E158 | The Melting Pot Webinar: Simple Numbers with Greg Crabtree
This week we’re bringing you a special episode: a recording of one of our live webinars with Greg Crabtree, founder of accountancy firm, Crabtree, Rowe and Berger. Greg is exactly the type of person that we love to be able to bring you here on The Melting Pot. If you weren’t able to join us for the live chat, don’t panic, you haven’t missed out.
Greg is author of The Simple Numbers, and is famous for cutting through jargon and making his theories accessible. He also co-wrote a chapter of Vern Harnish’s brilliant Scaling Up. More recently he’s written Simple Numbers 2.0, where he’s dug into some concepts that we wanted to talk about more – labour efficiency ratio and launch capital.
While Greg is an accountant, he comes at it from a very unusual perspective. As an entrepreneur himself and a small business financial expert he is such a fantastic person to listen to and learn from.
“The vast majority of businesses struggle to understand financial truth. And that’s really the epidemic crisis in the privately held business world. Entrepreneurs are trying to scale and they’re 100% focused on revenue. But [they’re like] are we profitable? How do we make money? You can’t just be changing quarters for dollars and think that’s success.”
We hope you enjoy this episode as much as we did, don’t forget to subscribe to stay up to date!
On today’s podcast:
- Why he’s an unusual accountant
- How to run a successful business
- Return on investment
- Labour efficiency ratio
- Importance of marketing
- Understanding launch capital
- Simple Numbers, Straight Talk, Big Profits
- Simple Numbers 2.0: Rules for Smart Scaling
- Scaling Up
- Twitter – @gregcrabtreecpa
- LinkedIn – Greg Crabtree
- Website – https://simplenumbers.me/
Understanding Simple Numbers to Grow Your Business with Greg Crabtree
Greg Crabtree is a speaker, author, consultant, entrepreneur and small business financial expert. Greg founded his own firm Crabtree, Rowe and Berger to focus on helping entrepreneurs build their economic engine. However, after being named to the INC 5000 list for 2019, Greg’s firm merged with Carr, Riggs & Ingram CPAs and Advisors, a top 25 U.S. accounting firm to help broaden their impact on the entrepreneur community.
In 2011, Greg’s first book, “Simple Numbers, Straight Talk, Big Profits” shares his core principles of how to turn your business into a wealth building engine. In 2014, Greg contributed a chapter to Verne Harnish’s book, “Scaling Up” on how to improve profits though labour efficiency. In 2020, Greg released his newest book, “Simple Numbers 2.0: Rules for Smart Scaling“.
The unusual accountant
“The vast majority of businesses struggle to understand financial truth. And that’s really the epidemic crisis in the privately held business world. Entrepreneurs are trying to scale and they’re 100% focused on revenue. But i[they’re like] are we profitable? How do we make money? You can’t just be changing quarters for dollars and think that’s success.”
Basic accountancy is pretty boring, says Greg, but his approach allows him to make a bigger difference in the world, to help people be successful in what they’re doing.
“There’s nothing worse than good, hard, blood and sweat and tears, that didn’t really accomplish anything.”
By studying his clients who were successful in spite of him, he became aware of what they were doing well, what was working for them, where other people in the same industry were failing. He quickly realised that as accountants, you’re taught numbers and debts etc, but you aren’t taught how to help people run a successful business.
How to run a successful business.
Greg says the first thing you have to do, to run a successful business, is clear distortions i.e. what are you doing that is causing you or an outside tax advisor to misinterpret your financial data? You don’t want to get to the end of the month and have to do mental olympics to figure out if you made money or not.
Once you get to true profitability, says Greg, you next have to figure out if it’s a sustainable level of profitability.
“In general, at 5% profit you’re on life support. 10%, you’re good business. 15%, you’re a great business. And that actually is a pretty solid number for probably 70% of the businesses out there.”
Don’t get upset if you don’t fall into these categories – your profit percentage target is driven by a capital requirement that your business needs. You set your individual profit targets. Greg says he has clients that are wildly profitable at 3%.
However, he warns:
“If you don’t understand the dynamics of the capital relative to the profit engine, you’re playing with fire because you have something that may be far more sensitive than you may think.”
Return on investment
It’s not about the profit percentage, or the dollar amount of profit, says Greg, you need to focus on the idea of return on investment. You want a return on investment of at least 50% or greater as a target.
“We see most privately held businesses that are run properly, they’re going to be returning probably more than 75% – 100% range. And so who wouldn’t want an investment that’s making 100% a year?”
How do you calculate your return on investment?
Easy, says Greg, you take out your balance sheet and you look at the very bottom of it for the thing labelled ‘equity’. Equity is the sum of assets minus liabilities.
“The first thing that you do is you take equity, and you adjust it down for any debt assets that are not necessary for the operation of the business, typically, shareholder loans, loans to related parties that aren’t related to this business, or goodwill.”
Once you’ve made your adjustments, what you’ve got leftover is invested capital. And that’s not the same as equity. Because invested capital is what it takes to run an operating business.
“It’s that number that you compare to your net operating income, or what’s commonly referred to as EBITDA. So EBITDA divided by invested capital is your return value. And it’s that number that we believe should be 50% or greater for a privately held business. And if you don’t have at least 50%, there’s something wrong with your business model.”
Labour efficiency ratio
In a nutshell, the labour efficiency ratio (LER) is universal to all businesses – it’s about the productivity of labour. There’s not a business in this world, says Greg, that does not produce profit relative to the output of labour.
“I don’t care what your product, business or services are, it still takes the productivity of labour, [people] doing their job – whether it’s direct labour, management labour, sales labour, marketing, whatever functionality of labour, it still takes labour.”
It’s never non-labour expenses that kills a business. In most cases, if labour does its work in every function, a business will be successful. The most important labour to get right, says Greg, is management. If these people do their job, direct labour will be productive.
“Management labour has basically three functions. They must look at all the myriad things that drive revenue – they have to control the cost of goods sold, draw a proper relationship of revenue relative to COGS, and manage direct labour to work off of the gross margin of revenue minus COGS. Those three functions, that’s it, that’s what creates profitability.”
The number one measure of true value of employee output, says Greg, is what revenue did that employee produce? What margin did they produce?
Importance of marketing
Companies that don’t grow as fast as they would like are often underinvesting in marketing.
“Marketing is like going to the craps table, you have to go to it with enough money that you’re willing to play the game long enough until you hit the win. It works essentially that way because for anybody to tell you that they know how to make something happen – no, I’m not buying it.”
Return on investment in marketing is another way of using your launch capital to decide whether your experiment has worked.
Launch capital has been hiding in plain sight for centuries, only it didn’t have a name before, says Greg. Launch capital is essentially money you’ve spent now, but you’re only going to see ROI or benefit on its expenditure in a future period.
90% of all business growth in the businesses that Greg works with, comes from launch capital. And number one on the list is marketing. Labour is number two. Technology development number three.
The number one use of profit, advises Greg, is to reinvest your profit back into the business. Because if you want your business to make you 50-100% return on investment, then you’ve got to keep throwing money back in to keep it going.
But bear in mind, says Greg, if you spend $100k, you want net profit to go up $50k. If you spend $100k, you want $150 back. And once you realise what you hope to achieve profitability wise, you’ll quickly see which investments will and won’t help you get there.
And remember, it’s all good and well generating leads, but you can’t take leads to the grocery store. You need dollars to buy groceries, says Greg.