for solving the one constraint. The big problem was back in the day is I didn't have financial visibility in my business, so therefore I didn't know how to identify the constraint correctly. But I could tell you everything will change in your business when you can identify your constraint with precision. And then you could put a, uh, disproportionate amount, uh, of resources behind it to solve it to the point where it would be unreasonable for you to solve that constraint because you've put so much effort, energy, capital, people, whatever it is behind solving that constraint. And that's the whole system that I follow when I turn around and scale companies. And you could do the exact same thing in your business. So if you're stressed out, if you feel stuck, if you feel like you need a transformation, but you don't even know where to begin, identifying the number one constraint in your business will give you clarity unlike anything you've had before and it will free you in so many ways. So that's condition number two. When you have financial visibility and then when you have the constraint identified, you're on your path to being more proactive in your business and less stressed out. Condition number three is predictable cash flow. Right? Running a business where you have profit is not the same thing as running a business where you have cash flow. I've seen so many companies because they come to me with cash flow issues and guess what? They have a lot of profit. Oftentimes sometimes they don't have profit, they have uh, a, they're in a profitability crisis. That's a whole nother conversation. But for a lot of these businesses, they're making money. Maybe it's not a lot of money, but the gap between what they're making in profit and what they have in free cash flow to pay down debt, to pay dividends or distributions, or to reinvest in their business, there's a big disparity between the two numbers. So having a business where you have predictable cash flow means you have to have your finops in order. Now when it comes to cash flow, there are eight levers. Four of them impact profit. Price, volume, cost of goods sold or your cost of delivery and opex. That's your overhead. Those are the four levers that impact profit. Then there are four levers and that impact your invested capital. Usually there are accounts receivable, inventory or whip. If you're in construction, you're over under bills, your accounts payable and your capex. Those are the eight levers of cash flow. The interesting thing is when you have profit but you don't have cash flow, it's because your cash is stuck in your invested capital. So it's stuck in your receivables, it's stuck in your inventory or you're over on your billings, it's stuck with your payables because maybe you're paying your vendors quicker than your terms or you're spending a lot of money on capex because you're not positioning yourself in the right markets or you're just not accounting for capex in your overall cash flow planning, whatever it is. When it comes to your cash flow, if you're making money but you're not converting it to cash flow, it's because it's stuck in these other buckets with invested capital. The first three at least the first three levers, accounts receivable, inventory and WIP and accounts payable, those levers have two parts. First they have a one time upside where you release a lot of money because you improve the management of those accounts. And then there's the ongoing benefit when you scale. So let me explain. Let's say you have accounts receivable and you have $5 million stuck in your accounts receivable and your DSO, which is your day sales outstanding. That's the key metric to measure your receivables. Let's say it's at 90, but it should be at, uh, 30. If you can break it down from 90 and get it down to 30, there's a lot of one time cash that you could free up and put into your bank account because right now it's sitting in your customer's bank account. So there are strategies you could do to improve that and free it up right now and have more money in your bank account. Then after you get that straight and you get that management of it straight, then it comes down to strategy where you compete, how you compete, the customers you go after, the contracts you sign, etc. Etc. There are, there are a lot of tactics here, but if you can improve that ongoing, and let's say you can maintain a DSO of 30 as you scale, guess what, you need less invested capital. But I've seen a lot of businesses who don't fix the management of their invested capital and they don't fix the ongoing strategy when it comes to their invested capital. So therefore they just scale and they need more invested capital. So you can literally be running a business and you think you're doing well because on paper you're earning, let's say, you know, $10 million in profit, but you have $100 million in invested capital to earn that 10 million. That's terrible. So you have to be mindful of this. In winning a, uh, predictable cash flow, everything changes. The other thing I'll say about predictable cash flow, it all starts with your strategy. The customers you choose to pursue, how sticky your revenue is, so how reoccurring or reoccurring your revenue is. So those two things are really important. Also your offer, right, the offer that you put out there to the world, and your payment terms of how you get collected when you sell an offer, all these things tied in with your pricing, your estimating, your bidding, all this stuff works together to give you predictable cash flow. When you can work on these things and you have predictable cash flow, things become so much easier. Just like with the other conditions, it doesn't mean your business is perfect, it doesn't mean your cash flow is always going to be predictable. But when you have a system in place, at least you know where money's getting stuck and you know the levers to pull to get it unstuck and into your bank account. Condition number four is when the business can run without you babysitting every single person in your company or, or being involved in every single decision. And if you're in the early stages of your business, chances are you're just grinding it out and everything does depend on you. There's a lot of key man risk in your business. That's normal for most companies. You just don't want to stay stuck there because as years go on, it becomes really hard to fix. If you could fix it in the beginning by having things documented, you could have processes and you could structure your offer. So whatever your product or service is, you can structure it in a way where it doesn't depend on you. It makes your business so much easier to run without you. And that's really the key. So the best businesses that we work with are the ones who understand their whole activity map. That means all the activities that they perform from the very moment a new customer comes in the door, all the way to closeout or delivering or fulfilling on a product. When you have that clearly mapped out, you can understand exactly what are the different activities we need to engage in as a company and where can we optimize, where can we automate, where can we implement an A.I. uh, agent, where can we just eliminate activities to make everything streamlined? But you have your whole blueprint of your company and how you perform right before your face. Then you can start putting in place processes on the most important activities, especially the ones that require you to be in the business. Until you do this, you're going to be at the center of the business. So I've worked with business owners and I've given them the tools and templates to create these activity maps. And some of them jump right on it. And when they do it, they understand their business a lot better. Others delay. And guess what? They feel the pain. And when I follow up with them, they're still feeling the pain. And until you actually chart things out, which is really hard because you're trying to get work, you're trying to do work, you're trying to put out fires. You got a million things going on in your business and it's really hard to just stop and then work on processes, systems, activities, and just the design of your company. But it's a super high leverage activity if you want to get out of the everyday grind of your company. Condition number five is when your return on invested capital is exceeds 20% or more. This works for most businesses. If you're in professional services or you have an asset light business, you have a company with lumpy upfront investments or heavy investments that are erratic, maybe ROIC doesn't work for you, but you can use things like economic profit instead. There's other metrics you can use, but for most people who listen to this, ROIC or return on invested capital is a great measure. And this is where you take your net operating profit after tax and you divide it by your invested capital or all the money you have invested in your business. When you do that calculation and it exceeds 20%, that means you are making a 20% return for every dollar you have in your business. And if you think about it, if you were to take your money and just put it in the stock market over the long term, it's going to earn like 9 or 10% on average based on the S&P 500. And it means at a 20% return based on the rule of 72. That's the rule in finance where you take the number 72, that's a fixed number divided by your rate of return and it tells you how fast you double your money. So if you take 72 divided by 20, it means you're doubling your money roughly every three and a half years. So it's a really good return. When we work with companies, that's the target we shoot for 20% or more. That's when we know companies have a really strong strategy. In your business, if you can sustain that, the key word is sustain. I'm not talking about earning a 40% return on invested capital one year and then a negative 15% the next year, and then a, ah, 30% the next year and then a negative 20% the next year. You don't want that. You just want stable, steady return on invested capital growth. When you have that in your business, you know your strategy is working. You know you have some type of advantage in the market, differentiation, cost leadership, or focus, some type of generic strategy is giving you a competitive advantage that your customers recognize and they're willing to compensate you for, or you have costs and capital efficiencies and you're able to reap those rewards, which, whatever it is, return on invested capital says your strategy is working. Now for some businesses, they put in place these strategies, they have these operating systems, whatever you want to call it, and they're measuring things and they're meeting and they think it's great, but it's not connecting to the returns of the business. So you could have your mission, vision and values. You could have your principles, you could have your SWAT analysis, you could have your rocks, you could have whatever you want, paste it on your break room wall. But if your strategy does not connect back to the economics of your business. And if you cannot consistently earn returns, there's work to be done. When you reach this point, then the fifth condition is met. Like I said, your return on invested capital exceeds your cost of capital. Therefore, you know that you got a solid business. If you don't have any of these conditions met, no need to worry. Just don't stay stuck here. You can always work on them and you can improve your business and you could have a better life. And like I said, I've seen business owners who are struggling, who are stressed out, and then I've seen others who get past that because they're working on the conditions that matter. And when they do it, everything changes. They're smiling once again, they're happy. And look, I think we're all stressed out. I'm not promising you that your stress is going to completely disappear, but things do get easier. I think life's supposed to be hard. I think everything's hard. Running a business is hard. Being a husband or a wife or a spouse or a partner or whatever it is, that's hard. Being a parent is hard. Everything's hard. Life is meant to be hard because we're meant to grow and progress. It doesn't have to be unnecessarily, uh, hard. That's the big difference. That's what I want to leave you with. I'll catch you in the next episode. Cheers.