How to Manage Cash in a Crisis | Mike Michalowicz Interview

Costs are in excess of sales. So we have to look at ways to reduce cost. Historically, we've been told that profit comes last, sales minus expenses equals profit. But what that means is on a behavioral vantage point, that profit is last.

Hey guys. Welcome back to another interview. Today we are blessed and humbled by Mike Malowitz. He's the author of an incredible book called Profit First. He's wrote tons of different books. I've seen him speak at an EO event. And his book around finance and cash flow changed my life and changed how I think about finance, managing money when it comes to founder and our business. And it's been such a game changer during this time. I had to have him come back on and just share with you guys what you should be thinking about if you are in business right now and you know, everything that's happened in the world. So, Mike, thanks so much for taking the time.

Nathan. Oh, it's my pleasure. Thanks so much for having me on.

You're welcome. So, yeah, look, as I mentioned that I'll never forget that time I, you know, saw you speak in Melbourne. So. Yeah. For those that are not familiar with you and your work, how did you.

Get your job as an author?

Well, just how did you find yourself doing the work you're doing today?

Yeah, yeah. After university I couldn't get a real job. So I worked for a local store, computer store, and one night went out for some drinks and was with another guy, was lamenting the work I was doing, how hard I was working. I thought the owner was sitting in the back room smoking cigars and counting money. So I said I'm going to start my own business. And I did. Apparently owners don't sit in the back room smoking cigars and counting money. They are worried about paying bills and calling vendors and coordinating things and trying customers and marketing. So I really came into the understanding that entrepreneurship was a lot of things and it was very fearful, driven too. I had to be successful, but had no idea how to do it. Fear is a great motivator. Was for me at least in the beginning, I was getting up at five in the morning. I was working till five the next morning. And anything to sustain, I think long term though fear can turn itself into stress and stress turn into really a deadly situation. So I was fearful, but I was seeking understanding and over time I was able to make that business successful, meaning I was making money. I wasn't really taking much home, but I was at least sustaining. I was living check by check. I sold it and that's where I made some money. I did it again. I started a new business, sold it. I said, oh, the key is build a business and sell it. So I started my third business with the pure intention of building a company and selling it well. I built it poorly and I was not able to sell it. In fact, it bankrupted me. I lost all my money on it. And that's when I had the newest realization that the entrepreneurial journey has so many variables and there's so much complexity that I really needed to find ways to simplify the different elements. I realized I didn't really understand entrepreneurship as nearly as much as I thought I did. I was very brash, but really didn't understand much at all. So on my fourth iteration, I said, I'm going to be an author. I'm going to really. I'm going to study the entrepreneurial journey as I run businesses. So where I am today, my job is I'm a small business author. I've written multiple books on the subject. Profit first, Clockwork, Fix this next. I'm also a business owner, so I'm at my offices now. I own two companies, and I use my companies to further the teachings of my books, but also admittedly as guinea pigs for future books. As I write, I test out stuff that I'm writing about. That's what I do.

Yeah. Wow, that's so cool. I. I'm mindful of your time, and I want to really just get to the nitty gritty around the current state of everything that's happening with businesses. You know, industries have been just turned upside down and, you know, it's really tough out there. And, you know, you one of the first people that I wanted to speak to to get your insights around how people should be thinking about managing cash flow during this time. So where would you like to start?

Well, I'll start with what I call it. I call it the great big shift. You got to be careful. You got to make sure the F is in there. It's the great big shift that's happening right now. The economy is changing dramatically. There's a reinvention of business. And I want people to realize that business isn't done in. It's just different. That needs, consumer needs still exist. They exist in a new flavor. And then some people are sidelining and await. Other people have to move forward decisions. But we got to get really curious about reinventing ourselves and the essence of cash flow. The starting point of cash flow is always sales. Sales, the creation of cash. I consider it the oxygen for business, profitability is the absorption of that oxygen into the blood system of a business. So if we're not breathing, if there's no sales coming in, let's not even worry about profit. We need the foundation of sales. Once we have sales established and we start focusing on profit. And for some businesses in this market, their sales actually have continued. Maybe they're down a little bit, but they've continued to some degree. In those cases, those businesses, we need to look at profit and say, how do we extract profit from the sales we have and. And really master profitability. Other businesses went cold to turkey. You know, restaurants, gathering points. I work with a baseball team and they can't baseball right now. Not in the spring, at least. In the spring here in the US in the fall where you are. And those businesses stopped cold turkey. They have a sales issue. They have to reinvent what they're selling. So we have to look at do we have a sales issue right now or profit issue. And for different businesses, it's a different thing.

Yeah, I see. Well, let's focus on businesses that still do have sales coming in, but now they have a profit issue.

So if you have sales coming in and have a profit issue, that means one of two scenarios. Always costs are in excess of sales. So we have to look at ways to reduce cost. There's a certain point where you can reduce cost, where it doesn't hurt the business cutting the fat. There's a certain point if you reduce it beyond that, you cut the muscle, the ability to deliver. But when sales drop, often there is an associated ability to drop costs. But many business owners are hesitant to do it. I have my 10 employees. I love my employees. Sales have dropped by 50%. I need to keep my 10 employees. But that's not true. That's just an emotional response. If. If I had my sales before and I need 10 employees and drop by 50%, could I cut my staff by 50%? In some cases you can. It's just a real hard, emotional decision. But is a necessary decision. So if your sales have dropped and therefore your profits drop, but you still have some sales, we got to look at cost control and make some hard decisions around it. The second thing is profit margin. What products are making money for us? Sometimes you still have ongoing sales, but some sales are generating no profit. There's a concept of loss leaders to sell something to get a customer in the door, but I'm going to lose money doing it. This is no situation for loss leaders. So we can actually even curtail what we're selling. So sometimes when sales are sustaining but you have a profit issue, you actually cut some of your sales, the unprofitable sales, the unhealthy sales, and actually boosts up your profitability.

I see. So once you start looking at kind of, I guess, do you have loss leaders? Where can you like, you know, reduce expenses? What comes first? Like, is it team? Is it, you know, like, you know, office? Is it like, how do you work out what to keep.

The first thing is the realization that the continuance of the business is the primary focus. I see some entrepreneurs and I've done this myself, saying I don't want to lay off anyone. I don't want to cut costs. I need to serve all these people. The only thing I can do is just hold on as long as I can and sacrifice myself. And at a certain point, it's exhausted. I can't keep running businesses normal without having income to support it. And those businesses then go cold turkey. So they save a few people at the compromise of losing the entire company. And I consider that the ultimate sin that everyone is going to be out of a job. If I just simply save a few people for a few months, everyone's going to lose a job in a few months. So we have to look at is our people, our other expenses, our office space and stuff, and determine what's the expense I'm incurring, what's the return on that expense and what are the biggest expenses with the lowest return that need to cut. In many cases, it. In this environment, office space is something we can cut. We can't even use office space because it's a gathering point. But some businesses are clinging onto it. If we can cut that cost, do it if you can't afford it. Secondly is employees. And it's a tough decision. And the rules in different countries are different ways. But I'll tell you, in the US I've never seen so much cushioning for employees. In many cases, it's better for an employee just to be laid off. You make more money that way right now for a period of time. It won't be that way forever. But me as an employer, if I have to let someone go, it's actually in their better interest. I do it today as opposed to three months from now, when the programs may not be as effective and it may be better in better interest my company to do it now when we have to make those hard decisions. It is hard. I also argue you got to make it all in one shot. Rip off the band aid. The businesses that say, you know what? I'm going to lay off one person today. I hate to do it, but let's see how we are in a month from now. I may have to lay two people off and we. I'll see. And then we'll cut the office space and then maybe four months from now, cut off another person. The people that remain see this dwindling, dying business. They see it wilting away. It is terrifying for the remaining people. Instead, if we rapidly cut off what we have to do, it's going to be a hard day or week, but people are going to see that you made a decisive decision, you cleaned up the business to bring it back to fiscal stability. They will have greater confidence because now they see the businesses moving forward. And, and you've made the hard decision in one shot. So don't chip away, cut once, cut deep and get done with.

And when it comes to kind of the profit first tongue twist that when it comes to the profit first methodology and framework, what can people take from that during these times?

So, you know, profit first, I teach to take a predetermined percentage as revenue comes in. Take 5% or 10, whatever your percentage is as profit. So the most common question I'm getting is, you know, changes is afoot. The economy's shifting significantly globally. Should I reduce the profit percentage? And some people actually ask me, should I increase it? Maybe there's an opportunity to ramp it up. The answer is actually neither. What I tell people is, if you're doing profit first, keep it as is, because that's what we've defined in that moment, what your health, what a business is, a healthy business is. So keep doing it. Then if you see that you can't pay your bills, your operating expenses, that's your business speaking to you, saying, to sustain this profit, we have to fix our operating expenses. If you see it is happening for a few businesses, the profit actually reserves increasing, meaning there's more money left over in opex that's pointing that you're actually turning to a more profitable model. And, and we can modify and increase the profit percentage. Don't change it. If we change it, it's artificial. If I say, historically I had a 20% profit because these tough times, I'm going to cut down to a 1% profit and take that 19% and move it to OPEX so I can sustain. You've artificially adjusted your business before. Any problems have presented themselves. So now you're paying expenses that maybe you shouldn't be, but you can't tell because You've reserved money for it. So leave the percentages as are and let the business talk to you.

Got you. For clarity, for those that are not aware of the profit first framework, can you just talk us through it? Top level. Because it's, it's very easy to understand. That's what I love about it.

Yeah. So the, the real top level is this. Historically, we've been told that profit comes last. Sales minus expenses equals profit. But what that means is on a behavioral vantage point, that profit is last. It's, it's the final consideration. And it's human nature. When something comes last, it gets ignored. So, right. Teach in profit first, it's sales minus profit equals expenses. Now we do this in practice is every time revenue comes into your business, we take a predetermined percentage of that money and allocate toward a profit account. So it's an actual crash cash transfer. It's the pay yourself first principle applied to business. Going a little bit deeper is we set this up at our bank. So I call the foundational five. There should be five accounts set up your bank. One's called income. It's where our deposits go. Another one's called profit. We allocate a percentage of profit there, as we already talked about. Another one's called owner's compensation to pay what I argue is the most important employee in the business, the owner, a percentage of the income. Another one's called taxes. The biggest bill associated with the operations of a business that business owners are least prepared for consistently is their personal taxes that they incur making money from a business. So the business will actually reserve taxes for you and pay your. Your bill. Then the final fifth account is OP X. That's the operating expense of a business. Now it's a framework. It can get more sophisticated than that. But that's the basics. And what happens now is money comes the income account. We pre allocate the money. We transfer money based upon the percentages to different accounts. And before we spend a penny, now we know what's available for what purpose. If $1,000 comes in, historically you say I have $1,000. But now, because money's been allocated these accounts, when I log into my bank and see which money's there, I see in the OPEX account, they only have $400 to spend and $300 has been reserved for taxes and $200 for to pay myself. And however the breakdown is. But you realize $1,000 is not $1,000 to spend. It's less than that. It's 400 and we work within the confines of what's truly available. The opex.

Yeah. Look, this was such a game changer for me. One thing that really helped me was because you have the different bank accounts and because when the money comes in, you know where to put it. It gives it purpose. And you talked about what was the law around, like the toothpaste. I'll never forget that story because it's so true. Dude, it was a game changer. I'm telling you, man.

I love that, brother.

Can you share that?

Parkinson's law. So Parkinson was a behavioral theorist studying human behavior. And he realized that as a resource expands in its availability, the more we have of something, the more we consume it. So I thought about toothpaste. You know, a full tube of toothpaste, we use more toothpaste. When it's empty, you squeeze out a little droplet, and that's what we work with. Well, Parkinson pointed out this is true for all elements of life, like time. Like if. If you and I had a contract, we're negotiating, and I say, hey, Nathan, I'll get you that. That contract in one week. It'll take me a week to get it done. But if the same guys have the same conversation about the same contract by say, I'll get to you in one day, I'll likely get you in a day. I compress the resource of time. I move more rapidly to complete it. Well, it's true for money, too. So when $1,000 or whatever the dollar number is plopped on the table in front of us and say, this is what you have. We subconsciously and behaviorally consume it. We justify the spend. I got $1,000. We need to grow, baby, grow. But when you constrain the availability. So fascinating is it's called forced frugality. There's less available. You have to spend less. But also, Parkinson pointed out the innovative mind. We start thinking differently. Like, oh, I only have $400. How do I get the result with only 400? Let me do X, Bargain, negotiate, use used equipment, whatever. But we find a way to work within the confines of what's available. So by intentionally constraining the cash, we actually work more effectively with that cash.

Yeah, that's an incredible example. And it's so true. And I've seen it work for me personally. I'm curious, though, for people that perhaps, let's just say their sales have been cut in half right now, how can you start allocating to tax, to op X, you know, to owners comp. Like, how do you do that? When like you're struggling, well, you have to.

The taxes, the government's still going to say, give me your money. I don't care if you had a dollar in sales this year, you know, or you had a $100 million, they're going to take their percentage. So realize the government is not going to give you any leeway and we shouldn't give ourselves any leeway either. Even if you make just $1, you, you deserve to be paid a portion of that. That's why you started this business in the first place. So struggle is really not necessarily the relevant term. It's a contextual term meaning when we think we're struggling, it's based upon what was happening before. We're not struggling. Things have just changed. So we have to see is this is now for today, the new normal for our business. And we have to work within the confines of it. So if sales have dropped, you're just not doing what you did before. You're not struggling. You have to find a way to optimize that. Then if business goes up, it's not. You're more successful now. You have to optimize around the new normal. And it's better to have more money flowing through because there's more to capture. It's just the new normal. So we have to adjust to the reality of the moment and always take these percentages.

So even right now, you would recommend people to take and will not take, but portion out owner's comp.

No question. Oh, no question, really. Because if you don't, you're sacrificing yourself. And actually, the funniest thing is I see some business owners doing this. They're saying, you know what, I can't afford to continue this business. I'm going to sacrifice myself. And when they don't pay themselves, like I can't pay for my mortgage or my house or whatever, and I'll wait. And so they start this self sacrifice. Here's the greatest irony when it comes to future financing, you know, loans and stuff like that. The biggest determinant if you're going to get funded by a bank or some external resource is not the fiscal health of the business, it's the fiscal health of the equity owners, us. So we sacrifice ourselves and then down the road we're like, you know, we'll recover and the business will do well. Maybe we can take on loans and expand again in the future. You've undermined that ability because you haven't been fiscally responsible. If you have to make a selection behind between the fiscal health of yourself personally or the fiscal health of your business? I hate saying this, but your personal physical health trumps the business. Like take care of you over the business, you matter more. Because if you're still around, if you're financially healthy, you can start a new business. If the business is around, but you're done, you're done. So, yeah, you got to pay yourself, even in tough times.

Okay, thank you for sharing, Mike. Look, mindful of your time, we have to work towards wrapping up two last questions. One, just any, just final words of wisdom that you'd like to share for people right now that you know they're experiencing this change. And two, where's the best place people can find out more about yourself and your work?

The word of wisdom, if you will, is listen to wallets, not words. It's very easy. We may have to reinvent our offerings. It's very easy to go to our customer base and prospects and say, I have an idea. What do you think? And those people say, that's a great idea. Go for it. And then we spend the time and money to develop it and we introduce it to them and say, are you ready to buy it? And they say, oh, I don't really need that. They back out. Words are a form of affirmation. It is socially appropriate to say it's a good idea to support. And ra ra smanan. Wallets, though, speak the truth. So when you have an idea, ask people, hey, are you willing to put down money today, a deposit right now on this? If people say no, they don't like your idea. So trust wallets. And if you want to learn more about me, while my last name is a bastardized massive name, Michalowicz, no one can spell it. So don't go to mikemicalicz.com that is my domain. Go to mikemotorbike, as in the motorcycle mikemotorbike.com that's my nickname. It's easy to remember because it rhymes. All my resources there, my books are free chapter downloads. I used to write for the Wall Street Journal. I have my own podcast. Everything's@mikemotorbike.com amazing.

Well, look, thank you so much for your time, Mike. Yeah, thank you for all your work you do and thanks for taking the time.

It's good seeing you again. Take care, brother. You too. The founder mission is to help you create an ass kicking business and help you learn straight from the mouths of world class class founders. Get your free printed edition of Founder magazine featuring Sir Richard Branson. Just cover shipping and handling@founder.com forward/branson.