Ep7 - Mt. Everest part 2 - Revenue Planning

Welcome back. Thanks for tuning in to the ESOP Guy's journey to an ESOP. This podcast is for those people that are thinking they may want to consider an ESOP. And last time, this is really a part two of the last episode, which was entitled Mount Everest, and the episode was the part one was regarding climbing the mountain of your revenue and understanding. That that's such an important part of, of any business in looking out into the future and creating a revenue plan that challenges both yourself and your team and against all the different odds that that come about in our business world and how important it is to continue to aim for something in your business. So I, I compared that to this idea of climbing the highest mountain, which is Mount Everest, which is 29,000 ft in the air, um, being the tallest summit in the world. And just the idea that getting up, gearing up for something like that takes a lot of planning, it takes a lot of um foresight, as well as endurance. And it's just the metaphor for the, for this podcast is to start thinking that I need to, I need to be thinking about the future and I need to be looking and aiming my sights high, so that I can um build a revenue plan that blends into my ultimate business plan. That will give me a forecast, not necessarily exactly according to the revenue plan, but really according to building my business stronger and stronger, um as time goes on. Now, this is from a timely standpoint, even more important as we start to start to feel in the economy, the effects of the economic turmoil created by the coronavirus. And There are a lot of things happening and changing very quickly in our economy, really, even over the last couple of weeks, that really in my mind, make this so much more important, when we start thinking about uh how that impacts our business going forward in 2020 and 2021. So instead of backing down from this, I'm saying even even from a more strong encouragement, building a strong revenue plan is going to be continually more, more essential as you go into an uncertain market. Sometimes when we get into these types of, of turmoil, things are changing very quickly, we contract and try to look, we're looking at this as, you know, recession proofing our companies. And although that's very important, and I think that cannot be understated. You can't control cost enough. We cannot also be shy about continuing to try to build out our market and to try to build out our revenue goals that we have in You know, set our sights in this, in this episode, um, really is going to speak more to the idea of building out more of a quality revenue plan and what is quality. Um, in our revenue, and so that we can identify that and be very strategic about what we're actually um trying to accomplish. As I said before, don't ask how, ask what? What are we going to aim for and then figure out the how. Sometimes we run into this within the evaluation, the feasibility stage. I have a company that I'm working with right now, who actually isn't really qualified for an ESOP as of yet. And that is when we do feasibility work, we find there, sometimes it's just not gonna work and At this point, their revenue plan doesn't match up in terms of, of where they need to be in their business model. There is, if, if you focus in on the essential overhead that they have, they are, they have to do more volume and revenue in order for that to make sense. So instead of just completely backing away, what we're actually doing with this client is we're going to enter into more of a strategic planning phase and start helping them to identify a 5 year revenue target and then work backwards towards the an annual plan. So we're going to reduce that 5 year plan to an annual business plan. And then we're going to reduce that annual business plan to a quarterly rocks plan so that them and their team have a very specific target. So, the question is, When we look at these kind of things, what type of revenue are you aiming for? What type should you pursue? What, what should we empty our backpacks out of and then put new stuff in in order for us to complete the, the long trek upwards towards what is metaphorically the Mount Everest for our business. From a evaluation perspective, I get the opportunity to review financial statements, forecasts, business plans, strategic plans. I do all this to really assess the quality of revenue. Quality of revenue is a critical factor in the quality of earnings for any company. It's a critical risk factor when you're valuing a business and you're creating the capitalization rate of the business for that cash flow. When your business is selling. Whether you're selling to an ESOP, or really anyone, the top line obviously is a critical element of what makes your business. In some cases, industries like to try to pin the valuation around revenue. It's very popular for our industry as a CPA firm to trade and sell based on revenue. And that works in the event that that revenue translates to The type of profit margins um for your cash flow. So, so for instance, in, in the CPA world, we would look at the revenue, but we're also going to look at, and this is my experience doing acquisitions for CPA firms, we're also going to look at the quality of those clients. In what they produce and the way we look at those is the average billing rates. And so that will help us define the quality of what each one of those hours bill is in terms of the client base that you're actually buying. So quality of revenue is very important. 11 thing if I discuss quality for a second is I like Toyota, Toyota cars. Um, I've driven them for a long time. They drive forever. Um, I am super cheap when it comes to driving a car. I hate buying a car and having to go to the mechanic all the time and get something fixed. And for me, the experience with Toyotas has been great. I have a Toyota RAV4 that is now my daughter's. And it was made in 2005 and that Toyota's got 290,000 miles on it. And, but if I compare that to a brand new 2019 Toyota RAV4 that has no miles on it, obviously, there's a major difference in what that car looks like and smells like. Um, it may drive the same in the sense of getting you from point A to point B, but there's certainly a different quality. Um, in my, in my 2005 Toyota RAV4, which is my daughter's, which I shouldn't be driving, there's, there's a little bit of rattle. And, um, you know, and the windows don't always go up and down. So definitely a difference in quality. So a car is meant to really just get us from point A to point B, but the experience in getting there makes all the difference. As I drove this brand new rental car recently in Dallas, Texas. Um, really the first time I've ever driven in Dallas, I will say, wow, what a crazy bunch of roads in Dallas. And I must have missed my lane changes a dozen times because I wasn't aware, but I can tell you, I did not think once that the brand new car that I had, which had only 1000 miles on it would break, like I do when I drive the old RAV. So, so when we start thinking about quality, we start thinking about the differences in uh what each business has behind the scenes, behind the curtain of revenue. So, I'm going to spend the next few minutes talking through categorically, um, and and certainly as a business evaluation expert, how that, um, how we evaluate and look at the business revenue. And this is really done to determine and aim yourself for the quality of revenue that you should be. And it's done to also assess what you start looking at in your own revenue base, and when you start thinking about Again, whether you're going ESOP this year or down the road, it's important to identify these areas in your, in your business planning to make sure that you've strengthened them as much as possible to create the quality you want um to present to the buyer. So the first one is the concept of recurring revenue versus non-recurring revenue. So recurring revenue is Things that, that revenue that just keeps coming back and there's nothing you have to do except keep performing well on, on the business that you're doing. Uh, obviously client service is important or, or, you know, product delivery time or whatever it is, but the clients, the customers keep coming back because they're buying something from you routinely and you have either a relationship around that, or they have, they have a, they've built you around their supply chain and they need you for, for what you produce. Obviously, that's higher quality than non-recurring revenue, which is every year you have to work really hard to get the revenue tied in to your business. Uh, so this is very common in industries like construction companies where they're constantly bidding and estimating jobs. Now, even construction companies though, can build a sense of recurring revenue around solid relationships and especially solid niche areas where they perform really well. So some construction companies are are geared towards Uh, uh, grocery stores or schools or, um, certain, certain types of uh building products or projects that, that they really specialize in and, and everybody gets to know who they are and they have a little more of a type of recurring revenue, but the reality is, is that there's no, there's no necessary reason that they have to buy from them every year. And so the closer, if you look at this as a spectrum, the non-recurring revenue being on the left and the recurring being on the right, obviously trying to move your business closer to the right is going to be very important to continue to strengthen the quality of that source of revenue. So the second category is looking at your gross profit and gross profit depending on the type of revenue. And if you start breaking down the types of revenue for a company, uh, what's very difficult for sometimes for people, for companies to produce in accounting is, is a very um specific revenue to cost example, so that those Those buckets of revenue can be analyzed at the gross profit level, specifically different. So a lot of times for small companies, everything gets lumped in under one big revenue item and everything gets slumped in into one big cost of goods sold item. So when you, when you are able to break that out, you're able to really analyze the quality of profitability per each type of revenue, and then more specifically, if you can break it out to to look at your customer base and assign profitability related to your customer base, I think that's even more valuable. Because what happens if We are not identifying that. You can, you can set your revenue targets and start growing, growing, growing, but if you're growing with the wrong type of, of customer, That is the lowest either lowest on your scale of profitability, or even when you really look at this, there are some cases where you start looking at a company's revenue breakdown, and they have a lot of mix and mingle revenue structure where The customers are not profitable and they, they keep growing that part, but somehow they, they still make money because other things are really much more profitable. And as a business in that analyst, you're gonna like, look, if you just eliminated that completely from your revenue mix, you would instantly have more profitability because you're gonna, you're going to eliminate the strain on your company and be able to read it. Now that, that would call for something that seems contrary to people that want to grow their business, it will call for a contraction in the business. But If we are trying to grow our revenue in a way that's not profitable to the bottom line, then I'm gonna say you're better off contracting it first, and then coming back with a, with a revenue plan that that addresses where you want to target your business. And the companies that can do that really well are the ones that will outcompete other companies, and that's just the truth. And the companies that do that really well as a business that's looking to go ESOP, are going to have more higher valuations, which is what you should expect and and in fact, what is actually what, what actually happens. So, so gross profit is essential, but looking at the details is, is really very important. The 3rd category is looking at this issue of concentration of customers. So one of the hardest things I've had to do in my life is to give up coffee. And recently, beginning in January, my wife and I both did this together and we gave up coffee. What's interesting about this podcast today is this is one of the first days over 3 months that I actually had coffee. So if I sound a little excited, it's because I'm raging inside with, with caffeine, but I, I gave up coffee, um, and I had been on, on coffee since I was 16. Um, I found it to be one of the greatest, um, You know, superhero drugs that I could think of. And anyway, I'm I'm, I like to do things and like to get things done. Um, when Starbucks was really building up, I was a huge raving fans of Starbucks and then I became more inclined to go to the more refined coffees. I gave up cream and so then I started actually tasting the notes of coffee and so I became, I guess in my my own head, a connoisseur of coffees. Um, but just like in your, um, your business, there's, there's this, this thing that happens with our, our businesses where we get this concentration of customers and they're producing so much revenue for us. And it's just like the addiction to say something like coffee. It's hard to get away from it, right? And it's hard to break that cycle. So reducing your reliance on your biggest customers is, is such an important part of it. But when we start to forecast that into revenue plans, it means we're going to have to actually start turning away maybe some business, um, or we have to put way more in our marketing budget towards growing the other parts of our business, which, which actually make way more sense. But I think the problem with, with concentration of customers in some people's businesses is that That because they're making so much money per se on, on the business right now. They don't see a problem with it and they just keep kind of um trying to make that happen. And suddenly something shifts quickly in the market. Now we're coming back to the the environment that we're in right now with, with uh the coronavirus and seeing how in some cases, um, even being in, in terms of your customer concentration issues, you're gonna see that that could affect revenue really quickly. Um, so we're way better off working on that and, you know, and You know, like say a 5 year increment of time and trying to set this, this reduction of concentration of customers in your goal plan. One way to accomplish this quicker is through acquiring other companies' revenue. I don't, I don't know if, if your company's ever gone through acquisitions. Um, but when you start thinking about the opportunities out there that you should be doing, um, When you buy a book of business, it is, it, it's instantly going to start to bring in new, now if you buy a company that has the same type of concentration of customers that you have, then obviously that's not going to help you. But when you analyze their customer list and you realize this could actually really benefit your company in reducing your reliance on one customer, then it becomes a pretty good strategic um goal for you to, to set out and do. In addition to that, the sales plan really should challenge your sales department to get outside their comfort zone. I, I find that when you ask the question of, of this to companies, the business owners and say, you know, in your weekly activity measurements, when you're looking at your scorecards, how many are you tracking that the number of outbound sales calls to non-existing customers? And what's that number on a weekly, monthly basis? When you ask that question, it should, it should really ask the deeper question is, are you continually trying to get outside of your comfort zone when it comes to concentration of customers? And if the answer is, is you're not tracking that and that your sales department is, is really just focusing on existing customers, then I think you need to really challenge that part of your business when you, when you come back to this idea of building out your revenue plan. And focusing on a strategic goal of good quality revenue. And then if you bring it back down into, into the sales department and say this is what we're going to be accomplishing in 2020, 2021. Then I think that needs to be incentive in the way and and what you do with your salespeople maybe differently to reward them for that and really look at, look at your compensation structured around those goals. So the other side of that coin is don't, don't sacrifice good customer service and don't lose good clients and customers over, over that as well. So there needs to be a well balanced approach in dealing with it. And I spent a lot of time with concentration and revenue, but I also would say that there's, there are absolute issues in the valuation when it comes to concentration of customers that affect the risk rating of your business. And in addition to the structure of the sale of your company. And so, looking at concentration of customers can be an issue when it comes to how you sell your company and, and being affected with a deal structure that includes negative deal structure like clawbacks. And uh different types of, of payment structures for the seller note. So it's definitely an uh an important one to deal with. Now, the 4th 1, and it's related to concentration of customers, but it's a little bit deeper than that, is going to be diversification of revenue. And this is, this is looking at the bigger picture. What types of revenue do you have? And so again, when we start thinking about the potential of a recession, what would happen to your revenue from the standpoint of, of the changes in the economy right now. Um, I have a, a great client that I've worked with for years and one of the objectives we've been working on is, is, is strengthening a completely different um revenue source that they have in their business. So this is, this is outside of the concentration of customers and now we're looking at industry revenue sources. And so they have one industry that is tied to the home builder market, and they have another industry that's tied to the commercial architecture environment, not the same industry, they're both kind of related to building, but they're different, different buyers at the end of the day. So does this reduce the risk of the company? Absolutely. And as we strengthen that and as we fund that new marketing plan, that sets that customer. That client on a path towards being not only stronger in terms of being able to withstand economic downturns, but there's certainly going to be worth more in a business valuation setting. And so we want to be really cognizant of when we're building our revenue plan and we're hiking up that mountain, how have we targeted um different areas. It's not comfortable. To target things you haven't done really well. It's not, it's not comfortable to go after something where you don't have a ton of success because when you enter into a new industry, there's going to be a process of learning curve and there's going to be, you know, this, this initial piece where you're, you're gonna have to fail a little bit, possibly for a little while, in order to get there, but you need to be thinking that's so important compared to the, um, just trying to build the other stuff bigger and bigger and bigger. So the other side of the coin is that he, too much diversification can be a problem as well, right? So I have so many revenue sources in so many different industries, I don't have any core competencies within my business. And so even if I can get there from a revenue standpoint, I really can't execute well in terms of profitability and delivery. And so that can affect my, my performance and that can affect the reputation of my business. So obviously, that has to be balanced and we can only go after so many things each year. But 11 thing that I do is when I do a business plan, and I do a strategic plan, I try to ask, and this is for our business and this is for our clients, as I try to ask the question, if we could. And let me see if we could, what if we added one new business revenue source this next year? What would it be? What product would it be? What service would it be? And it's not something that we do already. And so let that question float around a little bit. Because that's how businesses organically grow and diversify their revenue in a way that adds significant value over, over a longer term period of time. And this revenue plan I'm talking about is absolutely a uh a longer term operation, but it's very important for companies that are thinking about going towards an ESOP. So again, thank you for listening to the journey to an ESOP, and I appreciate your time today. If you like what you heard, please subscribe to this podcast and share it with a friend. Um, I will let you know my next podcast coming out is going to be how does the, the recession, how does this potential recession, how does the coronavirus affect Uh, the worth of your business, how, with all of the changes in the, uh, the interest rate that we've experienced recently, how does that affect your business valuation? So tune into that one, have a wonderful day. See you next time.