246: Creating Good Financial Systems
Michele Williams
Hello. My name is Michele, and you're listening to Profit is a Choice. Joining me today is Kelcee Sparks with Elite Ops, and we are going to be talking about financials. This is always one of my favorite topics to talk about, and so I'm excited to see and to hear the questions that she has for me.
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. Hey, Kelcee, welcome to the podcast.
Kelcee Sparks
Hey, Michele. Thanks for having me.
Michele Williams
It's my pleasure. We are back doing the Q&A and answering some of the most burning questions that we've been getting either asked in person, at our event that we held a month and a half ago, or also that our clients are asking, or that people are writing in. So, today we're about my favorite topic financials.
Kelcee Sparks
Okay, so I have some really good questions today. I'm excited to hear what you have to say.
Michele Williams
Okay.
Kelcee Sparks
The first one is simple, asked a lot by people who are learning more about what you do. What basic financial concepts should every interior designer be familiar with?
Michele Williams
Basic financial concepts. All right, I'm going to take a step back and actually say that I think the basic financial concepts that every business owner should be familiar with, and I think sometimes we think that our industry might make the answer different and I would suggest that, by and large, it doesn't. On basic financial concepts, I do think there is some more specific or niche kind of maybe metrics that we need to know. But here's what I think is really important for basic financial concepts, let me just say I didn't get these questions far enough in advance to actually think. This is going to be right off the top of my head. So here we go.
The first is I think every business owner should understand their major anchor points, especially from a P&L. What does that mean? It means I think they need to understand revenue, and how money comes into their business, and I think they really need a good understanding of what portion is product-based and which portion is time, billing, design, or service-based. I think they need to know the amount of their cost of goods and the percentage. I think they need to know their gross profit number and percentage of gross profit as a percentage of revenue. I believe they need to know what their monthly net or their expenses are each month for operating costs, and I think they need to have an idea of net profit. That's a basic understanding. I think they need to know how money flows through the business. Meaning when does it come in as revenue? The money that goes out, is it for a product and service or is it going out for an operating expense, and what type of profitability do we have?
The next basic thing that I think most business owners need to know is they really need to know where they make their money. You know, we've had a lot of conversations recently, Kelcee. I was at the Profit First convention and then I went to the Exciting Windows convention and then I went to the Custom Workroom conference, so I've been doing a lot of conferences and by the time this one comes out, I'm probably going to be at Luann Live. These conversations are happening everywhere, whether it's design, window treatments, or across all industries like at Profitcon. One of the things that came up there when we were talking about numbers and money and basic understanding is also knowing kind of what is the framework for your pricing model. Are you pricing based on a markup? Are you pricing based on a margin? And honestly, those are two halves of the same whole. One is just taking a number and going up and one is taking a number and dividing it into another. So, they have a direct correlation and relationship to each other. Just knowing how we look to make up profit in our company, whether it's by marking up or buying a margin, whatever it is, understanding that at the basic level so then we know how to make money, we know how money flows through and then just knowing what it takes to stay in business. That is the basic to me, that's like the dirt level of what we need to know and understand in a business.
Kelcee Sparks
Perfect. So, if everyone listening knows those things, let's talk then about how a strong grasp of your financials contributes to the overall health of a business.
Michele Williams
It's really interesting. One thing and I know that you all remember this when we just did the strategic planning event that we host every year, one of the things that I think was an AHA for some people, even though we talk about it and we say it, we kind of gave a moment of silence for them to do it. And in the doing, sometimes I believe that there is a bigger weight or importance to some of the choices that we make than when we just brush by them. Yeah. Yeah, I know. But one of the things that we actively had them do, Kelcee if you remember, was I had them look at every item that they had written into their strategic plan for the next year, everything that was on that goal list for the next year and to assign a dollar amount to it. Whether it was based on time or based on a sale of something or based on the expense of something. So, whether it's money in or money out, and that created a lot of AHA. I think sometimes we put things on the list to be planned for or to come in the future, and we don't know what that's going to cost.
The other thing that we talked about in that same conversation was if you have a limited amount of money and you say yes over here, what are you saying no to over there? Because you can't keep spending the same money three times. I mean, people have tried that and that's why they're in trouble. That's why they took money into their home that they shouldn't be taking into their home, or that's why they overpaid on a bill and they underpaid on another, and they don't have the money, because they just didn't keep up with the flow of everything. But knowing that saying yes to one thing could mean saying no to something else. It's not yes, yes. There are some yeses and some no's.
So really, knowing our financials gives us the ability to know when we are going to do a task, how much more it's going to cost us or save us, and then it also gives us the ability to know if I say yes over here, then I need to say no over here. It's a strength position of I own this bucket of money, or I have the task of managing, because it's not always what we own, if you will because we're going to be paying some of it out, but I have the task of managing this bucket and I want to manage it well.
The third thing that I would say is that the net profit has a huge job. Huge job. And quite often we don't look at the job of the net profit. And so one of the tasks that I had asked people to do as well was to write down the job description of the net profit in their company. So for some people, the job of the net profit is owner's pay or additional withdrawals that the owner is going to take for distributions. It could be paying taxes, it could be paying 401K or retirement or bonuses to your team, or capital investments and something else. But if we don't understand money coming in, money going out, and money saved in the relationship of money, we can't really make informed decisions because we don't even know what we're basing it on.
Kelcee Sparks
I think one of the things that we hear a lot when we talk about the things you just mentioned is, well, I've done this. I've taken too much money into my home. I haven't paid myself in two years. Different mistakes. Can you kind of talk a little bit more about those mistakes that you see from business owners often with their finances and how they could be avoided with some different processes and systems?
Michele Williams
It's so interesting, the idea of I paid myself too much or I didn't take any pay. It's just the flip side of the same problem. And that is not understanding what the money is there for and where it needs to be allocated. One is overindulgence or thinking that the money is free and clear to be allocated into your home, and the other is actually a fear-based result of I don't know where I have to pay that money, so I'll leave it all in the company and I won't take any home out of fear that I might be accidentally taking out money that should be used somewhere else. They both are just different reactions to the same problem, which is not knowing and understanding how that money needs to be spent.
The way to avoid that is to have a plan for your money. I think most of our listeners know by now that I'm Profit First, certified since 2015. And what that really means is it's not about just taking money out of your company; it's about being very clear on how the money is going to flow through and how it is going to be used. What that means is allocating a certain amount of money that can go into profit for the company, but we also allocate owner's benefit, which is money that can come into the home of the owner to be spent free and clear, separate from taxes. We also save tax money as part of a Profit First strategy. Profit First is simply a money management strategy, which means we're going to tell you how to manage the money. Now, I am not a purist in that I've said it before and I'll say it again, by a purist I mean I'm not just a please go set up the five accounts, and this is the percentage that you put in every account. Instead, I think it comes down to every business having to look at how they bring in money. How do you recognize revenue, what are the needs, what are the cycles of your business, and what are the first accounts you need? Where's the biggest problem that you're struggling with? Then it's creating a strategy, a money management strategy, Profit First, if you will, that overlays on the company as you run it, so that we can keep you cash-flush, cash positive, and then when we bring the money into your home, you can spend it that way. We're not leaving an excess of money sitting in the bank account, but we're also not bringing in money into our home that should be used to pay for a bill.
Kelcee Sparks
I think that also leads to my next question. I'm trying to think of some of the other things that people have asked about this. It's just all about healthy cash flow. When digging through questions, one of the things I kept seeing was, how do I do it? You just spoke about Profit First. Obviously, that's a big way. Do you have any other advice as far as maintaining a healthy cash flow in the business?
Michele Williams
One of the reasons I feel a little bit hesitant, I don't want to give too much detail, detail only because I think it can be different for each company. People who give a lot of big, sweeping characterizations of things, it kind of makes me like, do you really know what you're talking about? I'm going to say it this way.
The goal is always to be cash flow positive. The goal is to have money. Cash is still king, right, as far as the number that we have in a bank account. So, a couple of things. One I would say really is about creating some type some type of Profit First strategy, which means, first and foremost, watching the money, looking at the money, knowing when the money comes in, knowing how much we need to pay out every month kind of tells me how much I need to be bringing in every month to satisfy that particular need of the company. Also thinking about what I need to do to minimize expenses. What do I need to check for my balances?
Here's another big thing that I see, and Kelcee, I know that you see this as well is people that don't keep their accounting systems updated. Well, the numbers that we get, that we have to work with are only as clean as the last time we updated the data. For example, if I'm looking at a balance sheet from a month ago, that gives me the balances in my bank account as of a month ago, the balance in my bank is only telling me what has already cleared the bank. Some bank accounts might say, this one is pending, so you have an idea. But for the most part, it's not counting the six checks you just stuck in the mailbox. They're not there, right? Or the six bills that you just paid that haven't automatically drafted out yet. We don't have that. I see a lot of people waiting and updating their financials at the end of a month. Well, that's all fine and good if you're only going to look at things at the end of the month when everything's reconciled. But what happens in week two? What happens in week three? What happens right before you reconcile? You can go for a month. Think about that. Just in a month not knowing what the cash position is. Now, compound that by two or three months of not entering your invoices, not entering your bills, not having your QuickBooks tied to your bank accounts or whatever system you're using, and not keeping it completely updated all the time. How do you ever really know?
The challenge is with these interior design businesses that are rather large, that have a lot of products running through the company, you know like I do, because you've looked and worked and helped in procurement. We're talking lots and lots, hundreds and hundreds if not 1000 or more products. Ding, ding, ding, ding, ding, ding ding, going through that business. And so, if we're not entering all of those and we're waiting or we have broken links between our project management system and our accounting system, and we're not cleaning those up and we're not reconciling, we honestly are trying to manage the business with a hot mess, a super-hot mess. I will say it's not just the big businesses that are in trouble. I can see smaller businesses because they have this idea sometimes, and I've had it myself. I can remember one time, and I am telling on myself, been there, done that, done it wrong. I waited until March to reconcile my books from, like, the past May or June. So I had almost nine months of reconciliations to do because I'd gotten into a bad habit of thinking it's all so small, I can keep everything paid off. It's not a big deal. I'll tell you, the older I get, it is hard enough for me to remember detailed transactions from two to three weeks ago, but to try to remember nine months, some detailed chargeback, change this, refund that, there was no way I couldn't do it. The smaller the business, honestly, in some ways, the more we have to stay on top of some things because we tend to go longer before we clean them up. At least a large business usually will clean it up a little bit faster.
Kelcee Sparks
That's perfect. And I think we've all been guilty of waiting a little longer than we should have to clean up our books. You talked a little bit about minimizing expenses. We had a very specific question a few months ago. A designer came and said, hey, Michele, my business does about $800,000 a year. My expenses are like $750,000 a year. It doesn't feel like my numbers are lining up. Can you provide some insight about those types of financial situations where you are doing quite a bit of business, but perhaps aren't making the profit that you think you should?
Michele Williams
This is going to sound so weird, but I think I've only done it twice that I can actively remember where I have had to ask people to quit selling because the more they sold, the more in trouble they got. When you're losing money on every sale, then to sell more is not going to ever work. You'll never work your way out of that. I had them stop selling until we could revamp the entire sales process and the pricing. Usually what happens, Kelcee, in that example of, let's say, $800,000 in sales and their expenses between the cost of goods and the business and everything was $750,000, they might have $50,000 left at the end of the year from the whole thing and they may or may not have even been paid in that and still have taxes to pay. Here's the challenge. I've always said that making money is easy from this standpoint, sell the right product and service to the right person at the right price and manage the heck out of it.
There are two expense, large expense categories on a profit and loss statement. And that's going to be your cost of goods and your operating expenses. We have one big income place called Revenue. Now, yes, some of its product and some of it is for time billing or design time, or consulting, or however, we do that labor or service base.
The first thing we have to do is sell the right product, the right service, at the right price. So what that means is really making sure that we are marking up as much as we can with integrity. It's also making sure if we're looking at margin, that we have the highest margin we can. I am shocked by people who are marking up 20 and 30% and they think that they're going to make money. You're not going to make money only marking up 20 and 30%. You're just not, your expenses are going to outrun you every time. Now, I get that could be a balancing act with also charging for time and so it could come into play that you're marking up, I think, 20%. Personally, I just believe it to be way too low. I get that there are some things you can markup 15 and 20%, but overall, I would not use that as a money management strategy. When you're looking at making money, the first thing we have to do is sell the right product and the right service, so that means the product or service that you love to do, that you can do well, that you're equipped to do, that you have processes and workflows created so that you can do them in less time, and that you can do them at a service level that you're proud of and then that it's priced properly. That's the first piece.
The second piece then is to sell it to the right person. If you sell to the wrong person, look, if you've got the wrong client, you're going to know and they're going to cost you in time and they're going to cost you in money., and so then they're just going to cost you. So right product, service, right price, right person. All of that is what sets us up at the beginning to try to start making money.
Once we've done that properly, the next two places for money to come out are going to be expenses. The first one is going to be the cost of goods and that is where we're paying for the product or service that is tied to the sale. If we did not mark it up well, if we don't have a high enough margin, that's the first bite, if you will, out of revenue. It's taken the first big chunk and we can't do anything about that except pay the vendor who provided the product or the other service that we charge for. We have to pay them. You're going to have to pay FedEx as a service provider. You're going to have to pay your receiver or they're not going to give you your goods. You're going to have to pay your vendors or you're not going to have products to put into the home. So immediately that's the first bite. That tells me if we price well, if we price well and manage our cost of goods well, which makes sure that we're working with the right vendors who stand behind their product, that we're not having a lot of mistakes in the ordering process, that we're not having a lot of chargebacks, that we're doing business well, that means I come up with a really great gross profit, which is the money that I have to run the company.
Out of gross profit, the next chunk, if you will, the next bite out of that gross profit is going to be operating expenses. This is where I'm looking at do I have the right people on my team. Am I paying them the right amount for the work that they're doing? Do we have wasted time on processes again? Are we spending money on a tech stack for tech we don't use, or are we using our tech well? Are we making good on the resources that we're using in our firm? Pen, paper, ink, seriously, all the things are we buying everybody.
I've used this example about green smoothies every day. That's fine as long as they understand that's part of their pay because that is an expense that is coming out of gross profit. That is reducing bonus money if you're bonusing based on net profit because it got spent on green smoothies every day for ten people in an organization. Just saying. It's little things like that where we sometimes think that we're giving something that's awesome, but it's chewing into the profitability in such a way that if you ask that person if I could give you $2,000 at the end of the year or would you rather have a green smoothie every day that you come to work I will tell you most would say give me the $2000, I'll get my own green smoothie, but we're not thinking about it like that. So just really managing the money well. So right product, the right service, the right price to the right person and manage the heck out of it.
When I see a company that has $800,000 in sales, it tells me that they're good salespeople. They have the ability to sell. Now I want to see if they have the ability to price. I'm going to look at the difference between revenue and gross profit. If they can sell and they can price, I'm now going to look at how well they are in managing their money, and that gives me information for net profit. Honestly, Kelcee, the way that we go about looking at all of this is not only as a number but as percentages. We are setting key performance indicators if you will, or metrics that say, I want to measure this because here's what I've set up as a plan, as a budget, or as a financial goal, and this is what I want to manage to how am I doing.
Kelcee Sparks
Against that plan from all of that, no doubt we've had a lot of opportunity to take notes from everything that you've said so far, but are there any tools that you would recommend that would help create these metrics? From my previous life, I know sometimes all these calculations and pulling all the right numbers can take three, or four days every month to do. What do you recommend smaller business owners who may not have three or four days do to be able to track their financials effectively?
Michele Williams
Yes, so the first is, I would say use the accounting software that you have. Whether that is QuickBooks, FreshBooks, Wave, Zoho Books, Sage, Xero, Studio Designer whatever it is, first and foremost, use your accounting software. It keeps up with a lot of data and it has a lot of functionality in most cases. To that to me, would be number one.
Number two, keep up with your time. I would always suggest something like Harvest or Clockify are probably my top two standalone that I would suggest that most people are also using, you can also use something like TSheets that is tied into QuickBooks. I think some of the project management tools like Mydoma and Halspro, have some of that in there. Use your time management systems.
The third thing, of course, I'm going to suggest is Metrique Solutions. In Metrique, we use data from those two systems, along with helping you set KPIs, and modeling things out to show you quickly, very quickly, every month, where are you to what you said you wanted to do. You made a plan for the money. How is that going for you? You said you wanted this as a budget. How's it going? You said this is the plan that you have overall for the year. Where are you to that plan? And so, to me, it's about having a good accounting system, having a time tracking system, and then having a system like Metrique that pulls it all together to be able to look at it. There are certainly spreadsheets that you can create, but again, spreadsheets are constantly needing to be updated or tweaked. Unless you're really great or have paid somebody, you're not going to and usually, most people aren't able to build them on the fly.
Kelcee Sparks
I think that was very helpful for us. To understand a little bit more about financials as far as what you offer, and new offers to come, how can someone come to you for help with something like this?
Michele Williams
Okay, so a couple of ways. First and foremost, we have our really intensive, year-long coaching for businesses that want to transform their business in some way. We have our Designers Inner Circle and we have our Elite coaching program. Both of those use the Aim with Intent methodology, the align your team, ignite your processes, and manage your money with intention. Anybody that's interested in that, you can always go to Scarletthreadconsulting.com and go to the Work With Me page.
We also have a new offering which is the CFO offering. In that, there are a couple of different ways that you can go about that. You can find this information on Scarletthreadconsulting/CFO. We will do things like help you set up your KPIs. We will do an audit of your financials. We will help you think about what is your strategic plan and what each of the item's cost, all of the things, honestly, that we talked about today. Set up your Profit First percentages, and show you where you are to that. Help you really make a plan to own, look at, and manage your financials so that you can now make decisions with empirical data and not just a gut reaction. Those are our new CFO offerings. I'm really excited about them and with every CFO offer, they also get three months of Metrique. We can then show them how to take that information and turn it into something that is usable and that they can do within their own company. They really can have the tools to do it themselves instead of always having to hire, hire, hire.
Kelcee Sparks
Well, thank you so much for sharing all of this financial knowledge with us. I'm sure there's way more for all of us to learn, but we appreciate you.
Michele Williams
Well, thank you. You know, this is my favorite topic to talk about. I'm excited for our next opportunity to get together and to chat, so keep the questions coming and I will chat with you soon.
Thank you, Kelcee, once again for asking those questions. I want to encourage all of you to check out a couple of links. I know that normally we're only supposed to give you one call to action at the end, but I'm not. I'm going to give you multiples. One, I'm going to tell you to check out Metriquesolutions.com. We would love to have you join us in watching one of the free demos that we have some time or just see how Metrique can support you and be kind of the mini-CFO for your company.
The second is, if you want to work with me, you can go to Scartletthreadconsulting.com/workwithme. You can also go to Scarletthreadconsulting.com/CFO. Please don't ignore the financials in your company. Your financial health is so very important. Financial health is one of those things like all the rest doesn't happen by accident and neither does profit. 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.