185: Backwards Financials for the Win
Michele 00:01
Hello, my name is Michele, and you're listening to Profit is a Choice. Today I'm bringing you a replay of a podcast that we launched in the first few months of our podcast back in 2018. This particular podcast was in response to a question that Tracie Taylor emailed and asked me about how she could figure out her financials backwards. I work with my clients to create a top down and a bottom-up model of their financials. And on this episode, you will hear Tracie and I work through her numbers, I want you to really listen in for some actionable takeaways, so that you can look at your business financials backwards.
Michele 00:44
Every day, empowered entrepreneurs are taking ownership of their company financial health and enjoying the rewards of reduced stress and more creativity. With my background as a financial software developer, owner of multiple businesses in the interior design, industry, educator, and speaker, I coach women in the interior design industry to increase their profits, regain ownership of their bottom line, and to have fun again in their business. Welcome to Profit is a Choice.
Michele 01:19
Hey, Tracie, welcome to the Profit is a Choice Podcast. I'm glad to have you today.
Tracie Taylor 01:23
Hey, Michele, and happy to be here. Thanks for having me.
Michele 01:26
You are so welcome. All right, Tracie. So why don't you tell our listeners a little bit about your business, what you do, how long you've been in business, all that good stuff.
Tracie Taylor 01:36
Okay, so I am an interior decorator, and I'm back around 2002, I decided to take a course it was at that time an online or virtual courses that you could take to learn about interior decorating. And after I did that, I found that I could not find work in my small town. So I decided to jump in feet first and opened my first interior decorating company. I ran that company for about four years, and I hustled really hard to make something out of it. And while I was busy and making a great income, I just didn't handle my finances. Well, I didn't have that key part of the business structure figured out. So there was a lot of stress involved in and I had one client, you know that one client that comes along, that threatens to sue you because something isn't being delivered on time. And all it did to me and my young little early business, baby business hard was stressed me the heck out and stressed my family out. And so after that, I decided that I wasn't ready. And I closed the business when the housing market was crashing, the stress was just too great for me at that time. I ended up moving to the mountains shortly after that with my family and raising my kids. They're teenagers now and I'm ready to get back to doing what I love. So I opened up Tracie Grace Designs in July of last year, and we're doing really well. But I'm approaching my business this time with much more intention. And so I'm hoping to reach out today to you to learn. And hopefully my journey can help some others learn as well.
Michele 03:29
That's fantastic. So the business that you have today, read now I won't say reopened because it's a different business, but July of 2017 and so you're just a little over a year in crack. Okay. And are you doing primarily residential design Tracie?
Tracie Taylor 03:51
Primarily residential, although I have had small commercial, a couple small commercial things and one was virtual. So that's been a fun experience.
Michele 04:01
Okay. And employees, do you have any employees?
Tracie Taylor 04:05
No employees, just me.
Michele 04:08
Just you. Okay, perfect. So what would you say is the biggest challenge to your business right now?
Tracie Taylor 04:14
Oh, gosh, you know, rebuilding is quite a challenge. And back then when I ran my business before, just the industry as a whole was hugely different. We didn't have things like social media and Pinterest and all of these, these things that the design industry today has to operate around and with. So learning to navigate that learning to market myself in a new environment, and then also keeping my pipeline full right now I'm rebuilding everything, all of my sources from back then, you know, the local service providers, nearly all of them are not in business after the housing market crash. It really is took a toll on our area here.
Michele 05:02
Okay? And what have you done so far? So, you know, I am so thankful that you shared that you started with the first one like 2004 to 2008, something around there was around there, yeah, a five to nine, and then you took a break, and then you've come back, and I appreciate that. What did you do differently with intention when you started this time, Tracie Grace?
Tracie Taylor 05:29
You know, there's so much more out there that, again, was not there. Back then, with the resources that we have today and the support that you get the peer support in Facebook groups and the podcasts, it gave me the courage to try again. And so I've just opened my eyes to not only learning from others, but helping with my experience, and then, you know, digging into a proper contract and setting up the proper processes. And just doing what I can to reach out and learn about the way to structure our financial, and just our financial. I can't think of the words right now. But our, our plan
Michele 06:15
You systems, all of it sounds like to me that all of your systems were kind of on the table to be looked at. Would you say that your first business was maybe more built out of the passion to design or decorate, and this one came along with that same passion, but being tempered by I need to have that underlying business structure?
Tracie Taylor 06:39
Absolutely. I think I've always had an entrepreneurial spirit. But the majority of what I did before was out of the love for making things pretty and helping others do the same. And I think that's kind of all where we start. But then we have to figure out how to make it sustainable. I know that there are many of you, many of my fellow decorators and designers that stayed in business through the housing market crash, and there was a reason they were able to do that. And they were able to be flexible when the new technologies came out. And so I'm just really in it this time to learn how to do that.
Michele 07:16
I love that. So not just looking at it for short term gain of a beautiful space that maybe you could provide, but how to weather the storm. Because we all know our economy goes up and down. They all do over time, right? We're coming into a recession coming out of recession. Yeah, it's interesting. I owned a company in this industry since 2000. And it's still 2008, nine, in some ways, it feels like we just went through it, it doesn't feel like we are eight to nine years on the other side of it, I still sometimes step back and feel like we're all talking about, like we're just coming out of it. I also see while there's a lot of excitement and growth and opportunity. And you know, there was a lot that came out of that time where we had to do things differently. I still see those that have been around for a while, there's still that bit of trepidation sometimes about how do I protect so that I don't have to go through that the same way? Again, I can see some protections, even with our mindset coming in to play Have you have you found the same is true for you?
Tracie Taylor 08:26
Yeah, absolutely. I think that we approach things differently. And maybe it's, you know, think twice about decisions and, and changes in the companies. And also in my area. We are a huge oil community here. So when the oil industry has its highs and lows, it affects everyone in our community and all of our businesses. You know, just a year ago, oil was half the price that it is now. And so while Yeah, the housing market crashed many, many years ago, there still have been many struggles, many ups and downs. Between then and now that we still have to be able to weather for the local companies.
Michele 09:08
Yeah, I think that's a really great point. Tracie is the local economy could be contingent on you know, the industry that's in your area for sure. Which could be different for other areas of the country that may not they may be over here celebrating gas and oil prices going down where in your community, it may mean that you know, it changes the way people live drastically.
Tracie Taylor 09:31
It does hugely.
Michele 09:32
Yeah, that's really interesting. So what do you think is the missing piece for you to continue to grow? What are some of the things that you think are missing? I know you had mentioned some types of financial systems that that's something that you want to work on, and I know we're going to dig into that today. Are there other areas that you think that that are missing or that you're working on to solidify?
Tracie Taylor 09:57
Absolutely. One thing that I've done This time that I recently started is I'm working with a business coach. And she's helping me to navigate learning the marketing skills. You know, we are a very good oh boy type of town and word of mouth. But the market is noisy, its noisy with all of the Facebook and other social medias. People can get information and are inundated with information every day. So for you to stand out, it's, it's a little bit different. You're not just you know, they can look at any decorator or HGTV show. And I mean, it's just, it's wild, how much is out there. So she's helping me navigate that. I'm working with her. And also, like you said, the financial systems? Those are my two main things right now.
Michele 10:52
That's interesting. A lot of times people ask me, Should I do my marketing, or should I do my financials first. And I say they go hand in hand. Because if you have a full pipeline, so your marketing is working, and you can't manage the numbers and the money, you're in trouble. But you're also in trouble if you know how to manage the money, and nothing's in the pipeline. So they really do have to go together. And truthfully, our pricing plays into our marketing, we have to know where in the industry where marketing, who is our ideal client, what are the services and packages that we offer. And then the pricing that we put around what we deliver has to be in alignment with what we're marketing, I mean, the whole, in other words, the whole company needs to work as one well oiled machine, right, we it has to be a consistent brand and a consistent, almost internal conversation. And I see quite often I had Kate Greunke on one of the earlier podcasts, and she was talking about having a disconnect between when you meet someone, and then when you see their website. And so then you know, you see it one way, and you meet them, and you're like, I don't know how that fits together. And I would say if we're not careful, the same thing can happen, we spend all this time market market market, and then we still can go under if we don't have the financials, and vice versa. So being able to think of those as working together is really what's going to set us up for success.
Tracie Taylor 12:22
Right. And one of the things that I've learned that I think, you know, others could learn from is that in your busiest times, when you're working your tail off, and you have tons of projects, that's really when you need to be doing the majority of your marketing, so that you do keep that up and coming pipeline full. And so that's kind of a thing. And there was something else that you mentioned, that just popped out of my mind, and that was having your value align and charging the right price. You mentioned something about that. And I learned that from my old company, you know, we didn't have like a specific community and the conversation between peers back then. So I think I may have, in all honesty done a disservice to my industry in the local area, because I was probably undercutting what they were doing. And that's probably why I was so busy. But then that didn't serve me in my business structure. It also didn't serve me with the type of clientele that I often ended up with. So all of that is a huge learning point for me now in this kind of revisited. Company.
Michele 13:32
I love that. And you know, the point that you made, and I stress it all the time, people will say to me, the you know, the pipeline is empty. And I'll say then tell me what you did the last three to four months, and they're like I was swamped, I was the busiest I've ever been. And that's usually when we would, if you think in a car, we take our foot off the gas because we're coasting downhill, but we have nothing to propel us up the other side of the hill, right? We've gone down. And that's the problem is it's three, sometimes three to six months based on the scope of the projects for clients to come in. And so when we are super busy, we tend to pull back on the marketing or not market at all. And then that's what causes the up and down and up and down that we tend to see in the industry. And so you got to you're right, you have to mark it when you're swamped and busy, because as soon as the swamped and busy ends, you want to have something else to move into, unless you're trying to work a couple of seasons out of the year and take the rest of them off. Right.
Michele 14:34
Okay, so we're going to talk about your financials. As I mentioned in the intro, you reached out to me and said I want to learn how to do my backwards financials. You also are looking into Profit First and have talked about that a little bit. And so I said fine. Well, why don't you come on in Let's share this with everybody and make it a learning experience. And so I really appreciate you doing that, I'm sitting here with all my paperwork and a calculator for when we get started. And, and so there were two things that I asked you to do that all of the listeners can do as well, I asked you to go onto my website, scarlet thread consulting calm. And I asked you to download the financial health checkup. And I asked you to download the financial plan for anyone going to my site that's wanting to replicate what we're doing, when you go to my site, there's going to be a pop up box on the bottom right hand side, that will quickly get you both of these documents that you can download. And so I asked you in advance to fill those out. Before we get started, I do want to let everybody know that I have an entire course that creates an understanding of your financials, it creates kind of that base, that foundation, Tracie, that you mentioned that you want, because even knowing what your sales goal is, is not enough to manage your financials for an entire year. It's a number and it's a piece of a bigger puzzle. And so everything that we're going through today, is also taught in my understanding your financials course, which you can also get a link to on my website. Okay, plus a whole lot more. Alright, so let's jump in, I first asked you to do the financial health checkup. And in that checkup, let me tell you what I love about this. What it does is it quickly helps you recognize the areas of your company financials, that maybe you don't have as good a handle on as you think. Because what I see quite often is people come into this and they think I know I need to understand my financials, I know I need to understand my profitability. But it feels so overwhelming so many pieces and parts and cash flows and budgets and balance sheets, and oh my gosh, metrics that they just shut down and the lalalalala don't talk to me. And so what I want to do is go you probably know more than you think you know, and I don't want you spending your time on the piece that you know. So instead, let's look at the areas that you don't feel as confident. And let's work to build confidence in those areas. Because confidence leads to competency, right. And so we're going to It's a step at a time, just like anything, you don't just go open an interior design or decorating business without at least understanding how to put things in a room together in a space together. And so it's pieces of a puzzle, and I just want to build confidence and remove some of that frustration around it. So the financial health checkup for my one to one clients, it's a new thing that I have out. So I've been sending it to all of them. My goal is for them to use it at the end of every year as we're planning our financials for the next year. And then to use it when we do our mid year review. Okay, so I would highly recommend that we do it at a minimum twice a year. If it is something that you're focusing on in your company, then I would say you can do it quarterly just to see the improvement. You know that because we're making these improvements in our business just a little at a time. Sometimes they're sweeping changes, but often they're one in two degree course corrections. Okay, right. Right. So I had you do it to begin. And then what we'll have you do is at the end of this year, do it again, as you're starting to create your plan for 20, all the way into 2019. And then maybe check it again in July after your you've done the first half. And so some of the questions on the health checkup are questions like Do you know what your total sales were from the last year? Do you know what your sales to date are? Do you have a clear sales goal? Do you know your profit margin? Is it defined? Have you set aside this is my favorite funds for owners pay? Do you understand your payroll? Do you have bank and credit card reconciliation processes? Have you implemented a cash management system? So it's asking very detailed questions. And it had you ranked them from one to five on how comfortable you felt with each of these 20 areas? And then it gives you a percentage for your company, a financial health percentage. So share with us when you did yours what would what number did you come up with what percentage?
Tracie Taylor 19:28
For myself are the percentages overall, you can just say my percentage came out to 40%.
Michele 19:34
Okay, so that means of all of this, you understand 40% of your financials. Okay, overall, okay. Our goal is to get you up into that 80% or higher. So you're halfway there, right? That's one way to look at it. Alright, so now what I would ask you to do is look at it. Did you have any fives
Tracie Taylor 20:00
I DID I DO know my sales and my income, my sales income to date. Okay. Um, I know what my average monthly expenses are good. And we do. bank and credit card recommendation process I did mention before when you ask me that I don't have any employees. But I did hire a bookkeeper that did my monthly reconciliation for me and just made sure that everything was straightened out.
Michele 20:30
Perfect. So the first thing that I want you to do, and any listeners who go through this exercise, is I want you to celebrate that you have some fives. Okay, okay, like, Yep, I think we have to start with celebrating what we do know, if we always focus on what we don't know, it's very defeating. So let's celebrate that there are some financial areas of the company, Tracie, that you have a good handle on. And now our goal is to move some of the others up into that same level. Okay. Did you have any fours on your page?
Tracie Taylor 21:03
Yes. So I am aware of where my main sources of income are coming from. However, I feel like that might shift a little as I'm getting my structure kind of figured out and in lined up.
Michele 21:18
Okay, but for right now, you know, it and fours we celebrate. Okay, you get to get a whole nother opportunity. So great. Okay. Um, I'm guessing you probably have some threes?
Tracie Taylor 21:29
I do. Okay. I. Um, so as far as my financial reports being maintained and analyzed regularly, I think I need to get a better handle on how to analyze them well, and have a process behind that. But I do know how to access the reports. I'm using QuickBooks Online for my accounting system. And then my ideal client description and vetting process, I do have one in place. I'm fine tuning that. And also with the help of my business coach,
Michele 22:02
okay, perfect. And so now I'm going to ask you, do you have some ones and twos? I have a whole lot of ones. Okay, that's okay. All right. So here's what this tells us. Right? The very first thing that we probably need to take a look at. And we're going to do, we've already talked about the exercise the piece that we're going to look at today. But in general, when you go back into the office, and you're not being viewed on the podcast, go back and look at all the ones and then you're going to be able to start to make a plan for how to work through the ones. Let's get the ones up higher than they are. And then let's work on the twos. And then you work on the threes. And we're going to work our way up so that we're moving more and more up into the threes, fours and fives, instead of feeling like I've got to work on a four and a one. And, you know, we'll be all over the place.
Tracie Taylor 22:53
And, you know, I feel like the reason I have several ones on some of these questions is because not that I'm not aware that we don't need to have, you know, specified profit margin and goals around these areas of our financials. But what I'm uncomfortable with at this point, in my knowledge base is what is a healthy percentage, what is a healthy goal, you know, for a sustainable company. So that's what I really am hoping to learn today. Okay.
Michele 23:25
Great. And I love that you mentioned for a sustainable company I had Mike Michalowicz on earlier in the podcast journey. And, you know, we he and I had a great conversation. I'm a Profit First certified coach that specializes in profit first implementation for this industry for the interior design industry. And he and I were having the conversation that profit, separate from owner salary. So truly talking about company net profit, outside of all expenses, including owner's pay, actually is sustainability, that when we don't have that dollar amount at the bottom, it is very difficult to sustain without pulling away from the owner. And he talked about total sales or gross sales being responsibility, and net profit being sustainability. And that is what we want to build in. You know, I also just want to make a comment that I often hear primarily women in business, almost have a guilt feeling of having profit and accompany outside of owners pay. And I just want to put that to rest. Our profit is used for a lot of things. It's used to sustain the company. It's used sometimes to reinvest in the company. It's used to create that buffer when all things go wrong when that client wants to sue you. We've got that money there. It is money that is built and then we can maintain some of it in the company so that when there are dips and turns in the economy that you can maintain your staff maintain a building whatever It is that you need to hold on to it gives you that cushion to run your business. And so there is nothing wrong with having a profit. I mean, the goal here is that there is an exchange of what we do with what other people are willing to pay for, right, a good value exchange, we make money, it should cover all of our cost of goods, it should cover all of our expenses, it should pay the owner and there should be a profit. And that's where we have to line up our pricing with our services and our packages. So that's just one piece of it. Then as it flows through the company, we are responsible for managing it, which is, you know what it comes to the point of view asking, so what is a healthy margin and what is allow me to be sustainable. And so we're going to talk through that as we go. And the other piece that I'll tell you is when an owner doesn't get paid, it will absolutely destroy you. Okay, and so the other thing that I see that I'm getting ready to move into with you is in the financial plan, one of the first questions is what do you want your salary to be? And I am often quite amazed at the people that cannot answer that question. Did you find that question on the financial plan? Did you find that to be a difficult one? Or did you already have a number in mind?
Tracie Taylor 26:21
So I had a range of a number in mind. And I had a range of emotions that came up when I went to address it. And part of that was, because I know, you know how tough it's been to just rebuild this year. And so I think, am I being unreasonable by setting this? You know, what, should I should I gauge this on what I find to be, quote unquote, reasonable? Or should I just set a goal go from there? And if I hit it, great, if I don't, then we can address that later. And so that's what I, that's what I did. So I know what I need to have to help my family and then I know what I want.
Michele 26:59
I love that. And, you know, quite often in the financial coaching piece that I do, we do set these up multiple ways. So what do we think is I'm going to use the term doable in the short term, like, I really think that I can accomplish this, what might be a stretch goal, and what is it that I really want? And it may work out to be one year, two year, three year goals, or one year, three year five year goals, but we have to start somewhere. And if we don't even set a goal for salary, how in the world? Do we make a plan to manage it? And you know, I can remember when I first started, I mean, just with complete honesty, my story's already been told many times on my own podcast and others, I didn't come into it thinking how much of a salary I wanted to make, I came into it thinking, here's the small business that I can start from home while I raise my children, and I can make some money on the side. That's what I thought, but I didn't quantify that money. And I didn't qualify how I was going to earn it. And so did I have money coming in? Absolutely. I also had money going out. And I was not managing it in a way that was sustainable. And it brought me to a very devastating point, I probably killed the industry in my area, just like you did. And I was underpricing over delivering. I mean, I cannot even believe what some of the people got from working with me because I didn't know I didn't understand. And then I had a confidence issue. Because of the fact that that wasn't where my degree was. My degree was in, you know, business and, and processes and systems. And I just didn't connect at all. And so I had some of those same struggles until I remember, you know, having a real, direct conversation and realizing that when there was a negative number at the bottom of my profit and loss statement for the year, it meant that my husband had worked to put money into my business so I could serve a wealthy clientele.
Tracie Taylor 29:06
Yeah, I feel like you're speaking my story. I mean, really, with my first company, that's what it was, I can work from home with my babies and do something I love and it'll be extra money, you know, but then then we didn't manage it properly. And clearly, I just did not know how at that time. I've learned a lot since then. And I'm trying to learn more I think I always will be. So I'm excited about this and kind of getting a better grasp on it.
Michele 29:37
So well, let's start and what we're going to do just so the listener can understand we're going to I asked you to fill out the financial plan again, you can find that if anybody's looking for it on my website, ScarletThreadConsulting.com and what the financial plan what this one is that I've created is the inputs that we need to help you determine How to do what I call backwards financials. There is nothing wrong with building your financials, what we would call top down, which is total sales minus cost of goods equals gross profit minus expenses equals net profit. There's nothing wrong with building it that way, especially if you have historical data. But if you do not have that historical data, and you don't have much of it, you know, just less than a year, and that's you're getting started at Ground Zero, if you don't have all of that. Or if you're wanting to pivot or change or do things differently, or even know how to scale, sometimes we have to start bottom up, which is how much do I have to have a net profit? What does that consist of, because net profit can based on the structure of your business can be a lot of things, and work your way back up. And then you can play with this balancing act, if you will, of hours of service and product markup. And we can kind of find the balance that works because all of that impacts gross profit margin, okay. And so that's what we're going to do today is we're going to do a bottom up model, just one version of the model, there may be multiples. And we'll go through and look at that for you today to just to start enlighten you on how you can take those steps, next steps of understanding. So one of the things I asked you was what would I like my salary to be? And the in parentheses says it includes your income taxes. So what amount Did you say you wanted your salary to be? 150,000? Okay. 150,000, and that includes your taxes. Alright, it says my personal federal effective income tax rate is,
Tracie Taylor 31:44
I think this is 24%.
Michele 31:47
Okay, so let me make a comment here for all of us. So there's one thing and I'm not saying yours isn't 24, but I'm just going to explain something, there is our tax bracket, and then there is an effective tax rate. And so your tax bracket is the highest tax bracket that you're taxed in, they're changing all of our tax laws this year, right? 2018. However, the way that has always been done is it scaled. So it means like from zero to x 1000s of dollars, you might be taxed at, say 15%, from that amount up to here, it's 18%. And so it stays are scattered or scaled, the same thing is going to happen. That might mean you're in a 24, 28, 33 bracket, but effectively, it may only be like 21%. Okay, so the way that you can figure that out, and you know, everybody's going to have to refigure out what that looks like. I would say at the end of this year after all the new tax laws go into effect, is I know my accountant, and she's been on one of my podcast as well, Christy lot. What she does is she gives me a sheet with my taxes that says this is that your tax bracket, and then it says here's your effective tax rate. Okay. Okay. Just so everybody knows that. Now, do you have state income taxes?
Tracie Taylor 33:13
Yes. 9.3%. Okay.
Michele 33:16
9.3%, and you're self employed, so we're going to have self employment taxes. Okay. Okay. And those are usually it's like 15.2%, based on the type of are you an LLC? Yes. Okay. So that means you're only going to have to pay about half of that. There's a whole calculator for it, but I'm going to talk in generalities. So it's about seven and a half percent of net income, okay, there's a place on the taxes where they help, you can deduct half, and then they charge you the whole amount on the second page kind of thing. But in effect, that's going to be all of that, you know, Medicaid, Medicare, Social Security, all that kind of grouping of things. So that's another seven and a half. So if we were to just look at that, let's say that you were really at 2424 plus 9.3 plus 7.5. That means you are being taxed overall at 40.8%.
Tracie Taylor 34:14
Which is what I thought it was and that hurts.
Michele 34:17
I know that hurts, it hurts all of us. Okay. However, that is what it is. And so there you know, I could do a whole entire show on how to structure and how to save money with taxes but how to do it legally. We don't want any flags. We don't want any of that, you know, but for right now, we're just going to look at what we have. All right now. Then it says I want to save this amount either an amount or percentage of profit in the company. Did you have an amount for profit or a percentage of profit?
Tracie Taylor 34:47
Okay, so that's where I'm I want to know what the healthy what a healthy percentage would be. So I don't have an idea there. I was shooting at 20% But that's a guess. All
Michele 34:59
right. So I've got my profit first book out, I know what it is, we're going to do backwards. And then I'm going to tell you approximately the percentage based on where you are, my guess is that, that when we do this backwards, we're going to be at about 5% profit. And that, right, which is not that bad. Um, but that is outside of your owner's pay, and outside of paying taxes.
Tracie Taylor 35:29
Some people like you're seeing some people consider profit, before owners pay and all of that. So that's where I want to get that clarity.
Michele 35:36
That's right. If we're looking at a profit first method, we're talking about profit after every single thing has been covered. So it is separate from your pay. I'm not looking at net profit. On an income statement, I'm talking about true profit for the company. Okay, so let's start with that model. And we'll work backwards. Okay. And then I just asked this company, this question, How comfortable are you with a buffer of what amount your company some people like I need to have 10,000 in the bank account to feel comfortable? Some people need 15 to feel comfortable? 7050? How much do you need to feel like, if it was December 31? We're going into January? How much do you feel like you need to carry over to make you not sweat at night?
Tracie Taylor 36:23
At this time? I'm thinking five to 10,000 is where I'd like to be
Michele 36:27
okay. All right. What are your highest expenses in the company?
Tracie Taylor 36:32
My lease my studio lease?
Michele 36:34
And what does that How much is that?
Tracie Taylor 36:36
550 per month.
Michele 36:40
Okay, and what are your average monthly expenses? Not counting cost of goods and not counting your pay? Not counting owner straw, just true company expenses?
Tracie Taylor 36:52
Roughly $900.
Michele 36:54
Okay, that's great. You're running on the lean and mean,
Tracie Taylor 36:57
I've got to
Michele 37:00
How many weeks a year do you want to work?
Tracie Taylor 37:02
Ideally, I'd like to work 48.
Michele 37:05
Okay. And your average work week is how many hours?
Tracie Taylor 37:09
Ideally 30. But my spend a lot of hours, you know, as anyone does growing a business after hours doing things so, okay. Ideally, work 30 hours,
Michele 37:22
okay. You don't have payroll right now. And what kind of method do you use to price? Do you have a flat rate? Do you mark up? Do you do I really combination pricing? Value? Pricing? Combination? Okay. All right. And how often do you monitor your financials?
Tracie Taylor 37:43
Frequently? So weekly.
Michele 37:45
Okay. I always love to answer ghee, monitor what I have no idea what you're talking about. There. Some people have it absolutely marked that. Okay, so here's where I want to start. The first thing we want to do is we want to start by saying what net profit do we need at the bottom so that we can work our way up to sales? All right. So we know that if you are an LLC, your net profit, and this is in general, right? So it's not that we can't fine tune this when we go back to things, but in general, we want it to be made up of your salary, the amount that you're going to pay to tax is an amount set aside for profit. All right. So if we were to take your 150,000, if we were doing this by a Profit First method, what we would do is we would say, I'm going to I'm going to step backwards one other minute here. So let's go backwards one more time. If your expenses are 900 a month, and we multiply those by 12, your expenses are going to be $10,800. Okay, so for a minute, if I had just roughly that, let's say 150,000 is your net profit on a profit and loss statement? And we have, which was your salary, the taxes, and let's say we add in another $8,000, for profit, okay. So that would have your net profit on a profit loss statement are approximately $158,000. We know that your expenses are 10,800. Okay, now, if we were to add those together, so the net profit on the profit loss statement plus the expenses, so 150 8000 plus 10,800, gives us what 168,800 That would be your gross profit, or in profit first terms your real revenue. Okay. Okay. So we already know then, that if we have a gross profit of 160 $8,800 And we spend 10,800, and expenses, which is your average of 900 a month that when we do the subtraction off of that, we're going to be left with 150,000 for salary and taxes, and approximately $8,000 or profit. Now, under a Profit First method, if your gross profit or real revenue is 250,000 or less, a healthy percentage to save and company profit is 5%. So okay, take 168,800 times 5%. That's about 8440. So we were right close with $8,000. Okay. Okay. So you see where this is meant to be just a goal. It's not an exact, we can build an exact model. But right now we're trying to get it pretty close. All right. This is where the next part of the conversation comes up. What profit margins do we want? Right, which is kind of the conversation that you asked earlier. And so what I would say to you is, I am a firm believer that the smallest amount of gross profit margin that we should aim for is 40%. Okay, okay, I'd like for it to be higher. But 40% is kind of like, barely getting in there to be able to run this thing without killing yourself. Okay, now, how we get to a 40%, gross profit margin is a mixture of how we're charging for product and service. Okay, all right. And so if you are marking up as you can imagine, 1020 30%, you're going to have to make the rest of the money with what services, if you're marking up 4050 60% 8090 100%, you're going to be able to make less with services, or sell all the services you want and make even more. And so when we really start thinking about how we're going to initially structure it, and then how we're going to grow it, we have different ways to bring that money in from markup on product. And from service dollars. Gotcha. Okay. So if we were to start at 40%, that gross profit margin is 40%, we just have to do the math. 168,800 is 40% of what number,
Michele 42:38
and that number is $422,000. The way we get that is we take 168 800 divided by point four, zero, and that gives us 422,000. If you take the 168 800 and then divide it by 422,000. It again gives you the 40%. If you were to take 422,000 times point four, it gives you the 168. So it's a way for you to check your math. Okay, that's the beautiful thing about math is we can check it multiple ways. Yes. Now the difference between 422,160 8800 is what cost of goods? Yeah. Right. So then what would our cost of goods be? It's going to be 60%. So we can do an easy way to 422,000 minus 168,800. Your cost of goods, so your product cost or items that are going out as cogs could be subcontractors or whatever, is $253,200. Got it. So in this model, we're going to have a net profit of 158,000, which is our salary, taxes, and profit, we're going to have expenses of 10,800. Together, when we add those up, it gives us a gross profit of 168. Eight. If we use the minimum of 40% margin, then we can figure out the top two. Let's look at this for a minute and just see what would happen if you had the gross profit margin of 168 800. And if that were 60%, if it were closer to the top. When if I were to ask you to guess do you think your total sales would go up? Or do you think they would go down from the 422?
Tracie Taylor 44:39
I think they're going to go down.
Michele 44:41
You're right. So let's look at that 168 800 divided by point six $281,000.03 100 $281,333. So two, eight 1333 minus 168 800, your cost of goods are only $112,533. So what you see here is, cost of goods can greatly vary based on marking up, you'll see on this bottom model where we let our gross profit margin be 60%. That means we're marking up our product, a healthy portion 75 80%. And then we're making the rest of it probably in services, it doesn't mean we're marking up with 110 120%. In most cases, it just means we've got an extremely healthy markup on product. Or if you're looking at it, we might have a 5% discount off retail of MSRP. Right. And then we're charging healthy for our services. Now, I can have a smaller company, if you're looking at total sales, but I'm still making the same amount of money. This is the conversation that Mike McCalla wits and I had, I'll take the company all day long, right? That that makes money, it doesn't have to be a half million-dollar company. Right? So it really has to do with how much you're willing to markup can markup how your value pricing what you're doing? But do you see how in both of these examples, Tracie, one of them was 422,000 in sales, with 253,200, and cost of goods and a 40% gross profit margin. But it gave us the same gross profit margin as a company that sold 281,333 With only 112,533 is cost of goods, but the way it flows through the rest of the company is the same.
Tracie Taylor 46:57
Yeah, got it.
Michele 46:58
Okay, this is also why it's easy for me to work with companies of all sizes. And I'm not always looking just at gross sales, total sales is great, but that means that you're a great salesman, what I really want to look at, and this is why in the Profit First methodology, we look at that real revenue, which is total sales minus cost of goods, or materials and subs, right? Not on a job costing side, you know, so we're not like taking your time and applying it to the job. That's not what we do and profit. First, we look at true cost of goods as materials and subcontractors outside of the company. So if you look at that, you can see how in these two companies, total sales cost of goods are different. But what really matters is what are we doing to run the company, which is in our case, this gross profit slash real revenue number of 168,800, then it comes down to how do we manage it going down? Right? Now, if we were to look at this under a profit first model, okay, Profit First doesn't say a whole lot about cost of goods, because that that truly changes based on the model that you have. And that's where I go back to the model of our industry, that the goal would be that your gross profit margin would be 40 to 60%. So of course, as it goes from 40 to 60, cost of goods goes from 60 to 40. So the two of those together, percentage wise, total 100%. Right. Okay. So if we look at this gross profit, with a gross profit, or a real revenue of 250,000, or below, I would say the starting point for your expenses should be 30% or less of that number. So let's do that math. 168,800 times point three, that would say your expenses could be up to $50,640 and still be considered healthy. Okay. Now, here's what I would say about this piece. This is where it really comes down to managing setting goals. So notice the goal that you set for your salary. Okay, that's a very great goal, healthy goal. But what it does is it means you have to really manage expenses, because the same way we had a trade off between cost of goods and gross profit, we have a trade off between expenses and net profit. As expenses go down, net profit goes up as net profit goes up expenses go down the total of those two total 100% of gross profit in the Profit First method. Okay. Okay. And then profit for is for a company this size. The goal is to have 70% Is that right? Yes, net profit, which is 50%. Owners draw 15% of real revenue for your taxes and 5% for profit, there's so many numbers, I have to stop and think of them in my head. Okay, so if we were to look at that for you, just to look at that method 168,800, which was your real revenue, gross profit, if we looked at the 30%, we said it could have been up to 50,000. Right? Now yours is a lot lower. So 10,800 divided by 168 800, you were only at 6%. That's amazing. That's how that's why the minute you said it, I said lean and mean. And that just means that we're going to take that the rest of the percentage, the other 94%, and push that down for what we would call owner's benefit. Okay, we got to you. That's what you've done already. It's managing those expenses. Because if we look at in your example, having 158,000 at the bottom line, and we divide that by 168 800, that's 94%. So that means 94% of all the real revenue or gross profit that comes into the company is for Tracie's benefit. So it either pays your salary, it can pay your 401k, your IRA, it can pay your taxes, it can pay profit in the company, but everything there is your benefit, as the owner of that company.
Tracie Taylor 51:32
Gotcha.
Michele 51:34
And this is how you go back and forth and play around with what is my markup so that I know what margin it's going to create. What do I so let's say that you thought to yourself, I'm going to need to bring on an assistant next year. So let's just skip all that for a minute. Okay. And let's say that on average, you're going to need to pay this person, let's say $1,000 a month, we'll keep it pretty low, pretty easy. So that means we're going to need to do what we're going to need to come up with an additional $12,000 In our expenses category. So where is that coming from?
Tracie Taylor 52:13
So that 12,000 is going to come from the Tracie's benefit.
Michele 52:19
Or we're going to have to increase real revenue. If we're starting at the bottom and going up, we're going to increase. If we're starting from the top going down, we're going to decrease Tracey's benefit. So since we're in plan mode, we're going to start from the bottom and go up. So we want to keep your 158 at the bottom. Okay. Now what we're going to do is where you had 10,800 As your expenses, we're going to add 12,000 to that. So that now becomes $22,800. Right? This 10,800 I'm going to just double check on my calculator, because this is the equivalent of working on a whiteboard in front of 5000 people even though I'm doing it in my head. Okay, so now let's add those together. So 22 800 plus 158,000, our gross profit, real revenue number is 180,800. Do you see that working bottom up? And if we were to take that number and say it's 60% of what number, that number would be $301,333. So we have to earn 20,000 more dollars to pay 12,000 more dollars. Got it? If we keep percentages. Okay, do you see how that works? Yes. If we were doing top down and we did not adjust our sales, then it is going to come from the net profit, which was your money, right? We could also go top down and make it something that we earned service based, but that might start changing could potentially change or as profit margin. That doesn't mean it's bad. It just means it might change it. Okay. Okay. And so what I usually do is I plan my next year bottom up, and then I look top down. And then I start asking Where do I want to make trade offs? And do I want to look at my pricing model? Is it serving me? There are many designers out there that are marking up 10 and 20%. And that's all they're marking up? Well, the only way to get what they want is they've got to sell a gigantic amount of product. Right? That's such a low market. You mean you got to sell so much, or you got to have a an extremely high hourly rate that they may or may not feel comfortable putting out into the world. And so it literally is creating this little petri dish, that is not what they want to grow. That's not what they want to get. So what they have to do is figure out where do I want to be uncomfortable? And I'm going to am I going to be uncomfortable is the client going to be uncomfortable, I got to work through it. And so, you know, really finding what is a reasonable rate for your area, I don't think there's one right across the country, I can't stand it when people go, everybody should be charging 100 an hour, or everybody should be charged. Listen, there are certain numbers that I think are good and fair and reasonable. But we have to know a few things we have to know the area in which we live, we have to know the industry or the area that we serve. Because where you live and who you serve can be two different things. You need to understand what knowledge what experience, what are you bringing to the table, we can't just come out and charge 200, because the designer decorator down the street charges 200, if our works not worth 200. But we also don't need to charge 100 If our works with 200, because the designer down the streets only charging that. And so it's a very personal conversation that we have to have that says again, is there a fair and reasonable exchange between me as the service and product provider and my client, I want to feel that it was fair and reasonable. And I want them to feel that it was fair and reasonable. Right. And so that's why our pricing methodology, strategic and tactical, has to fit into our profit methodology into our cash management, and into how we determine our financials. And all of it is to sustain. So like, let's say that you looked at what you did last year, and let's just, I don't even know what your numbers are. So I'm just gonna say, let's say that you looked at this and you said, Okay, I'm going to go on the higher for gross profit margin. So this year, I need or 2019, I need to sell 281,000. But say last year, you only sold 50,000. That's quite a job. Right? And it for some it may feel unattainable. But what I would say is look at the pricing model that you use for 50,000 and ask yourself, will that pricing model? Will that pricing strategy support you if you need to make 281,000 or if you need to make 422,000? It may and it may not? It may be that the pricing strategy was perfect, you didn't have enough clients. And now we got to go fill that? Well, it may be that pricing was fine. But efficiencies within the company cost overruns, which caused all kinds of cost of goods mistakes that you had to eat that you didn't get a markup on, or that caused inefficiencies in the company that you had to pay somebody to come in and fix, or that you lost money on expenses, or time that you weren't billing for that you should have been billing, or that you had broken communication that you can bill for. So there are so many areas for profit to leak out of our company to truly make it work. We've got to keep an eye on it all the time. Right? You probably feel like you just got hit with a fire hydrant?
Tracie Taylor 58:19
No, I mean, it's a lot of information, but it is exactly what I was looking for. And you're so right. I mean, we need to be doing checks and balances after every project in the middle of them, you know, to be making sure that we're not leaving those gaps.
Michele 58:34
That's exactly right. And I will tell you, when the biggest place that I would say that I see most designers losing money, the biggest profit Lake. Let's assume for a minute that they plan to be profitable that they don't wake up in the morning and think, oh my gosh, is Tuesday, I think I'd like to lose money today. So I'm assuming that's not how we wake up right? So let's make the assumption that they plan to make money. Here's what they don't do by enlarge, or here's where they struggle. And that is keeping up with their time. And I have to tell you, Tracie, our time is one of the biggest currencies that we have. And
Tracie Taylor 59:17
Yeah, and let me mention here something that I learned and I also have experience in project management and project controls in the oil industry and electrical industry. And so I learned a lot from them on the back end and it applies to what I do and we even down admin staff when you are working on a project you are noting your time in 15 minute increments. So if you if you are you know and you can set that up, however you're comfortable with your company, but if you are just doing email correspondence, you might want to mark it down for at least a 15 minute increment. So that You are charging for your time it adds up.
Michele 1:00:02
That's right. And all of that needs to be in your contract or letter of agreement how you do that. But I agree in the 15 minute increments, and my sons are in construction. And when they are building these huge multimillion dollar projects over multiple years, they're building their time out to the projects, because they're working on more than one sometimes. And they have to build their time. But what they do is they look, they estimate just like we do, this is how long I think it's going to take, then they keep up with their time. And then they do what we've always called in software, a post mortem. Alright, so how much time did it really take? And what did I build for so that next time I use the inputs from the actual, not what I thought, because when we think about it, Tracie by and large, we think low? Surely it doesn't take that long. Certainly I can do this in 20 hours when historically it takes 30 every time. And so we're losing 10 hours over and over and over. If I were to, I'm going to ask you, I've done this with quite a few people lately, I'm going to ask you, if you had to and just be honest, if you had to tell me how many hours a week you think you lose that or billable that could be build that you're not billing, either because you didn't have the confidence you didn't keep track of it. You felt like they won't like that for what ever reason? How many hours would you guesstimate per week that you don't bill that you have the ability to bill?
Tracie Taylor 1:01:31
I mean, I'll just give you an
Michele 1:01:35
just an average number. What would you think?
Tracie Taylor 1:01:37
Maybe an hour or two? I really don't? I'm not billed for my time. Not No, not now that I had the experience that okay, um, the other industries that I worked in? Had you asked me that question, and my first company, I would have been probably astronomical, my confidence level wasn't there. And just knowing how construction industries as a whole in all these different areas of work, actually do work when you're working for a corporation? Yes. Perspective?
Michele 1:02:11
Absolutely. Okay. So let's just go with two hours, then since you have your systems in place, because that seems like a small amount, no big deal. Maybe if I forget. But that's right. That's right. And that's fine. So two hours, and we did I did it for 48 weeks. And what would you say an hourly rate should be? What should we do your billable hour will be right at 125. Okay, so 96 times 125, that's $12,000. Right? That can be lost for two hours. For any amount of reasons, I'm going to tell you what I hear is somewhere between five and eight hours, which you can see if you go back and look at your first business where your eye wasn't on that. Because what happens is they're not keeping up with it. Or they wait two or three weeks to fill out the time. And then it starts to get fuzzy. And then they feel like I can't really build for that. And it just creates this cascade effect. So let's just get five hours, times we'll keep the same 48 weeks, we'll keep the same amount at 125. Best $30,000.
Tracie Taylor 1:03:17
Yeah, that's steep.
Michele 1:03:18
That's steep. :Let's do eight times 48 times 125 $48,000. By missing eight hours, I just didn't mean for one client, that just means eight hours during the week, which could have been a little what, two hours a day or hour and, you know, 45 minutes a day or something like that.
Tracie Taylor 1:03:40
Yeah, I think another area in our industry that's tough for a lot of a lot of us is drive time. Yes, the ones all of a sudden, you're spending all this time in the car and not billing for it. And even the act of doing the paperwork in putting my time into an invoice and into my financial system. I charge for that as well. And so if I'm doing it, then I'm charging that or maybe in my contract, I have an administrative rate that I charge for that. But I'm just out of my own experience, try to line all those things out in your contract ahead of time. And then you can always have that as your backbone.
Michele 1:04:22
That's exactly right. And writing these things in your contract or your letter of agreement. It really does give you a backbone, having this goal set up now I'm going to tell you the second part I do when I create my financial goals every year, I create a vision board. And on that vision board, it is visual. So I've got pictures, logos, things that I am working for, so that when I make that $158,000 And I pull that salary into my house, I know what it's going for. So I've connected those dots. And so when I have the goal, like if we were to take your was the first one When we had the 281,333, and we divide that by four, I now know your quarterly goes a little over $70,000. If I were to take it and divide it by 12, little lover, oh, that didn't work out 281,000 divided by 12, what, $23,417 a month, now you have a sales goal. So now when you walk out of the house, you know what your liver ate. But right at $8,000 a week, I have a plan for walking out of my house this week, I need to sell $8,000. And if I do, I'm tracking towards where I want to be at the end of the year. That's why I say in this podcast all the time, the number at the bottom of your profit and loss at the end of the year, is just an amalgamation of every choice you made all year. Because you have to make the choices all year that get you there is like the goal at the end of the race, you got to run the race to get there. But every decision counts every eight hours a week that should be billable that we don't bill for matters 40 something $1,000. That's huge. That's a salary. That's the admin person that we want to hire and don't know how we're going to pay them.
Tracie Taylor 1:06:17
Yeah, absolutely.
Michele 1:06:18
So is this been helpful?
Tracie Taylor 1:06:20
Yes, immensely.
Michele 1:06:22
Okay, great.
Tracie Taylor 1:06:24
I'm kind of excited and nerdy nerding out a little bit about my numbers. I know, you didn't know my Excel spreadsheet.
Michele 1:06:31
Well, I'm excited that somebody can nerd out with me, because most people, I think people really want to know this. But they don't know what to do with it. They don't know how to necessarily apply it to themselves. And, you know, this is what I do all day, every day is help people have financial freedom in their business. Because if you have financial freedom in your business, you can work towards financial freedom in your home, they're all
Tracie Taylor 1:06:55
tied up. And I love numbers, I like to have the confidence in my numbers. So really, the huge piece for me on this was understanding what healthy percentages are and how to how to use that to structure what I want to accomplish,
Michele 1:07:10
right. And I would always suggest that we start if you're looking at the Profit First methodology, start with the numbers that they recommend. But then we tweak them. Like if I were to work with somebody, and they came to me and they had these numbers, but they had, you know, an admin or they had, we would start to tweak here and there, we still can get to the numbers that you need. In most cases, we just need to tweak it. The other thing that I was going to say is primarily, and this isn't true all the time. But I'm going to tell you one other big hole where I see people getting themselves in trouble. When your gross profit is 150,000 or below, you really cannot afford help. And I see a lot of people getting to $150,000 gross profit and real revenue, and running out and starting to hire admin or hiring another designer. And that's not bad. But I want them to stop and think before they do that way. If the sales don't increase by this action, if it's not a billable subcontractor or employee that can build the majority of their time plus some right. If that's not what they can do, then the only place that money can come is from your pocket, which is just what I said earlier, if I have to add the 12,000, but I haven't adjusted the model. And so we get a lot of people I do that are making 150,000 in gross profit, however they're selling and marking up. But at the end of the day, they're not making anything as the owner because they're paying their staff. So in general, I would say 150,000 can maintain about one person, because the 150 we're going to take expenses out, we got to take taxes out, it really can maybe maintain one person, it takes more than that to maintain two, three or four. Right? And I see it all the time. And I get it because there's a lot of overload. So what I would say to that is get your systems clean. Think about project management software, get those things done so that instead of hiring people, you've got systems and technologies supporting you, then hire the people be ready to hire the people. And I need you to make sure that you're hiring people that are billable unless that number is big enough to absorb both.
Tracie Taylor 1:09:38
Right. You don't just need general overhead. You need what you can build the project. Exactly. Yeah.
Michele 1:09:45
Any other questions? Tracie? You have been such a great sport. I really.
Tracie Taylor 1:09:51
I mean, it's a lot of numbers. And I think maybe hearing it on the podcast, you know, people might have to listen to it a time or two and to absorb it. But it's so valuable to just kind of have an idea of where to start from with a structure.
Michele 1:10:06
Absolutely, absolutely. Well, thank you for reaching out, I, you know, I put the call out there, if there's something you want to know, something you want to hear, and you took me up on it, and made me really think about a different way that I could do this particular podcast and meet your need, and the need of the listeners, because I knew, you know, mine is normally an interview style. And I knew that the minute you asked that question, it was taking me outside of my standard style. But I know it's what everybody wants to know, because I build a whole business on the fact that most people don't know it. And, and so I really appreciate you working back and forth with me and doing the pre work to be able to have a session today where we can look at the different numbers. And yes, I know, I go fast. Yes, I know, my brain works really fast with this, but I've done it for 10 years, and built software to do it, you know, years ago. So it's just, it's just a natural way of thinking for me.
Tracie Taylor 1:11:05
Right. And I think that's one thing that all of us are doing when we're starting out. And we're solopreneurs mean, this whole big thing that we call business and our craft, and we don't have to have 20 years of experience in every little aspect because we have people like you that we can call upon and and get that coaching from so I feel honored that I got the opportunity to be here today and get gained some knowledge from you.
Michele 1:11:31
That sounds great. I'm so glad you were.
Michele 1:11:33
So I do want to let everybody know that if you want to go through your own personal exercise similar to Tracie's, you can go to ScarletThreadConsulting.com. And again, you're going to want to download your financial plan and you're going to want to download the health checkup that is out there the financial health checkup. And you can use both of those listen to the podcast, the beautiful thing is it's recorded, and you can go through it over and over and stop it and do your numbers the exact same way. It was so good to revisit this podcast and my of the others that we've done. If you have questions that you want me to answer on the podcast, you can email me at support@ scarletthreadconsulting.com And I'll try to answer them and hopefully on the podcast. If you're interested in taking a course to understand more about your financials, we go through this exact exercise that Tracie and I covered today in the Understanding Your Financials course which you can find on my website at ScarletThreadConsulting.com and you'll see that under the resources tab. Please please please do the hard work to be profitable. Because profit doesn't happen by accident. Profit is a Choice is proud to be part of the designnetwork.org where you can discover more design media reaching creative listeners. Thanks for listening, and stay creative and business minded.