Dashboard: Three Metrics for ‘White Knuckle’ Times

[Music] Welcome to another 21 Hats dashboard. I'm Lauren Felman and I'm here with Tracy Beck who is co-author of the 60inut CFO and CEO of Driven uh a company that facilitates CEO forums. Welcome back Tracy. Hi Lauren, thanks for having me. Always a pleasure. Tracy, you have been here many times. Thank you. and we've talked about many aspects of how business owners should manage their finances, what they should watch, uh what metrics they should be paying attention to. Given how much uncertainty there is in our economic world these days, I'm wondering if there are particular metrics you recommend tracking during times like these. Well, Lauren, you know my answer because uh our whole teachings about financial fluency for business owners center around metrics and we have 14 of them that we recommend for business owners to focus on. However, uh lately it's it seems like people are as busy as ever and 14 well you know you you 14's not really too many. People could really use a shorter list of those things. And also I think it's been helpful lately to tell people and um coach people on some that really make a more immediate difference, right? Some some you affect over a longer period of time, some you can kind of make a change on a week by week, month by month basis. So uh so those are the ones I've been talking about the most and especially during these kind of weird white knuckle uncertain times, right? So so those are the things that uh that I'm talking about. So number one I would start with is gross profit margin. So a lot of times we know what our net profit margins are, right? We we know what our revenue is and we know what money we have left which is our net profit margins. But there is another level of profitability in there and that's how much money we have left after our cost of goods or our cost of sales. And these things really measure when we we look at our gross profit margin that really measures the efficiency of what we're selling, right? Does it do we make a lot of money when we sell what we sell or are we left with very little after that sale? Just asking for a for a friend. Could you tell us what exactly gross profit margin is and how to calculate it? Yeah, so the first thing you need to know is what your your cost of goods or your cost of sales are or in other words the cost of providing your goods or services, right? So, if you sell t-shirts, your cost of goods would be how much money it was for you to purchase that t-shirt in or to or to produce that t-shirt, right? And get it all the way to the customer. So, let's say you sell t-shirts online. So, your cost of goods would be the uh the raw goods of that t-shirt. And if you manufacture the t-shirt, it's probably, you know, the thread, the materials, you know, all the things that go into it. or if not, it's the cost you paid, you know, wholesale for that t-shirt, plus probably the shipping and handling to get that t-shirt all the way to the customer. And so your gross profits would be the the cost of the the price of the t-shirt, if you sold the t-shirt for $20 to the consumer. And if the cost of the t-shirt was uh plus the shipping and the handling was $10, your gross profits at the end would be $10, right? So 20 - 10 is 10. And that would be a 50% gross profit margin. So we would take what's left, you know, your your profits from that and divide it back into revenue. So you get a margin. And you can see, you know, that 50% is a pretty efficient rate for selling t-shirts, right? But if your cost of that t-shirt was was uh uh maybe like $19 and you only had $1 left, we have a lot less efficiency of selling that t-shirt. So in other words, it's it costs a lot of money to get up and and produce our goods or services. So, one thing that you can do is you can really look at, you know, if your cost can't go down, if you cannot get a t-shirt and sell a t-shirt for anything less than $10, the only way for you to raise that gross profit margin is to raise the price, right? And so, we really during these times have to be very careful about what we're selling for and not selling at a discount too where we would really start to erode those profit margins. So, if you're importing those t-shirts from overseas, uh, and you're considering China or Vietnam or India or various options, this is what you want to look at, right? You have no choice but to either take a hit on your gross profit margin, right? Which will, spoiler alert, definitely erode your net profit margin, which is how much money you keep at the end of the day. or you need to very unapologetically explain why your price needs to go up in order for you to retain the margin, right? And unless you can find a way to save money elsewhere in your company, if you're going to erode the margins on your gross profit margin because tariffs went up or what your costs went up, uh you will make less money, right? So, this is something we should really know um like the back of our hand what our target gross profit margin is and what's affecting it. Um that's really your front line of profitability because before you even before you even you can't even make any money without selling the t-shirt, right? So, if we aren't making enough when we sell the t-shirt, we set ourselves up for just less profitability overall. And obviously that's something that's going to vary dramatically by product, by industry. I guess the key here is to track it over time and make sure you're watching what's happening to the to the margin. Exactly. And that's a really important piece because if we are seeing it degrade, right? Okay. Well, something's gone on here. We are paying more for shipping. We're paying more for importing. We're paying uh we're paying an increased tariff. We may not need to sound the alarm bells right away, but we need to know what that trend is, right? So our if as we pay more for our goods and services that we need to sell, our profitability is going down, we need to know how far we'll let it go before we change what's happening. So yeah, and that and that's something then we can keep an eye on. And the more we manage it, the more we we know, right? And the more we can make changes. Okay. So that's one. Yes. Okay. So that's one. So that one alone actually can make a huge difference. It can make a huge difference and it starts to um relate into the next two that I'll talk about. So the the second one is really understanding cash flow. And by telling you this, I'm actually kind of tricking you into learning a few more metrics because cash flow cash flow doesn't really operate um alone. But let's just let's just define what cash flow is. So cash flow is not the same as profits because cash flow is going to really it's going to really tell you what's going on with your bank account balance, right? Specifically operating cash flow. So um when we talk about profits, uh there's a lot of things that happen in our company that don't get shown on our income statement, which is where our profits live. For example, when you buy inventory, that that gets taken out of your bank account, but we we keep track of our inventory expenses on our balance sheet. So, when you buy inventory, you actually increase your assets on your balance sheet. But if you're just looking at your income statement, that won't affect your profitability. It's a huge gotcha, right? because you'll notice that you could be a very you could have a very profitable month, but if you also were reinvesting in your inventory to replenish it, your cash, which you used to buy the inventory, will be very low, but your profits might be very high. So we really need to keep a close eye on what's happening, how quickly we are um increasing our assets which is going to reduce our cash and have a real impact on our cash flow. Cash flow is just the change in the amount of cash we have from one period to another. So, uh, so, so like very rudimentary speaking, if we had $50,000 at the beginning of the month and we had $25,000 at the end of the month, that would be a a net negative cash flow because we had $25,000 less. Or if we had $50,000 at the beginning of the month and $100,000 at the end of the month, that would be a net positive cash flow. So, we really want to keep an eye on that. Now, of course, I think as any business owner would know or understand innately, cash is the oxygen of our business. So, I've I've heard it called king. It's also king. Yeah. So, so we we run we run a lot better when we have plenty of cash in the bank or fuel in the tank or oxygen in our lungs, right? So, um that's why it's really important and it's it's just very important to start to understand what that looks like. So you can um you can use our tool that we have, you know, our our free download to help understand your cash flow by looking at that historically and kind of going, "Oh yeah, you know, we we typically, you know, whatever your your inventory purchasing schedule is or when you replenish assets." Um the other piece of that is uh as you pay down debts, um your debt payments are not shown on your income statement. So we have to remember that those are affecting our cash flow. So, um, that's tricking you because I'm I'm telling you that you really it helps to know a few other ratios like your inventory days, um, and your debt to equity ratio. Those are going to help help you understand your cash flow. But honestly, really starting to place an emphasis on getting to know what your cash flow cycle looks like. Um, and just anticipating those swings is going to make it so much easier to run your business. And it also is a virtuous cycle because it's going to help us be more confident in any other changes we might make in our company specifically to um our pricing if we need to increase our pricing because our cash flow is really suffering um as well as terms and how quickly we pay our vendors and how quickly we require our customers to pay us. Right? So, it really opens our eyes and brings a lot of confidence to how we operate. Did you say you have a a free tool that people can use to track their cash flow? Yeah. So, our business mastery spreadsheet is is um a free download on our website and it allows you Which website is that? Oh, 60inut CFO.com. Um, so 60minut cfo.com you go to downloads and you you download business mastery and what you can do is you can start to track your income statement and balance sheet over time and that will spit out just a the end product of that when you when you uh apply our cash flow formulas to it. It'll give you a cash flow statement and you'll really be able to see, oh yeah, okay, so we had negative cash flow last month. Uh maybe the month before that it was positive and you can look at it. You could zoom out. Okay, so for these last two months we actually had positive net cash flow, but it was because we had really positive in the previous month but a little bit negative in the second month. It really starts to give you an overall picture of how cash is behaving in your company. Got it? So that's two. Okay. Number three. So number three is this this this one is the current ratio. We also call it liquidity. Um so current ratio is very simply a measure of how much you have in current assets divided by how much you have in current liabilities. And those are two jargony words. Let me just break those down. So a current asset is anything that either is cash or can be converted to cash in the short term. So in the next 12 months. So so very simply put those are usually things in a company like your actual cash and your inventory and your accounts receivable. Right? So it's cash. It's the stuff that people owe you and then it's stuff that you can sell that you can convert to cash. Those are your current assets. And then your current liabilities are what you owe in the short term. So it's any um ongoing, you know, recurring bills that you might have like your utilities, your payroll, and your debt uh that you debt payments that you might owe in the near term. So let's just look at that. Let's say the near term is the next month. So we look at what cash we have in the bank plus what's in our accounts receivables. Let's say we don't have any inventory. Okay? Let's say we're just a service- based business. and you divide that by what you owe. So, it might be this month's payroll, this month's utilities, um, and other bills that are due plus a little debt payment that you that you make. And what I would urge you to do is know what that number is. Now, the number might be one. You might have an equal amount of cash in the bank to stuff that you owe. You might have a 1 to1 ratio, and you're feeling it because that's a pretty low liquidity number, right? You can pay your bills, but you can only pay them one time over. There's no wiggle room. You're living handtomouth. Yeah. You're living hand to mouth. But you're living, right? You are living, right? And then, as you can imagine, once you get it up to two or three, that multiple is making you feel so much easier because what you're actually saying is, I have two or three times the amount of cash or receivables for every $1 I owe. It's not a big deal. I can easily with breathing room pay my bills. And and that is actually where most businesses like to be is between two and three. Uh one and a half might be their very low low, but once they start getting below one and a half, one or below one, well, now we're in actual we're in a liquidity crisis, right? We're actually not able to pay our bills and we have to start looking for new ways to do that. So, so when we're when we're looking at, hey, I need to set my business up for easy uh times. I don't want to be scraping. I don't want to be wondering. I don't want to be stressing that current ratio, which is truly and honestly very related to the two previous ratios I gave you, which is your gross profit margin and your operating cash flow. That that third one though is another quick and easy way for you to to see where are we, right? Like very, you know, how many how many current assets do we have? How many current liabilities you have? Do that quick division and you can see, okay, well, we're we're we're not at three. We'd love to be at three. How can we get there? Well, the answer is in the other ratios, but it's uh honestly, if you circle back to the gross profit margin, you're going to increase your profits, you're going to retain more cash, and it's going to be this virtuous cycle. So, so those are the three that I think that if you really take um time to measure and understand in your business in the context of what you do or make or sell, you can really start to see, oh yeah, this is actually uh going to bring me so much more freedom if I get these three things under control. That makes sense. As I think is probably possible these days. I think you referred to them as the white knuckle days. Where do you suggest someone look if they are struggling? Their maybe their gross profit margin has gotten out of whack. Their cash flow is not where it should be. They've got payroll due or whatever it might be. Is there an obvious next step that you recommend people take? Well, we want to get a really clear handle on why. Right. So we as long it's so much easier to solve a problem when we know exactly what the problem is. So the answer is in the histories. It's in your numbers. So taking again you can use the the the spreadsheet that I referenced to gain that clarity. I would I would go back month by month and really look at when was our gross profit. Let's use gross profit margin as an example. When was it last um the healthiest? When was our last really great month of gross profit margin? and and analyze what the economic situation was. Were our costs lower? Were was our overhead lower? And then I would recommend going through the rest of the income statement line by line. The the very first thing before we want to hit a panic button or or ring an alarm bell is to make sure that we've turned over all the rocks, right? So, is all of this stuff necessary to running our business? And if it is um then what do we need to do in order to retain the profits that we need, right? And when and how do we know how do we know what those profits are? Well, we look back to when months that was really good, right? Okay. Well, that month we were doing 15% net profits. How did we do that? How did we get there? And that's going to enlighten us a lot. A lot of times the answers are sitting right in front of us in plain in plain sight. we just haven't looked for them and really taken a moment to um just assess, right? Just really assess. Um that I mean that's always the first the first place to go. That makes sense. You talk to a lot of business owners, you you run your CEO forums. When people come to you, do most of them have a sense of where these metrics stand or are most people still figuring it out? You know, there is such a spectrum. I I get a lot of my students and I always ask people, how do you rate yourself on a scale of 1 to 10 in your financial fluency? And I get everything. I get uh people who are like, I'm a one, I'm a two, I really don't know anything to people who are sevens and eights and nines. Um the key is to know your your what your main drivers are, right? So, um I am getting to a point where most of my students know and this is such a I really I maybe I'm bragging here, Lauren, because this is a really big deal. Um I think it it's a really big deal if they know what their target and what their current gross profit margin is. It's the big reason it's a big deal is because that's actually a goal that you can rally your team around and you can you can convey it to the sales team. you can convey it to the ops team and it's something that even if you're not a fan of openbook management which I am but let's say you don't like divulging all of your financials to your team that's a number that is not scary or dangerous to to show anybody it really tells everybody what the financial uh efficiency of the company is on just a production level. So, um I get I I am getting to a point where a lot of people know that. But honestly, just the other day I went through an exercise with one of my new uh peer group members and he showed me his income statement and it was it was almost unreadable because the way the chart of accounts is set up just was never set up with an eye for um a leadership person to look at. Right? So it was very um obtuse what these uh names of the charts of accounts were. And so we we had a question. We had to call in his bookkeeper on the first line and say, "What is this?" Which means he doesn't look at it, right? So if that's you and you don't look at your income statement on a regular basis, it's really not too late to start. You can start any time and it will it will be advantageous. Well, that's sort of what I was getting at. And if you if you are in that situation, you're not alone, right? No, no, no. Absolutely not. And and the thing is is it's um tedious. And a lot of especially leaders do not like this level of detail. But when you when you begin with the end in mind and you're not you're not actually trying to become the bookkeeper. You're actually not even trying to become the master of this chart of accounts. But what you are trying to do is get your arms around it. So you you sit with someone and you you begin to digest this information. And it doesn't it doesn't mean you have to do it every day. You don't have to sit here and live in this space, but you um you know, I've been using this analogy a lot lately. You It's a lot like going to the gym, right? And if you only go to the gym one time and you go like quarterly, it's so hard, right? It like really hurts. But if you can make it more of a regular habit, it begins to become less painful. And actually, you start to see gains, right? You start to like build a muscle, it starts to feel better, you start to kind of crave it a little bit. And um and you do slowly but surely level it up. You and you get stronger, you get better. And you see that in your company. Again, especially if you're coming in and your goal is to really understand what's driving your gross profit margin, that's a goal you can actually that's a gain. You will actually start to see pretty quickly because you'll you'll you'll see as a strategic leader, which almost all leaders are, they're going to start to see, oh my gosh, we don't need to spend this much money to produce this product. Like now that I see how this is affecting our profitability. Uh we can do this differently. We can do this more efficiently. We can change a process. We can change a supplier. We could ask for a cash discount on this part. We could, you know, buy it in bulk. Like there's you really start to see all these new opportunities once you really get your eyes on it. So, how often should you check these three metrics? So, I Well, if you're just getting started, uh you might spend like a couple hours on it and you might end up having to do that like weekly for a little bit depending on the state of affairs. Like I said, if you look at your income statement and it looks like Greek to you, you might have a little bit of work to do. But if you if you have things to a place that are pretty dialed in, honestly, you're going to start to look at this just on a monthly basis. And and the reason we named the company 60-minute CFO is because we don't want you to spend a lot of time on this. We want you to build a 60-minute monthly habit and get yourself oriented in that amount of time. So, no, you don't have to go to the gym three times a week. I'm saying go to this gym once a month and but do it on a regular basis. Don't do it every six months. It's really hard to fix a problem that you've been having for, you know, it takes six times more energy, right, if it's been happen happening for six months, like catch it in in the first month if something's, you know, arai. So, um, that's the thought process. Got it. Tracy Beck is co-author of the 60-minute CFO book and CEO of Driven. Thank you, Tracy. Oh, thank you, Lauren. Have a great week, everybody. [Music]