Benchmarking for Success

I would say one of the greater areas of sort of generalization for financial benchmarking is what I call the rule of a third. Once you start building a team, you start bringing in other coaches, you start bringing in team members, you start advertising, more significantly, those margins are going to come down fairly drastically. Benchmarking and understanding where your business is at compared to industry standards is really, really important. Good day and welcome to the Wealthy Entrepreneur Podcast. I am your host, Bob Govreau. It is great to have you here with me today. I just want to remind you the Wealthy Entrepreneur podcast. What are we all about? Why are we here? This is the place where we dissect the elements that contribute to entrepreneurial success, from mindset and leadership to profits and revenue. This episode I'm going to share with you something that I've been working on the last few months in our million dollar year community and that is the idea of understanding financial reports. But specifically in here, what I'm going to talk about is understanding how to benchmark and understanding some of the financial outcomes in your business and where you stand, where your target should be in your business. And also I'm going to talk about the small business, I think one of the greatest drivers of financial success in here as well. So I want to jump in and get started. So one of the questions I get often is, okay, so these are my financial results in my business, which typically comes directly from a profit and loss statement or an income statement. And business owners will say, well, is this good, is this bad? Where can I do better? Where am I doing extremely well and I need to continue to focus on. And those are all really good questions. And there is a generalization of where we can essentially put in a benchmark to say, are you performing in a positive way or in a negative way or are there things that we can work towards? So I would say one of the greater areas of sort of generalization for financial benchmarking is what I call the rule of a third. And it depends on the type of business that you're in, honestly. So if you're in a service related industry where you're not buying or reselling something or you don't have products that are coming into play that you need to essentially pay for, you're really in the business of managing people and those people are delivering on your revenue. And in that particular industry. So in the service based industry, the law of a third would essentially be this 100% of your revenue comes in. So let's call it $90,000 a third of that should go towards your wages. So what does that mean? Well, of $90,000, a third is $30,000. And that is a direct cost associated with delivering your revenue. So you should really be charging 3 times what your wages costs are to generate revenue. And that's purely a generalization again, but a third model. So we've got, in this business, we've got $90,000, we've got 30,000 going to payroll. That gives us a gross profit of 67% or 2/3, right? 1/3 is payroll, 2/3 is gross profit. And then in this case we take our 60,000 gross profit and we also reduce it by a third, which would be our overhead costs. So that would be our office rent, our supplies, our insurance and anything like that. And then the last third is essentially that we have 20,000 or, sorry, $30,000 of profit. So of net income. So we started with 90,000, we take off 30, that gives us $60,000 gross profit, which is essentially a 67% margin. We then take off $30,000 in overhead costs. That's also a third. And that leaves us with one third net income. Now in this case, 33% net income is pretty, pretty solid. You know, if you have a business where you're getting one of these margins, one, if you're getting 67% gross profit, you're doing extremely well. If you're getting a bottom line net income that's at 33%, you're doing extremely well. Those are very, very healthy numbers. As you continue to grow and scale a business, those numbers are going to be more difficult to have. Let me share an example with you. Right? So let's say in my, my world is accounting. So let's say that I have $90,000 of revenue in my world now in that case, I'm going to have limited employees. And I'm going to argue that at 90,000, I'm not going to have any employees. And at 90,000 I'm going to deliver all of that service myself. So if I'm pairing myself fair market value, that's likely the 20,000. In my case, in my business, I might say I'm not going to pay myself anything. That means that all of my revenue is gross profit less my overhead cost, which we said, okay, it's $30,000. In this case, I, that would leave me $60,000 of net income at the end of the day. Now that is 67% net income. That is going to be existent in very small businesses. You know, a lot of coaching businesses, they're able to scale it up with fairly profitable margins. But once you start building a team, you start bringing in other coaches, you start bringing in team members, you start advertising, more significantly, those margins are going to come down fairly drastically. So back to my example, in this case, let's say I do have employees and it is fairly scalable. I am going to be very lucky if I can charge three times my salaries to get that revenue annually. So if I'm paying $30,000 in salary, it's going to be really hard for me to charge 90. Especially as I scale that from 90,000 to 9 million. The likelihood of us having a profit margin in there for a service company that's 50% or higher is going to be really great. So as a benchmark, as you're growing and scaling a service based industry, if you can have a 20% or sorry, a 50% gross profit margin, that's extremely strong, likely it's going to be on a strong side. If you were 40% to 50%, that's very strong. Now keeping in mind too, and I'm going to hit the non service industry in a second, but in the service industry we likely are, if, if our revenue is higher, we're likely incurring a lot of overhead. So in the service industry we typically need to have a space for people to, to come to, to be able to deliver. Now more remote environments are being created. It makes it more efficient. There's somewhat of an expectation from a consumer standpoint if you're fully remote, that they're not maybe paying as much. And typically if it's all fully remote, there tends to be more challenges with continuity and consistency of people and whatnot. So having overhead costs is fairly typical. And if you're remote, you have membership fees that tend to be more significant and a lot of overhead related costs. So if you're the service industry and you're scaling a business 40, 50% is very strong. And then at the same token, what you want to try and do is get your overhead costs down to about 20%. 20 to 25% is ideal. And then that would leave you 25 to 30% net income. Now you guys have heard, I've talked about it before, spent some time with Tony Robbins. His benchmark for net income being successful is 20%, which is good. And if you think of business valuations and an average earnings multiple of 5 times earnings, essentially when we're looking at that, that's, you know, your profit times 5 equals your revenues 20%. So interesting sort of numbers in there. Again, the rule of three is a really good place to start. Especially if your revenues are a little bit smaller. A third of your costs should go into the direct costs so your wages, a third should go into your overhead. That should leave you a third of profit and, and then continue to work towards that. If you're not quite on those benchmarks, work towards getting there, work towards reducing your wage costs or pricing higher so that you get your profit in the right space and work on getting your overhead down so that it's under that level. A lot of smaller businesses are really good at keeping the overhead limited down to relatively nothing. So if you can do that in your business, the rule of a third will essentially help you continue to drive higher profitability in your business. So now let's talk about the non service business. So this is where we're buying and selling something or you know, if you're in the trade space, you're buying something and delivering and putting products and materials plus labor into whatever it is that you're delivering. So you're building homes, you're in electrical, you're doing plumbing, whatever. There's wages and then there's products and materials that we have to buy. So in this case again you could look at it and say the rule of thirds now it tends to be a little bit different in this case. So sometimes our thirds really look at a third of wages. A third of our revenue should be wages, which is 33%. I'd like to see that down to 20, 20 to 25% for wages. And then we're probably, you know, if you think of a third related to products or purchases, that would leave us with a 33% gross profit. Now that's fairly standard in the non service related business. So whether it's profitability on retail or any of the trades, 33% gross profit is sort of a benchmark that I would say you wouldn't want it to go any lower. And then we look at our overhead costs and we say, okay, well we've got a third profit there, we can't give another third here. So what do we want that to be? We want that to stay under 20%. And a lot of times in the trades businesses were able to keep the overhead fairly low. So I would argue that if we've got 33% profit, we want to try and keep our overhead costs around that 13%, 13 to 15% mark, so that we keep our net income around 20%. Again, that is our goal is to have our net income at 20% in whatever type of business. Now you Might be thinking, okay, well Bob, in the plumbing space, the plumbing costs are, you know, a third of, of what it is. Maybe they're 20%. Great. Maybe the labor costs are a little bit higher than a third, that's fine. But what our objective is is to make sure that our gross profit is at least one third, which is 33%. We want to maybe try and get that up to 40%. Some of the best trades and retail are in the 40 to 45% mark, even 50%. I've got a plumbing business out of the Ottawa region that has gross profit margins around the 50% and works hard to keep it there. Now also has fairly substantial overhead. When our business is growing, overhead is going to be the challenge to keep down. You know, between office costs and investment in team members and fixed salaried management, Once you start building out a management team, you will watch your overhead start to excel. So we want to keep those in check. So those are some really good starting points. Again, overall, I would try and keep wages around that 25% mark if we can. Even 20% depending on the type of business that we're in. If you're selling something and it's high value, high quality, the product costs are high, we would likely want to see our wages lower than that. So under 20%, we want to look at our gross profit in both instances. Whether you're a service based business or a buy and sell retail, construction trades, anything that's got purchases as part of the service or product deliverable, we want to see that as a minimum 1/3 profit margin. So these again are benchmarks. But a third is going to be, you want to be above 33%. You want to be at least at that 33% as a threshold. And that's why these are important. So you can look at your profit loss right now you can pull up percentages of revenue and you should be able to look at this and say, where is my gross profit at? I want you to see that you're above 33%. If not, we've got a bunch of trainings in our million dollar year program that talks about how to eliminate some of those direct costs or some of the things that we can do to focus on that. So that's really important. And then on the service side, again, I would be suggesting that 33% is probably low. I would like to see it in the 40 to 50% mark. And again, keep in mind guys, as we scale our business, our profit margins should be fairly scalable. You know, if you're A really small business with no employees. Your profit margins are inflated because you don't have the cost of you and you're doing all the delivery. But once we take you out of the equation and we start looking at everyone else, you should be able to scale the costs and, and your profitability from $90,000 up to $9 million. And you should be able to maintain your margins in there. It's our overhead that starts to get a little trickier when we bring in management and leadership teams and other non billable administrative support people in there. It becomes more challenging to continue to keep our, our overhead costs low. But that is our goal. 33% as a profit margin regardless, should be a minimum that we are looking at. And then if we can keep our overhead costs, you know, between 15 and 25% in there, we should be in pretty good shape. Net income percentage to listen to Tony, Tony puts a benchmark at 20%. And I can tell you as a business, as a, you know, a multiple eight figure business that we have now, which is very exciting, if you do not keep your percentage of net income at that 20% or higher, you can very quickly have cash flow swings that will cause you pain. So you need to be focusing from a sustainability standpoint in your business to have your percentage of net income greater than 20%. If it's not, if the wind blows out of the wrong direction, a client defaults on a payment, or someone doesn't pay at all, or you have to write something off, or if a job doesn't go the way that you need to, or you have an upfront costs that you can't avoid, you have all of these combinations coming together, it can have a serious impact on your cash flow and the sustainability of your business. So when you're looking at your business and you look at the bottom line, you should be looking at 20% or higher. That should be our objective. Most businesses are not, in this case they're sub 20%. But our goal should be to build this up so that we're 20% plus. Now here's how we do it. When we are looking at our business for the year and we're starting to plan out what our goals are. And you guys have probably heard me talk about this, it's also in our million dollar year program starting to do at the planning of what the 10 year, three year, one year sort of markers look like. What is our vision for 10 years, what is our vision for three years and what is our vision for our one year mark? And when we're looking at that one year mark, we're likely looking at setting goals. One, that they're realistic but that we can start to build out critical drivers of what actions we need to take today to help realize that goal. When we're doing this, when we're planning out our 12 month or our one year goals, we then should be building out a budget of all the costs associated with, with accomplishing those goals. Now we use this budget as a framework and a benchmark to see if we're on the path to success. My good friend Simon Bowen talks a lot about a four futures model which essentially says you've got four futures. One you're going to desperate, you're going to fail miserably. One, you're going to slightly miss your goals and objectives. The other third one is that you're going to just barely make your goals and objectives. And lastly that you will crush your goals and objectives and far surpass them. So when you're looking at these, you want to make sure that you're as close to being on track as you need to be right now. Because if we're off track and we don't discover this for six, seven months, going to be really hard to get on track. The closest time you can be to being on track, to accomplishing your goals is right in the present moment. We have to make sure that our critical drivers and our goals are achievable, they're timely, they're being measured and that we know what actions we need to take to accomplish it. When we do this, we build out a budget and a framework to say these are all the investments that we need to make during this next 12 month period in order to accomplish those goals. It should show us our net income that's expected. And again, we can't make this up, we can't make it unreasonable. We want to make this so that we can succeed and that we will succeed. And then we track our progress. We get this budget in, especially in QuickBooks Online. It's really good. You get your budget in and then every single month we're tracking it to see if we're on track by using the benchmarking tools that we talked about earlier today. The third, the third, a third or the 20% net income. When you're building your budget, you want to be considering those as part of it. If you know your margins are starting to fall outside of that. We need to tweak them. We need to understand how we can improve them. We need to do it now so that we can build out the future that we really deserve in our business. Again, 20% plus net income in our business is needed for long term sustainability for cash flow management and the success of your organization, especially if you're continuing to reinvest in growth. Guys, I know this was a lot of information, but benchmarking and understanding where your business is at compared to industry standards is really, really important. If you in your business want to understand more about where you stand, make sure that one you click on the link below. You like this podcast, you follow it. We're going to continue to talk about this too. Check out our team at govrocpa Ca inquire definitely look into our million dollar year program. Inside our million dollar your program. We talk about this. We talk about how we get our business on track to accomplishing these benchmarks. Because if you can do that, you can get to your results faster, you can achieve your wealth accumulation goals quicker, and you can accomplish financial freedom in a different way than you ever thought was possible. So check out those resources. If you like this podcast, give it a like drop us a comment, give us a follow. I have an episode coming out every single week. This episode has been on benchmarking and the Power of Budgeting, what I call the secret weapon to small business enterprise success. My name is Bob Gover. I'm your host. Hopefully this has been really valuable. If you know somebody that could benefit from this, feel free to share it with them. We're here to help empower all entrepreneurs to achieve the financial confidence they need to change the world. Because you guys as entrepreneurs are are making the biggest difference in the world of any community that's out there. You guys are making the changes and we want to empower you to take that to the next level. Guys, it's been an absolute pleasure. Hope you enjoyed this and we'll catch you next time.