Should You Share Your Financials with Your Employees? With Ryan Deiss

I mean, again, we've done it wrong way more often than we've done it right. And many of the times we've done it wrong. It comes down to what you said earlier, which is cash flow.

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Hey everybody, Roland Frazier and Ryan Deiss with Business Lunch this episode, we're going to talk about something that came up through a conversation that was taking place in one of the text threads that I'm a part of. And somebody was asking, actually it was our friend John Asaraf was asking about whether it was best to be transparent with your financial information, with your employees, or it was better to not do that and if you were going to be transparent, how much information should be available. And I thought that was really interesting. Somebody came back and said it was interesting too, because it was very split. Several of the people were, oh, heck no, that's your business, not anybody else's business. And several of the people were like, probably fewer of the people were, I'd say maybe even 70. 30. 70. Don't show anything. 30. Be completely transparent. And they recommended a book called the Great Game of Business, which is an interesting book to read or listen to. It doesn't take very long to get through it.

Yeah, Jack Stack is the author of that.

Yeah, Jack is a very ultra transparent kind of approach. And so I just thought it'd be kind of interesting for us to chat today about that. So, Ryan, let's start with transparent or opaque, which is better?

I mean, it's a spectrum, right? I mean, it's sort of like transparency with people. Right? I mean, like, you know, I, like I'm transparent with my wife, but do I say everything I'm thinking at all times, like at some point it's incredibly unwise.

You also have a survival instinct is.

What you're saying, right? It's like, I don't want to die. And so, so no, I mean, I think, look, I think completely opaque, telling your people nothing that's bad. Like I think both extremes is the case with all extremes, you know, can be bad. And I also think it's important to acknowledge there are people who say that you shouldn't share anything, you know, it's your business. The thing I'd point out there is there's this thing called public companies that are out there. They do pretty much share everything with the public and they tend to do just fine. So I don't think that it's necessarily one of these things where it's, you know, where, where it's bad. We actually tried it like years and years and years ago. I remember reading the Great Game of Business and Jack Stack, I was like, all right, this is the answer to everything. This is absolutely what's going to create employee buy in. It's what's going to motivate them. And so we're implementing fully open book management. And for us it was a disaster. And now I'll tell you, I don't believe it was a disaster because the concept is bad. I think it was a disaster because it was implemented poorly by us. Right. So it's on us now. But the reason that we haven't sought to go back and try it again is because I think it's incredibly difficult for small entrepreneurial companies to implement it well, because I think for most small entrepreneurial companies they don't know their numbers either. Yeah.

And in fairness, he had a division of International Harvester. They were making hundreds of these big tractors and engine rebuilds a year, had, you know, a large number of employees and fairly sophisticated financial information. So just so that you guys know that, that when you're thinking about your small or medium sized business versus what I would call a large, medium or large business that he has, there are some, some challenges and differences that come.

Yeah. So in general, I think like what, what we decided is we share our revenue targets. So we share. Here are the revenue targets with the company as a whole. So this is our three year target. This is where we're going. But, and then what we do is we say, anytime we, that I ever share revenue, I say now I want to remind all of you, you Know, if we go and make $10 million this quarter, that doesn't mean that every, you know, that, that me and the partners are all buying Lamborghinis. I hope you all realize that the, and that the amount of money that just like in your own home, like when you, when you receive a paycheck, you have to pay bills with that. We do too. Right. So our goal, you know, our target is we're targeting this margin, right. And it's out of this margin where we're able to, you know, grow and you know, pay back debts and fundamentals. So we're able to do all that. So in general, we're happy to share revenue and margin company wide with individual teams. Like so for the programs team, for example, that's when we can get into, well, what's the gross margin of this particular program? So what are you spending on these different things? Because they need to manage that. But I think, by and large, I'm happy to say, look, if you've got a question about the financials of the business, but just in the same way that like I don't share all the details of our household finances with, with my kids, I'm not going to do it with, with our team, not because they're children, but because they don't have all of the context and it isn't necessarily the information that they need to succeed at their job. And that is the question I always ask is what information does this person need to do their best work? And if that's related to finance, then great, let's talk about that. And if it isn't, then I'm happy to have the conversation. But are we going to necessarily put it out there for all the world to see? No, because it's not helpful, right? In our experience, it isn't helpful. So that's kind of where we've landed. What do you think?

I've gone back and forth on it. You know, I think that one comment that he made, he didn't say it this way, but I've always said, like when you're an entrepreneur and you have people that work for you, your employees all assume that gross equals net. And so they think that if you, if your business generated $3 million this year, that you made $3 million and they really don't think about it. I mean, they really don't think about expenses at all generally. And so what was interesting to me was that that they polled their employees and many of them believed that it was 50% or more profit. And I think that that's something that a lot of people think. And I think that that also like if you listen to a lot of people that are in the information or E commerce space or SaaS or services, a lot of the things that we're into, you'll hear margins of 40, 50, 60%. Frequently those are gross margins by the way. They're not taking out all the operational expenses and they're not even allowing for compensation for the owners. But what was interesting was that many people said that. So I think that if you really want to have buy in from your employees to be motivated and not think that you're just squirreling away millions and millions and millions of dollars that letting them know what the margin is, they can do the math. So if you're going to let them know what the margin is and you're going to let them know what the gross is, then you're effectively letting them know the net. And so you might as well tell them because it's going to be way less in almost every circumstance than they believe it is, which will then help them feel like, oh I see, like it's not, I'm not working to make this person rich. And not that there should be anything wrong with that because as long as everybody's getting what they want out of the relationship, it should be okay. But you know, fairness comes into play. So I think the first thing is I agree with you. I like the idea of people knowing what those three numbers are. I think that's really important.

Just the three are revenue, profit margin and I guess bottom line profit after they do the math.

Yes. Yeah. Okay. And I don't, I don't. I mean whether you want to do the math or not do the math I think is it doesn't matter. But I like the idea of that because then you get into assignment of ownership for different categories of expenses related to, you know, what, what those things are. And just as we in the scalable operating system we've got the key financials are the balance sheet, income statement, cash flows, those are really, really important. I think that like that's gotta be core. Now what you said, I want to know when you guys implemented it before because that was before I came in. What do you think was the failure point?

I think it was twofold. Number one, our numbers were wrong, we didn't have good financials and so what we were reporting was inaccurate and we had to keep going back and changing things because it was just, we were just trying to figure out, I mean we were pretty early. I mean like you Said, you and I have been working together for 10 plus years and this was years before that. So I mean, it was. We were still just trying to figure out what's an income statement. Right. And so what we were reporting would change. And it made it look like we didn't know what we were doing, which was accurate. But at times it made it look deceptive because it was like, oh, we're making all this money. It's like, oh, never mind, now we're not. And because, because the talking about it was tied to incentive comp. The result was that, hey everybody, we're making a lot of money and you're all going to make these big bonuses next month. Oh, crap, never mind. We got it wrong. You're actually not.

And that's terrible.

Right. And so what was it? It was incompetence on our part. Utter and complete incompetence. What did it look like? Deception. And when you're kind of choosing between incompetence and deception. So I think the first thing, if you're going to do this, you need to have your ducks in a row. I mean, really, you should be running solid financials for a good year and know what's going on. So I don't think that this is an early stage business kind of thing. Right? It's not an early stage business kind of thing. This is for latter stage, you know, businesses. You've been doing this for a couple of years, you know, you've actually paid taxes, you understand your bills and you're paying them. And so I think that's kind of the first piece of it. The other piece was that we didn't do a good job of aligning the goals of the company with kind of the incentive comp plan that we were doing. So the incentive comp was based almost entirely on sales growth. Right. And that's what we were incentivizing people to do. Grow, grow, grow. Like there, everybody's comp was based on how much did we grow? It wasn't based on profitability. And so there were some months where we actually paid out bonuses, where we lost money as a company. And so while we were going through all the trouble of explaining or badly explaining, this is how a business works. And yep, this is what we make and this is how much we actually, you know, get to keep at the end of it. We were doing that badly. And then we had misaligned incentives where we were trying to explain what profitability is and how it works and, you know, contribution margins and all that other stuff. And yet we were compensating people based on just growth. And so I think you want to make sure that again it goes to why do they need this information? How is it going to help them do their best work? Don't make a big deal about profitability, but then compensate people on growth because what's the point? Just talk about how much money you're making. Top line.

Yeah, I think that what is that metric that is important to you? And growth is certainly a legitimate metric. It's not wise to make growth the metric with no regard to profitability and cash flow. Those are two things that I think a lot of people confuse. That the amount of profit that the business might be making from a financial statement accounting perspective might be fairly different in terms of timing from what the amount of cash that's going to be in the businesses. And if it's very scary, if you are only focusing on let's grow or some other metric like this number of customers added or customer satisfaction or any of those things. Right. There's a lot of goals that you might have, but generally there's one primary thing you're after, at least thematically for a quarter. And so if one of those is growth, that's cool. You just have to decide is that going to be growth at all costs? Because if it's at all costs with no regard to profit and cash flow, you might find yourself unable to pay bonuses and therefore have a lot of very upset employees. Because if you can't pay those bonuses, you lose trust. Right.

You and I had an executive at one of our companies that we owned that was growing very, very quickly. And I'll never forget one of the like traffic managers was, was compensated based on it was a combination of ad spend, the more the better, the number of clicks, the more the better and the number of basically leads generated. Right. So it was all just growth, growth, growth. And that's where all the comp was. And there was no but it has to be at an acceptable, you know, return on ad spend. Roas it was none of that. It was just like grow. And this person was getting massive like 25, $30,000 bonus checks some months, right. When we're hemorrhaging cash, acting like we were a funded company. And I think this is a mistake that a lot of entrepreneurs do is they look at these funded companies that have hundreds of millions of dollars in dry powder who frankly know their unit economics way better than most entrepreneurial companies do and know how eventually this will ROI and they try to model them and it's you can't do that. You're trying to fund growth out of operating capital. You don't get to do that. So, I mean, I get into when we've done it right, how that worked. But I can tell you what definitely did not work was poorly constructed financials that changed all the time, poorly explaining how financials work. So I think also if you want to implement any type of, you know, open book accounting, you as an entrepreneur should probably take some accounting classes. Not kidding. You should know the difference between just gross margin and net margin. You know, that's pretty simple, basic stuff. And make sure that when you're doing it that you are aligning whatever that number is to people's incentives.

I love it. Let's take a break for our sponsors and then let's come back and chat a little bit about, like, the details of how you might implement something like this.

Hey, business hunch listeners, we're going to get right back to the show, but Roland wanted me to invite you to a brand new training that he's doing on acquiring businesses with no money out of pocket. It's something that he's talked quite a bit about on the show, but he's doing a free training where he's going to walk through the entire process. So if you want to get access to that, go to businesslunchpodcast.com epic that's businesslunchpodcast.com epic and you can get signed up.

Okay, we're back and we're talking about this open book accounting concept of should we make our numbers available to everybody in the company or should we not? Generally, Ryan and I believe it's probably better to be open at least about the amount of the company is making in terms of sales, the margin that it's operating at. And either you give them the, you do the calculation and give them the net, or they can do that math themselves. But we're generally both pro that the most of the arguments against that that I've seen don't make a whole lot of sense because if you don't give those numbers, they're going to come out anyway. In terms of sales, your employees are going to figure out what sales are and then they're going to either assume that 100% of sales is profit or they're going to assume that your profit margin that you're keeping is dramatically higher than it is because they're not thinking at all, like even just reinvestment and what you've got to put back into the company to keep it going. And what are the actual costs of operations below gross margin, below what the cost of the goods that you're selling or the services that you're selling are, they're not generally thinking about that. They almost always estimate too high. So knowing that, I think generally you're going to be better off to let them know because at least they won't think that you are taking advantage of them and making all of this money when you're not. So now when you get into kind of some strategies for implementing this, do you have any thoughts on that, Ryan?

I mean, again, we've done it wrong way more often than we've done it right. And many of the times we've done it wrong. It comes down to what you said earlier, which is cash flow, right? And so, so if you, if you're.

Going to be mindful of doing this and you're going to say, okay, I want to, I want to have an open book system. And so I'm cool with that. That's easy, you just release those numbers. Now if I'm going to release those numbers, to what detail do I release it? I think those three numbers are the only ones that they really need to know. Until you get into department meant heads who then should be really focused on the numbers that are applicable to them. And so one thing that was interesting in the Jack Stack book was that he said they assigned expenses to everyone in the company to own an expense. And one of the examples that he gave was toilet paper. And it's like, you know, they'd spend a lot of money on toilet paper. It turns out they found out that when people were working more on the line, they used the bathroom less and therefore they use less toilet paper. Now they have a lot of employees for, for us that might be, I don't know, you know, a role a week. So it's not going to be any giant difference. But I think if you have a big company to help someone get more ownership in something and feel a part of it, maybe giving those people ownership about some expense that applies to the whole company can be good. In a smaller company like ours, I think that like most of ours, I think I like the department head kind of having that, that's a, that's a call. But what I did really like was that if you lay out first what is our goal for this year and you identify your leading or lagging indicators and all the things we have in the scalable business system, and if you, if you haven't checked out the scalable operating system, then you definitely Should. And Ryan, where's the easiest place for people to check that out?

Yeah, if you go to scalable co. Scroll down a little bit, there's a button right in the center that'll take you to information about the scalable os.

Yeah.

This is where we cover how exactly, how we do exactly what we're talking about here.

Right. What I really like about certainly the way they talk about it in that book was that they lay out this is our goal for the year and this is our margin that we're targeting. And so now I know if my goal is 10 million and my margin is 13%, then I'm going to make a million three. Or my margin is 25%, I'm going to make two point. And now from that profit, I need to have some ability to reinvest in the company. And you know, the cost of operations, they set theirs at 5%. So on 10 million, you know, that's $500,000, which is not, I mean, not very high. Right. So that's like as at a minimum, before anybody gets any incentive compensation, they're saying the business ROI has to be 5%. And so anything above that, then they get into profitability. And I really thought, I liked the way that they laid it out there. And we haven't gotten to talk about this a lot, so it's kind of fun talking about it here. But basically they divide into quarters what the target is, and then 5% of whatever bonus that's agreed upon. Well, first they say, here's the maximum bonus that anybody can get. The maximum bonus in his company was 13% for employees and 18% for managers. And so you could get 13% or 18% of your salary. So if you make $100,000 a year, you can make an extra 13,000 if you're an employee, you can make an extra 18,000 if you're a manager. So everybody really got that that was possible and that those were numbers that made sense because that would allow the company to pay them but also have profit left over. So now then they're reverse engineering. They're going back and saying, okay, if Our target is $10 million in profit this year, and we know that combined we're gonna pay roughly 15% when we average the 18% for managers and the 13%, if everybody was gonna get the max and that they would get the max if we did 10 million in profit, then we know that we have a million and a half in bonuses that we have to give. We also know that we have 500,000 to hit our 5% minimum cost of operating that we want our minimum return on operations. Right. So that's 2 million of the 10 million. And then I've got my margins and everything else. And so I like that because they like, they really go into building the incentive based on can we afford to pay this? Like can we afford to pay that? And then they said that half of each quarterly bonus, like so half of each quarterly bonus, whatever it would be that the employees could receive, employees and managers could receive would be paid immediately at the end of the quarter, each quarter. But if you missed, then the excess would be rolled over each quarter up till the end of the year. So that like if you had, if you hit 10% of what you want, excuse me, if you hit 5% during the first quarter and the goal was 10, then you missed by 5, but you could roll that over to the next quarter. And I, I thought, I just thought that was kind of an interesting concept. What do you think about doing something like that?

Yeah, I mean, so founders board members will know. We did a couple of months ago, we did an intensive on this designing an incentive comp plan so I can actually share. It's basically what you talked about because it was I'll give credit where credit's due. A lot of this was informed by Jack Stack. But I mean it's basically. Yeah, establish the trigger. What's the minimum threshold that must be achieved before any payout is generated? Right. Because out of profits, like you said, some of that profit needs to be paid out to other things. I mean there's going to need to be taxes. Taxes, by the way, taxes have to be paid. And so that's a big part of it. You may have debt service that needs to be paid that you're not currently factoring in as an expense. There may be obligatory distributions that are made to certain shareholders who have a preferred kind of thing that needs to be paid out. So here's the minimum threshold. You said theirs was like 5%. I mean, yeah, you could say like this is what we're kind of targeting. And that's the other thing I will say like the way we do it is we say this is our three year goal. Like we set a three year target and then that's broken into 90 day, you know, for this quarter, our profit, you know, our revenue target is this. Our profit margin that we're targeting is this. And it could be 20%, 25%, 18%. We tell everybody what we're targeting and then we tell them where we came in. Hey, we came in at 17% instead of 18, came in at 22% instead of 20. Right. So everybody knows, and this gets announced and talked about at the all hands meeting that kicks off a new quarter. So every quarter we're saying this is a three year target we're shooting towards. And here's the quarter that we're in. You know, we're a third of the way through to our three year target. This is our goal this quarter, this is what we're targeting in terms of profitability. And then remember, everything over and above this amount goes into the pool. Right. So there's the trigger, then there's the percentage that goes into the incentive pool. And then it's like who's included in that pool. And I'm a big fan of, of, you know, if you can afford it. Right. Again, the money needs to be there, the cash needs to be there. Consistent profitability needs to be there. Of everyone having some participation in the pool. Right. Everybody having some participation in the pool. If you're going to talk about profitability, then I think you should align the incentive towards that. I think in terms of who gets what, you know, determining kind of the payoff method, I think certain people are going to get a larger percentage of the pool than others, but I think everyone should get something. And then in terms of the payout timing. Yeah, what you said, I love the idea of doing a quarterly, doing a quarterly payout, but it's a percentage. Whether it's 50% or 80% of that quarter, the rest of it is held back to the end of the year. And so for us, the executive team participates in quarterly profit sharing. Everybody else at the company, they're generally getting an end of the year bonus. And so there's stacks that way. It feels a lot larger when it hits. It hits at a time of the year when people frankly are shelling out money and it's traditional to pay out holiday bonuses anyway. It's also just good for retention throughout the year. Right. To do that. So that strategy is, you know, is exactly it. Make it known. This is our revenue target, this is our margin target. If we hit this, this is the percentage that's going to go into the pool. People understand their participation in that pool because it's explained as an aspect of their compensation plan. And you're sharing, hey, good news, everybody. This quarter we were able to sweep this much into the pool. And I think that's the important thing to say because it's not just about profitability, it's in light of us hitting this profitability number, we were able to sweep this much into the pool after all the other stuff's paid. And that's so incredibly important because sometimes just because you profited it, that doesn't mean you get to keep it.

Yeah. And to that end, lay over that, your cash flow, you've got to have statement of cash flows. You've got to have an income statement. They are not going to be the same very often.

They.

They are very often not going to be the same. So just be sure that the cash is there to cover everything that you need to do, because the last thing you want to do is sweep it.

Into a different account. And I think that's important. It should be swept into a different account. And that's where it sits. It's money to be paid out, getting set on the balance sheet. But that is not operating cash anymore.

Exactly. Cool. Well, I think that's something for you guys to think about. So we'd love for you to let us know. I don't remember the site, the forward/onbusinesslaunchpodcast.com where people can. Is it just ask?

Yeah, ask a S k. Yeah.

So businesslunch.com ask if you would like to ask questions. But don't just ask questions there. Let us know what you're doing because we'd kind of love to see what other people are doing in terms of incentive plans. And you know, do you make the numbers available to your. To your people or not? And if you do make them available, then what. What do you let them know? So that I think it can be really helpful to you. So, guys, thanks for tuning in this time. And if you found this helpful, please share it with a friend or 20 friends or even 100 friends, and we'll see you next time.

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