Defining the Health of Your Business

Don't focus on growth as much right now. I mean, yeah, grow, but if you grow, you might grow yourself into oblivion. Like, let's focus on profitability for a season.

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this is Business Lunch with Roland Frazier and Ryan Dice. Welcome to another episode of Business Lunch and today's a snackable episode with Roland where he's going to get into some more tactical strategies that you can start using to live a rich and happy life. If this is the first snackable episode you're hearing, I'd encourage you to go back and listen to some of the other episodes that Roland has put out. And if you want to get notified every time we release a new episode, go to the new businesslunchpodcast.com website and we'll send you detailed notes along with every episode. That's businesslunchpodcast.com www.businesslunchpodcast.com and you can sign up for the free email newsletter where you'll be able to get all the highlights and resources from the episodes.

Hey everybody. Welcome to another episode of Business Lunch with your host, Roland Frazier. That is me. And your other host, Ryan Dice, which is not me.

That's me. How you doing? I'm great. I'm really good. I'm feeling like, feeling like things are getting back to what I would classify as some version of normal. You know, we've had quite a season of late. Lots of, I think a lot of entrepreneurs and you know, people go through this where you get into a super busy season and even though it's your work, it doesn't feel normal. I guess it's, I guess it's equivalent to like if you're an athlete and you're in the playoffs kind of thing. Like that's the goal. It's what you want to have happen, but it doesn't feel normal. And so it's kind of nice, I think, to get on the other side. It's like I'm just going to be doing spring training and kind of getting ready, getting back to quote, unquote, normal. So.

So you had a kind of an interesting conversation with one of our founders board people as I recall, with a pretty cool question. You want to share a little bit about that?

Ye, yeah, yeah. We were doing just every, every month. I like just in kind of an open AMA office hours, like let's talk about whatever you want to talk about with our founders, board members. And somebody asked a question, and they're always good questions. I mean, these are smart people, successful entrepreneurs. But it's rare that people ask me a question where I just don't have some kind of answer. And that sounds super arrogant.

I get it.

But, you know, you do enough of these things, you kind of get asked the same questions a lot of times. It's not that they're bad questions, it's just we dealt with them. But I'd never been asked this question before, and I didn't have a good answer. So I told him. I was like, I'm sor. I don't have a good answer. Let me think about it. And the question was, what do you believe is the number one business health metric? Like, what is a metric that you could track to really understand the health of your business? So not. I mean, there's lots of metrics out there with respect to growth, profitability, value, things like that. But when they use term health, like, how healthy really is my business? I thought it was such a good question because I think as entrepreneurs and CEOs, we want to make sure we're building healthy businesses as. As investors, right? If we're going to invest in a company, if we're going to acquire a company, I think it's important that you have a really good understanding of how healthy is the business that you are buying. And so it's such a simple question that didn't have a great answer. I didn't have a great answer to. Maybe you will and maybe other people, like Ryan. There's obviously these things out here that everybody knows about, and I'm going to be exposed for the moron that I am. But I'm just curious. Like, I've thought about a lot. I'm happy to reveal what I was thinking, but I'd love to know. Just kind of first glance, since we're talking about this first time, what do you think?

I'd love to hear. What was the first thing that came into your mind when they asked?

So the first thing that popped into my mind was nps Net Promoter Score. I thought about that. And if you don't know what Net Promoter Score is, it is basically, on a scale of 1 to 10, how likely are you to refer this product or service to a friend or colleague? And I know the folks, and I believe in nps. I think it's great. I think it's certainly limited if you take it out of the context. If you don't look at overall engagement and stuff like that. And I know that the people at Net Promoter Score would love to say that this is absolutely your kind of number one health metric. They would want us all to believe that. But we know from experience, both businesses that we've owned and businesses that we've been partners in, that it is a metric that if you want to game it, you can game it. And so I was thinking, if this is going to be the number one business health metric, it should be something that isn't easy to game. And it also should speak to more than just what is the, the customer's perception of the product and the experience. I think customer per se. Like customer experience is a big aspect of it, but it's not all of it. And so then I started thinking about, you know, in terms of, I thought about revenue per employee. Right, revenue per employee. Because revenue per employee would certainly speak to how efficiently, you know, are you running your business. Since, you know, in general, people costs are our biggest expense for most, for most companies, people is going to be the biggest expense area. You know, but you could have a high revenue but not be profitable. So maybe look at profit per employee was kind of where I went to next. But that still didn't speak, you know, enough, you know, some of the other aspects of business. So, so those are ones that I thought about. I don't think they're bad. I think they could be really solid metrics to look at all of them. And I think they could. They, you know, probably should be some of those evergreen metrics that you just track. Like, I know for us, at the top of our, the, the company scorecard, we're always looking at both, you know, NPS and, you know, revenue per employee. Like, these are metrics that we're tracking, but are they the number one business health metric? Ultimately I was like, nah, I don't think so.

So what did you settle on and how did you come up with it?

I want to hear if you've got any ideas before.

I mean, mine is so like, I think most of those things because you could also look at some of the financial ratios, like debt to equity and, but, and all of those are things that buyers consider when they are trying to determine is this a company that we should invest in?

Right.

And including ENPs like your employee Net Promoter Score as well, how likely would you be to refer a job at this, you know, to recommend working at this company to a friend? I think those are all good. But if, if I was going to try to, to as if I had to pick Just one, which I think is difficult. It probably would have to be compound annual growth rate of profit because looking at anything that is a measurement in time right now that, you know, that's, that's tough because you might have a very high NPS right now. You might have a great debt to equity ratio right now. You might have any of the things all clicking, you might have a great valuation, your stock price might be high, you have a compound annual growth rate that's high. But, but in this moment it doesn't really tell you about kind of the health of the company. It just, it's a snapshot versus a trend. So I would like compound annual growth rate of profitability because it'll tell me that this is a company that over several years has been able to continue to be in business and earn a profit at a higher rate and over time.

Break that down. If I don't know immediately what that is, break that down for me. How would I go about figuring that out?

I would just say what is my, you know, what is the rate at which my profit is compounding my ebitda, you know, if you're in a, in a professionally managed business or my sde, my seller, discretionary earnings, if you're in an owner operated business. But is my profit compounding at a healthy rate over time? So I think that's a, a pretty good way to look at it because it's going to take a period of years into account and you're just going to basically say how's our profit growing? Right? That's, that's, that's the one that would work for me because it's, it's trend based and you have to have some way. Now you, you could be destroying your customers at a terrible rate and serving, you know, no one and doing a bad job and just somehow you've got an offer that continues to drive people in for some period of time. Ultimately that will blow up. But you know, so I think you can game anything but that. That's probably the one I would look at. What, what did you come up with?

Yeah, and I, and I do think it's important. Like I think one of the lessons is that there probably isn't one. There is. It's going to be, yeah, it's going to be a combination of things. But I think if you distill it down and say, yeah, but what if I had to sell down to one, what would it be? It creates some interesting ones. So just so I understand yours, the one that, the one that you recommend that you were thinking about it is not how much profit did we generate over a period of time. It is, what is the growth of our profitability over time. Right.

Do we have.

Is that expressed as a percentage or as a dollar amount?

Well, the growth rate would be a percentage. So basically it's like, is our profit growing at a healthy percentage? Which, you know, 20% would be fantastic over and compounded over a period of time, because that's going to take into account a whole lot of things.

Yeah, I think we're. We're thinking along the same lines. Which is. Which is good. I think yours, and I'm not surprised, is a bit more sophisticated than what I was thinking because it takes into account, you know, time. But I was thinking just distributable cash. And I was purposefully trying to not come up with a metric that already had, like, a meaning because I thought about, you know, free cash flow that can mean different things to different companies. Bookkeepers and accountants will call that. I didn't. I didn't necessarily want to say, because I thought about profit, but my thinking about profit is sometimes you do want to pour profits back into the company. And so when I thought about distributable cash, it really was like, maybe we chose to put it back in, we chose to reinvest it, but we could have distributed it, right? We could have distributed it and we could have still, you know, achieved certain kind of growth. And so especially maybe if you were to look in and say, like, well, what if we weren't going to do as much, you know, lower down R and D to lower, lower levels, maybe you're above industry standards and those kinds of things. But to come up with and to say, what is our distributable cash? How much cash could we distribute in form of dividends, distributions, whatever you want to call it, and still maintain a, like a solid growth rate, that, to me, when I thought about it, number one, it suggests that sales are strong. Right? You really aren't going to be able to have distributable cash unless you have sales coming in. The first thing that goes away. If sales dip, generally the distribution stop. Right? You're going to keep paying employees, you're going to keep paying rent, you're going to keep paying all of your other stuff. You're just going to stop paying yourself, especially for entrepreneurial companies, which is a lesson that you taught me. You don't want to do that. Right. But that is generally the first one that gets lopped off. It also suggests that you're running efficiently, you know, from operationally speaking. Because I know in the past we've been guilty. And by that I mean the companies we run, not necessarily just you and I specifically, but our companies have been. Have been guilty of reinvesting too much, quote, unquote profit and basically allowing inefficiencies to run amok for the sake of. And calling it R and D. Call it like we're trying this new thing out.

Good news, we've got some giant R and D credits that we're going to

be able to get. Oh yeah. Oh, yeah, yeah, yeah. We definitely have some gen R and D credits because we are indeed the hell out of some things. But. But I do like, the reality is you should be able to do both. Yeah, you should both budget in testing and R and D and profitability. The two are not mutually exclusive. Like, there's a point in time where maybe a business can't afford to do it, but I would say at that point in time, it's not as healthy as it could be. Right. If you can't both have this free distributable cash and fund growth and fund future investment R and D, then I would say that you're not as healthy as you could and probably should be. Things just aren't turning over. It also suggests that cash is being managed effectively because PNL is lie. Cash doesn't.

How are you defining. How are you calculating distributable cash?

And that's what I'm saying that the reason that I came up with this kind of metric is I think that it would. I wanted to come up with something where the business could define it based on what they feel like it is. I wanted to add some ambiguity into it. So the way that I would generally define it is, you know, the actual true, like free cash flow that popped to the bottom plot to the bottom line that could be sent out. But also, let's say you're saying, you know, we want to make a big investment in something that is unrelated to the core business. We understand that. We're taking a flyer on it. We don't have to do it. I would, I would add that back in into distributable cash because as a buyer, like, if I were buying that business, I could decide, well, I'm not going to make that investment. Whereas I wouldn't add back in all R and D or all testing because any business to continue to function, run and operate is going to need to have some budget for testing in R and D. Does that make sense?

It does, it does.

And obviously anything that was actually distributed would be the purest form of it. Like how much did we actually send out? And so that was, I mean, for me, that's what I came up with. And I thought about it. I think, you know this. But in a former life, the only job I ever had was as a financial planner. And one of the things that they taught us, it's like the only thing I remember is that a really good, good like stock investment strategy. By the way, this is not investment advice, but there are people out there who, a core tenant of their investing strategy is to buy dividend producing stocks. Like to only buy companies that are growing and that have a dividend. And specifically you're looking for companies that have increased their dividend. To your point, and I don't, I don't remember the paper, maybe somebody else could look at it, we could drop it in the show notes. But there was a whole study that was done on if all you did was invest in companies that steadily over time had increased their dividend, you would beat the market, right? You would steady, you would steady beat the market if you factored in, especially if you were to dollar cost average and do stock purch versus from the dividend reinvestment type stuff. So that to me says if it works for the big companies, why not? Why wouldn't it work for the little companies? So make it about distributable cash. And I love the idea of adding in your metric of the rate of growth of distributable cash. How much is it increasing? So anyway, that's what I was thinking. And again, it's not a hill I'm prepared to die on if somebody feels like they have a better one. But I would encourage anybody here to try to come up with what should a business health metric be? Is there some metric that we just look at to know that, okay, across the board we're doing a good job? And I think if you know, distributable cash, if that works for you, do that growth and profit, you know, the profitable growth month over month, year over year. I just wanted something we could track monthly.

So yeah, I like it. I think that one thing for people to think about that, that they may or may not know is that when you're thinking about choosing something like this, you're, you know, I do think over time is a good thing to look at. And so like if you were looking at a number like cash on hand at the end of the year or something like that, that would be A balance sheet number. And the balance sheet is a snapshot in time. So balance sheets are dated as of the date that the snapshot occurs. So you would have a balance sheet that might be dated, you know, December 31, whatever year it is, and it only represents what's happening on that day. So if cash on that day or other assets were one thing, but then the next day something bad happened or a big payment was made or something like that, the next day, literally everything can change. The nice thing about an income statement or a P and L, a profit and loss statement is that it is over a period of time. So it'll say for the period from January 1st of whatever year through December 31st. So that's representing longer period of time, not just a single snapshot. And then when we start looking at trend type things like compound annual growth rates of different numbers that are on there, we're getting to look over a span of years. And so I think whenever you're thinking about how can I see where I stand, where you stand right now today might be radically changed tomorrow. A recent case in point would be the FTX exchange. That was worth I think 30, that was, I think it was worth 34 billion one day and listed as a dollar the next by Bloomberg. So like that, which is less that snapshot in time of that one day to the next day, that was a pretty, pretty big change. But yeah, I think it's great. I don't think the number that we picked was terribly different because I would say I would be kind of curious because you were looking at being basically a stockbroker 20 years ago more.

Oh God, yeah, yeah, 20 years ago.

Because now I think that like one of the things that we always have to think about is what's going to increase the value of the company. And so a lot of companies that don't pay giant dividends plug the money back either into buying stock to increase the net shareholder value or they put it into growth things. And I think that, I think probably now it'd be interesting to look at that study because I remember seeing that, that as well. And I bet you over the last 20 or so years it's that that wouldn't still hold compared to the people like the big companies that didn't do distributions or didn't do great ones. Are the trillion dollar companies that are out there now, I think so. Be kind of interesting. I hadn't thought about that in a while, but that'd be something to look at.

Yeah, you definitely miss all the growth stocks. If you do that, right? You're playing in the value stock game. And so I think the idea there is, you know, you're not swinging for the fences, you're not trying to hit a grand slam. It's, it's basically how do we, how do we do better than the market without taking too much downside risk? And I think the same, frankly, is true for, for us, for our companies. I mean, as entrepreneurs, as investors, we make the same decision, right. There are plenty of people, entrepreneurs, who make the decision to shoot for the stars, to take that VC money and to basically say this is going to be a billion dollar company or bust. Right. At a certain point, you take enough VC money, you got to get to VC level scale or you're worth nothing. Right? And so that is kind of taking that growth path. And there's plenty of other people who go the bootstrap route. And you know, they have really solid companies, in many cases multiple, you know, of them that deliver, you know, life changing results, but not necessarily at the same orders of magnitude as, you know, I don't know, a Zuckerberg. So, you know, I think it's a, I think it's a choice. I think it's important to know the game that you're playing. Right. Are you playing a game for growth? I think the mistake that a lot of entrepreneurs make is we don't think enough like investors.

Right.

I think a lot of entrepreneurs think very much like, this is my baby, this is my thing. You know, this is the only one

that I got to take out today.

How much cash can I take out today? Or the inverse. I need to make sure that it grows and it gets all the love and nourishment that it needs. And therefore, if I wither and die, that's okay because the company's more important than me.

I think it's good more than anything else based on what I've seen.

Good lord. It certainly is what the media has been telling us we should be doing. So. So, yeah, I think that, I think it's good to take a step back and I think, especially now, I love the fact that, that the trends are shifting. I don't necessarily love the reasons that they're all shifting, but I love the fact that profitability is becoming cool again. Yeah. That it's not just growth at all costs. I mean, how much now are we telling people? Don't, don't focus on growth as much right now? I mean, yeah, grow, but you know, if you grow, you might grow yourself into oblivion. Like, let's focus on profitability for a season. That's why if that's kind of where you are growable. Say that again.

So that's why we have a company called Scalable Co. Not Growable Co. Yeah, yeah.

Any company is growable. But you may not be scale able because scale is going to require that pesky profit and fuel, cash fuel at some point anyway. Yeah, I thought it was a, I thought it was interesting discussion. I'm going to keep thinking on it and I would love it if you're listening, if you want to comment with any of your ideas, feedback, what do we miss? I would love to hear it, especially if you're going to say that you agree with me over Roland.

Yes. Yes. Yes. Although I don't think we didn't. We didn't, we didn't disagree too much. Awesome. Well, thank you guys for listening, watching or sharing this time with us. And we'll see you next time on Business Lunch.

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