Highly recommended.
The reason I liked this book so much was that for a book about numbers, it isn’t over loaded with calculations or accounting jargon. It does have some discussions about numbers, but the discussions were more about the thought process of how to make your financial decisions rather than how to do the math equations. That is why I think this book is so valuable. Business financial decisions are only partially about the math equation. If everything just came down to the math, it would be much easier. But the way you think about money, your mindset, has a significant impact on how you decide.
So it is only one part numbers and the rest is mindset and human behavior. Failure to understand this can negatively impact your results. Let’s look at one of the big issues that he discusses in the book for an example. How much compensation do you pay yourself as a business owner? His short answer is a market wage based on the tasks that you are performing for the company. He discusses all of the reasons for his recommendation for this and then weighs that against what happens often times in small businesses. Many business owners don’t pay themselves at all and just take profit distributions when they need cash. Or they will pay themselves a small salary that really isn’t indicative of the work that they are performing.
There are multiple problems with this approach:
- In some cases you could be opening yourself up to question by the IRS. They may look at this as a way you are avoiding the payment of payroll taxes on the portion that should be wages.
- You don’t have a clear picture of what you are making as an employee vs as an investor. If you are the owner and the employee your compensation is for both of these roles. Not being clear about these distorts your profitablitiy.
- If you don’t pay yourself properly, you may start valuing your time inappropriately. Why hire someone to do the rote tasks even for a low salary when you are working for “free”? Your time is probably way more valuable than that but you don’t think of it that way when you aren’t paying yourself.
- Related to this, you may be doing task that you don’t do very well that could be hired out and get a better result.
- If you have business partners, the issues can become even messier. Are you all worth exactly the same? Are you all putting in the same level of effort AND value. If people are only getting paid profit distributions equally but putting in varing levels of time, effort and expertise it won’t take long before someone resents the arrangement.
The best approach is to pay based on economic reality. What would it cost to hire someone to do what you are doing? Some of the negative reviews that I read of this book pointed out that there are some legitimate tax strategies that can be invoked to save hard dollars and that to ignore them is throwing money away. I would agree if you are only viewing this as the math equation. And it is a valid argument and easy to agree with that thought process. I know I am making a harder argument to translate into hard numbers. But when you aren’t valuing your own labor you are making different decisions that could have negative impacts on your business and those decisions compound over time. It isn’t just math, its mindset.
He also argues that you should be glad that you are paying taxes. I know that this one is hard to swallow too. But making money only counts if you get to keep it. And you can’t keep it and take it home if you haven’t paid tax on it. Again, the critics argued that you should look at minimizing you tax bill…….agreed. But too many business owners get caught up in this mindset of spending money to keep from giving a portion of it to the IRS. They would rather spend a dollar so they can save 40 cents. But then the dollar is gone and you take nothing home. You have to have after tax profits to build your personal wealth.
In the chapter about the Four Forces of Cash Flow I found myself cheering as I was reading. This one sounds so simple on paper, but I have seen it create problems all the time by getting the ordering of the priorities wrong. And the order of the priorities is the critical piece. I was joking with my husband and comparing it to the priorities wh have when we go scuba diving. We have four priorities there too: diving, eating, sleeping and partying. All of those are fine unless we get them out of order. Putting partying at the front of the list can have some really bad results. So the order of priorities matters.
The order he laid out was:
- Paying your taxes
- Repaying debt
- Reaching your core capital target (building working capital)
- Taking profit distributions
The first two are probably, for the most part, already determined in the amount. You know approximately what your tax rate is. Why spend that money when it really is already committed? It is better to set it aside to assure that it will be there when the bill needs to be paid. The same is true of your debt payment. You know when the payment is due and how much it will be. That money needs to come from your after tax profits so you need to set that aside right after the tax payment.
I get that when you first start out, and cash is tight you may be using that already committed pile of money to meet other more pressing obligations for some brief periods of time. But if you can move past that circumstance, you will always be struggling.
The next two categories are more discretionary. You work toward building the working capital that you need to keep in your business:
- to keep the day to day operations running smoothly
- build for growth
- provide for the unexpected.
How quickly you build that will be up to you and how fast you are trying to build your business. This will be balanced with the last priority. The last is the distribution of profits. You are in business afterall to make a profit. If you can’t get to a point where you can take home the profits, you will begin to wonder why it is that you are in business and not just someone else’s employee. But you need to feel confident that you aren’t limiting your growth potential by taking too much of the profit out and stunting that growth.
These are some of the key take aways that I got from this book but there was so much more. He had a lot of discussion about maximizing labor productivity which I will write about in another post in more detail. His discussion on this topic was a mindshift for me but I really liked his approach.
In summary, for every dollar of profit (or revenue for that matter) that comes in the door there are innumerable ways that that dollar can be redeployed. Figuring out the most productive way to allocate those dollars is the key to managing your cash flow. And managing your cash flow productively is the key to growing a healthy business. The struggle that many business owners have is how do you decide what the best use is for that dollar? How do you allocate between the different competing forces? Math and mindset both have an impact on how you make these decisions. This book gives you a great road map to help you work through both the math and the mindset.
What strategies have you used to make these decisions?
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