You’re Rich on Paper, Poor in Real Life

Hey, everyone, it's Mike Andes from the Home Service Millionaire podcast. Today we're talking about why you're rich on paper, but poor in real life. We're gonna have five different topics that we're gonna go through on the docket and if you enjoy this comment below on the podcast. So we're talking about why your QuickBooks shows a $300,000 profit, yet you're calling the bank to float payroll. First off, I'm looking at cash flow. Secondly, I'm looking at debt. So from a cash flow perspective, I'm saying, are you paying out invoices, bills, and the thing that you are owing very quickly and then taking a long time to get paid? That's a cash flow problem. And so there's a lot of ways to solve that. And a lot of times when big commercial companies have this problem, I'm actually recommending they fix the whole business model, like cut out certain services, certain vendors, like third, third parties between you and a huge company. I was at a turnaround not a couple weeks ago and they had a third party contractor between them and a bunch of Walmarts. And Walmart would pay the third party. The third party would then pay them, but it could take six months to get paid and they were owed over $200,000. And so it's almost impossible to grow a business when you have 20% of your revenue tied up in receivables. And so that's the first problem is if cash flow is bad, you're not getting the money paid to you fast enough. If you're doing residential work, that's where it's like, look, this is. Can be tightened up pretty quickly with estimate verbiage penalties if they don't pay on time, require a credit card on file, requiring deposit thresholds. There's a lot of stuff you can clean up very quickly on residential, on commercial. That's when sometimes you actually just need to cut ties with certain third parties or middlemen that are causing a huge delay in payment or completely just change the service and not serve those type of jobs that require huge amounts of capital outlay. Because I cannot be having that much accounts receivable not getting paid to me. So cash flow would be the first thing I'm looking at. The second thing I'm looking at if someone has a whole bunch of profit on the P and L, but they don't have any money in their bank account is if they have a bunch of debt. Because on a P and L, you're only seeing expenses and an expense is Interest expense. Cool. But when you're paying down a loan, you have monthly payments of principal that have nothing to do with interest. And in home services, a lot of times we'll get very low interest payments, interest percentages on equipment. So, for example, you might get 0% down for 48 months. Your monthly payment going back to the dealer or to that Sheffield Financial or whatever. That doesn't show up in your P and L at all because there is no interest expense. And the monthly payment you're sending that principal pay down doesn't show up on a PNL. So I could very well have $300,000 of profit. But because I had $20,000 a month going out, that's $240,000 in loan payments. Assuming there's no interest, I could literally have hardly. Like what, 80% of my profit is going out the door. On paper, I look like I have $300,000. In reality, I have 60 grand. And that's simply because of debt payments. That's why you always need to see a balance sheet with the P and L to the profit and loss statement. I'm seeing money in and money out. Great. But that doesn't tell the full story. I need to know the bank balances, I need to know the debt payment balances. I need to know all of that stuff. And that comes on the balance sheet. So I always think of the profit and loss statement as telling a story over the course of some period of time. So a week, a month, a year, and then for a balance sheet, it's a snapshot in time that shows the balances of everything in the business, all my bank accounts, credit cards, debts, etc. And a balance sheet is your assets and your liabilities. And you see all of them. Okay, so those are the first two things I'm looking at if a business is profitable on paper, but no money in the bank account, cash flow problems or debt payments. And. And again, it's very possible that you could just simply keep doing what you're doing and not get more debt payments. And if you just pay things off over the next year or two, you actually become really profitable. Because all of a sudden, instead of having 60 grand in profit and being very, very skinny, you could very well have $300,000 of profit actually hitting your bank account if you just paid off those. Those loans and those debts that you're on that are on your balance sheet. All right, number two on the docket, are you scaling from $1 million to $5 million by stacking debt and vendor terms instead of building true cash reserves. Yeah. So the thing that I'm always trying to figure out in a business is how much working capital do I need to have to grow the business? I think you need cash in order to grow. And you're like, well, I can just use debt. Yes, you can. But if you just compound your amount of debt but you're not increasing the amount of working capital, you're going to eventually have a huge rude awakening when like one pay you or one crash of a truck happens, or one lawsuit can wipe you out. And so I recommend allowing your cash to increase as you grow the business. This is why in the 4L framework, when we have liquidity, leads, labor and leadership, I consider any business has less than one month of cash in the bank as having a constraint around capital or cash or liquidity. And the reason I do that is because as the business grows in revenue and if I get more debt, I'm growing top line revenue. And if I grow top line revenue, it's forcing me in that constraint of one month of revenue to have that much capital on hand, that much cash. And so in my opinion, you gotta have cash because the oxygen. And so there are times when you're growing really quickly and you need cash to fund asset purchases or expansion in new markets, then I'm going to use debt. However, I'm still going to make sure I have enough cash on hand. And there are certainly times where I would rather go get debt and then have all of my cash resource cash reserves depleted. Because as soon as I deplete my cash down to like a few days worth of revenue, I am in a world of hurt and stress and I will not make good decisions. As a business owner, I see this over and over and over again. And so is it a short term fix if the business collapsing to go get debt and give yourself a working capital? Yes. That's why in general, I don't want to take debt for working capital, but I will take debt on assets so that I don't deplete my working capital and I allow my working capital be able to continue growing at one month's worth of revenue. So yeah, I think if you're scaling revenue top line revenue, I want to also be scaling my cash reserves. You're like, well, I'm not in profit mode. I still, I still need cash reserves to think clearly, to preserve the business in the event that something crazy happens. A key person leaves a key client stops using you. If 20% of your revenue drops around anything, all of a sudden you go from 10% profit to negative 5% profit, we have a big problem. We need cash reserves. And ultimately, making great decisions in a business is usually what leads it to growth. And so making poor decisions is much more likely when you have low amounts of cash because you act more instinctively, you act very reactively instead of thinking more proactively with planning and good resource management. And so I'm going to think much better as a leader and make better calculated decisions when I have a little bit of cash in the bank. Now, number three on the docket is why most owners in this range treat distributions like a bonus check, then wonder why the company can't breathe. Okay, so when we talk about owners in this range, we're talking about the business owner between a 1 million and $5 million in annual revenue. I would look at yourself at this size as your metric of success is distributable cash. How much money can I get out of this business after I pay myself a reasonable salary? How much can I take out of the business if each quarter on distributions? So I would set it up to where you know exactly how much working capital you need and everything above that you take out of the business. Like, well, what about for taxes? If you're an S corporation, you're getting taxed on the money, regardless of it's in your bank account or the business bank account. So get in the habit of taking money out of the business checking account. And so I would personally, this is how I've set it up, is where you have three months worth of revenue over the past quarter. I take the average of the past three months. So if I did 150,000 in monthly revenue, 200,000 in monthly revenue, and 250,000 in monthly revenue, I would have an average of $200,000 in monthly revenue. I would then keep that much working capital inside the bank. Anything above $200,000 is distributable cash and gets immediately sucked out of the business and back into the owner's account. And then that's where down the road, I would give a piece of that distributable cash to a general manager or someone else managing the business because they now have the best interest of mine in mind. And that is I want money to come out of this business. The whole reason a business exists is free cash flow. And so I want to compensate my general managers based upon that. And I also want to be thinking about the fact that that is my unit for success. If you actually took most businesses and just said, hey, pay yourself what you would have to pay someone to replace you and take that out of the business. Most businesses would be profitable by a couple percentage points. And so if you're able to pay yourself a salary that you are worth and you're making 2, 3, 4, $5 million business pay yourself a salary that's probably 120 to $140,000 if you were to replace yourself in the business. So take that as a salary and then every single quarter make sure you have enough working capital. And in my opinion, it's one month worth of revenue averaged over the last three months. Anything above that is money in your bank account. And don't tell me it's about taxes, because money in the checking account of the business, if you're an S corp with which you should be, and money in your personal checking account is going to get taxed the same way. And so yes, maybe at the end of the year I do some sort of tax strategy or I want to get money out of this business. It's the whole reason the business exists. And so I do not look at distributions like a oh wow, that's a gravy on top. No, the whole reason this business exists is that check at the end of the quarter and not my pay, not my paycheck, not my W2, not what I get on salary. That is what is required for me to go put work into the business. And eventually the whole goal is to replace myself in the business with someone else. That will be a W2. And there's still distributions on top. I went to business school for two years to get my mba, my master's in Business administration. I've compiled all that information into over a hundred videos that are useful for small business owners. You can find an mbaforantrepreneurs.com it's completely free and it takes those two years of business school and smashes it down an online course completely free. If you don't have that, you're not an owner. You are working at a job that you also so happen to be writing out your own paycheck. It's high risk. And so the whole goal and the whole again, I would measure your success as an entrepreneur by how much distributions do I take out of this business after I pay myself a reasonable salary? And again, I'm saying this to the business owner doing a million dollars plus if you're a I just want freedom. I'm doing 500,000 in annual revenue, got two or three employees being really profitable. I don't mind working out in the field. Awesome. But if the business owner that has 20, 30 employees is trying to grow an enterprise and thinking that having 150 to $200,000 in bottom line on their P and L is somehow going to be good. If you got hit by a bus, you're replacing yourself and immediately that business is unprofitable. And so think about paying yourself a reasonable salary and then thinking about your personal scorecard as the amount of money that comes out of the business after that. So, all right, fourth thing on the docket today from the producer is the 1 million to 5 million dollar trap, 500,000 plus in receivables. But you're the one financing your clients lifestyles. Yeah. Like look, if, if you want to have what someone else has, follow and repeat the recipe they have got and they've used. And the reason the whole banking industry, where there's so much money in finance and like you know, Morgan Stanley's over there, or JP Morgan's over there making like a $3 billion office right now in New York, they're building the skyscraper. The reason there's so much money in finance is they realize one thing, cash flow. It is I want to get paid as fast as possible and I want to get money going out as slow as possible. And the whole premise of the banking industry is I will get money from someone that is saving money and I will give them like 0.01% interest on that savings account. I will take that money, leverage it nine times over and then, and then give it to someone else at a 5, 10, 15, 20% interest rate on a credit card. And that's the whole banking model is they take someone else's money and then they give it to someone else and they charge a higher interest rate. And so the function is when it comes to receivables, the people that are not paying you, the ones that are slowing things down, who are they? They're commercial companies, usually big conglomerates, and that's why we usually avoid them. But the reason they have so much money is because they understand they don't want to pay you fast, they want to slow things down as much as possible. And so you will have to put things in place in your business in terms of systems that make it in their best interest to pay you sooner. So make them pay penalties, put them on a, hey, this invoice is due upon receipt and after seven days you're getting fees. And if you're not okay with that, you're not a customer of ours. So that's fine, whether it be fees, whether it Be having a car on file, ach on file. A lot of times that's easier for residential. And again, it's not like these companies don't have credit cards. What company doesn't have credit cards? What company doesn't have a bank account that they can put. Can't put ach. They haven't. They just know that the slower they pay you, the time value of money accrues. The time value of money is, hey, if I pay you $5 today versus $20, you're like, oh, wow, you're gonna be paying me four times as much. Here's the kicker. I'm gonna pay you in 20 years. No longer is the $20 option a good deal for you, because the time value of money. And if you understand the time value of money, you will realize that you are getting robbed every single time you allow someone to have an overdue invoice. Every single time that you do service on the 1st, the 7th, the 14th, the 21st, and the 28th of the month, and then you invoice them on the first, and then they pay you 60 days later. It's now 90 days after you. And guess who's not waiting 90 days to get paid? Your employees and the gas station and everyone else that you had to get paid. The brakes on the truck, the tires on the truck, all that you have to get paid, you had to go pay out to other people and then get paid for it. Months down the road.

You have become a bank. But this bank just so happens to not get any interest, to not have any fees or any costs of capital when you're holding onto that debt. And because that's what it is when you've done the service, paid for everything, and then they pay you three months later. And so if you want to have a really profitable business like banking, they charge when they give someone money, and then they wait to get it back, and so they'll give you money for your house, and then they want it back. And 30 years later, they've doubled the amount of money they've got. You got a $300,000 mortgage, and all of a sudden you're giving 700 grand. Over the next 30 years, they expect interest back. And if you in your business are allowing people to not pay you and they're not getting fees, interest, or penalties, we've got a problem. So in copilot, just go to the settings and just adjust it to where as they become overdue, they start getting hit with fees, and all of a sudden, people start to pay up sooner. All of a sudden the credit cards are like, oh, yes, we do have a credit card. Property management companies have credit cards. Property management companies have ach. They have bank accounts. Make it in their best interest to use it by having fees and penalties. Know that they can delay payment and not get hurt for it. They know they can delay payment for months and all at your expense. And don't allow that to happen, otherwise you will become a bank. That is simply the worst business model in the world, which is free money given out to people that they can use as much as they want and pay you whenever they want. All right, fifth and final on the docket. At this stage of business, 1 to 5 million in revenue. Net income is a vanity metric. Why free cash flow is the only number that determines survival. Okay, so when we talk about net income, I'm just going to say this is the bottom of the P and L, okay? The reason this doesn't matter is because the business is still paying for loans and all the debt service. And so again, many times your bottom line can hide a lot of debt. And so I have gone into businesses for turnarounds where I look at their P and L, I'm like, man, this business is great. Like 17, 18% profit margin on a 3 or $4 million business like this is fantastic. And then all of a sudden I get there and I realize that they're having 20 to $30,000 a month in payments, and they have $100,000 of credit cards, and they're juggling credit cards to pay them off every month. And that was all hidden on the P and L because the P and L only shows interest, expense. And a lot of times equipment is very low interest, but the principal pay down is extremely high. And people always buying this logic that I'll pay it off in four or five years and we'll be good in four or five years, that equipment will be done and you'll need to buy more equipment to keep the business alive. And so be very careful about this treadmill of debt, which is constantly. The mindset is, when I pay this off, I will become profitable. I only look at the metric of net cash flow, not be very clear, not net income. That's on the bottom heel. I want free cash flow coming out of the business. That's my unit of success as a business owner. And so especially again, when you've crossed a million, we're in 2, 3, 4, $5 million range. And now you've been in business for 5, 10 years. The metric of success is money coming out of that business, how much does it spit off? How much do you take away from the business and still survive and have enough working capital? And once you make. Look, if you're in your second year and you're growing really quickly, like how much money you take out of the business has nothing to do with your success because you're trying to grow. You're trying to get more customers, hire more people, get more trucks, gain more market share. But when the business got to the point of 3, 4, 5 million in revenue, you've been doing this for 5, 10, 15 years. It's time to switch the metric away from what looks good on a P and L that you show a banker to what actually, actually is the unit of success, which is, I take money out of this bank, take money out of the business checking account and into my personal checking account. And they're like, well, what about taxes? You can go do some really cool stuff with real estate, starting another location, starting other businesses, investing in the stock market or getting bonds where you get interest free returns. Like, there's so much you can do from a tax perspective. You don't need to convince yourself that you got to go buy more equipment. And just constantly saying this growth engine, you've got to eventually go from grow, grow, grow, 10, 15 years of growing this business to 3, 4 million dollars. Awesome. You've crushed it. Switch over into profit mode. We suck money out of this business because it's been sucking money itself in growth mode. And you've been putting money back in for years. It's time to switch it. And once you've done that, it actually becomes where you have a rate of return, there's a percentage that you could actually go to an investor and say, hey, I put a hundred dollars in and I got $20 out in year one, $40 out in year two, $80 out in year three. And all of a sudden you have an investable asset. And so if you're trying to sell your business down the road, I can guarantee you the amount that you will get for that acquisition. Your multiple, if you want to call it your multiple, your valuation will be a lot better if you've been taking money out of the business and then you're able to show to investor, look, this business, yes, it did 4 million in revenue. I've been building it over the past 20 years also, by the way, I took $500,000 of free cash flow out of this business into my personal account. Oh, and by the way, I also pay myself $150,000 salary already prior to that 500,000 distribution, that business is worth far more than the business that is doing $4 million in revenue. The business owner keeps plowing money back into trucks and equipment. I was like, oh, I'm investing back in the business. No. Are we investing back in the business or we simply buying more trucks and equipment under the guise of Section 179 and saving on taxes, when reality, we have never gone into profit mode and say, oh, we're not going to keep growing. We're going to raise prices, stop buying trucks, stop hiring people, and we're going to actually get free cash flow from this business. On a $4 million business, if you raise prices by 20% and lost 10% of your customers, you would literally make hundreds of thousands of dollars extra in profit, which then you can use this free cash flow to take out of the business and then prove to an investor that there's real money in from this business. Because that's what an investor looks at. They don't look at how much you're making on the P and L. They ask, how much free cash flow does this business make? When you think about, like a publicly traded company, they do distributions. Those distributions is free cash flow that it gets distributed to investors. That's why how the business is valuated, that's how we come up with the actual, like, price to earnings ratio, is how much free cash flow, this money, how much money does this business actually kick out of the machine? And we're going to give a multiple to it. And if you don't have that number, good luck trying to find an investor, trying to find someone that's going to like, there are people that if you have a great rate of return, if you know exactly how much you're going to make in year one and two and three and how long it takes to get the business up to profitability. If you have the model, you could go to people like a doctor, a dentist, a chiropractor that has a million dollars and they're like, yes, I will give you 250 grand. I understand there will be two years where you'll be plowing money back into the business for growth. But I also don't understand in year three, four, five, I understand what the rate of return is because you've actually switched it into profit mode where you take distributable cash, you take net free cash flow. And just looking at a P and L and looking at just that hides so much information. You're either having bad cash flow or you could potentially be having a whole bunch of debt payments that is making the income statement look good. But the balance sheet is weak. And the balance sheet is really what shows the value of the business and the health of the company. All right. My name is Mike Andes. This has been the Home Service Millionaire channel. Comment below what you learned that might be new and what topics you'd like me to discuss next.