Empowering Healthy Business: The Podcast for Small Business Owners

#14 - Putting Profit First

February 06, 2024 Cal Wilder Episode 14
#14 - Putting Profit First
Empowering Healthy Business: The Podcast for Small Business Owners
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Empowering Healthy Business: The Podcast for Small Business Owners
#14 - Putting Profit First
Feb 06, 2024 Episode 14
Cal Wilder

Profitability is one of the indicators of a healthy business. Although business owners aspire to have healthy profit margins, it can be challenging to achieve them. This episode’s guest Rocky Lalvani serves as Chief Profitability Officer to small and midsize businesses. He presents philosophy and tactics that help small businesses improve their profitability.

This episode includes:

  • The Origin and Philosophy of the Profit First System
  • How to Implement Profit First
  • Building an Appropriate Cash Reserve
  • Don't Spend $1 to Save 30 Cents of Taxes
  • Ways to Improve Profitability
  • Is Banking a Hassle with Profit First?

Sponsored by SmartBooks. To schedule a free consultation, visit smartbooks.com.

Thanks for listening!

Host Cal Wilder can be reached at:

Show Notes Transcript Chapter Markers

Profitability is one of the indicators of a healthy business. Although business owners aspire to have healthy profit margins, it can be challenging to achieve them. This episode’s guest Rocky Lalvani serves as Chief Profitability Officer to small and midsize businesses. He presents philosophy and tactics that help small businesses improve their profitability.

This episode includes:

  • The Origin and Philosophy of the Profit First System
  • How to Implement Profit First
  • Building an Appropriate Cash Reserve
  • Don't Spend $1 to Save 30 Cents of Taxes
  • Ways to Improve Profitability
  • Is Banking a Hassle with Profit First?

Sponsored by SmartBooks. To schedule a free consultation, visit smartbooks.com.

Thanks for listening!

Host Cal Wilder can be reached at:

Moderator  00:00
Welcome to the Empowering Healthy Business podcast, THE podcast for small business owners. Your host, Cal Wilder, has built and sold businesses of his own and he has helped hundreds of other small businesses. Whether it is improving sales, profitability and cash flow; building a sustainable, scalable and saleable business; reducing your stress level, achieving work life balance, or improving physical and emotional fitness, Cal and his guests are here to help you run a healthier business, and in turn, have a healthier life.

Cal Wilder  00:34
Welcome. Today, I'm very excited to be joined by Rocky Lalvani. Welcome to the show, Rocky.

Rocky Lalvani  00:39
Thank you so much for having me Cal. 

Cal Wilder  00:42
You're joining us from Pennsylvania, right? 

Rocky Lalvani  00:44
I am.

Cal Wilder  00:48
So when we first got connected, one of the first things I noticed was one of the titles you go by of Chief Profit Officer, which is interesting. Because we're used to thinking in terms of Chief Executive Officer, Chief Finance Officer or Chief Operating Officer, and these days you may have Chief Revenue Officers, but I don't see a lot of Chief Profit Officers. So tell me how you got to this point where that's what you focus on with your clients. 

Rocky Lalvani  01:14
So I'll go way, way back. When when I was a kid, I was very entrepreneurial.  I was always figuring out how to make a buck. And I made a bunch of money. And I took a good chunk of that, and I walked into a computer store with cash. And I bought an apple two back in the day, you know, as a 15 year old kid with $2,000, when it was actually worth something before inflation. And one of the first programs I really started playing with on there was a program called VisiCalc. VisiCalc, is the precursor to Lotus 123, which is now Excel. In literally most things today, business wise, numbers wise, you know, everyone dumps all their information into Excel, and then starts to analyze it, manipulate it, figure out what's going on. Some people just run their business on Excel, which is really, really cool. To me, spreadsheets just tell me stories. And so that's kind of what got me into playing with spreadsheets. 

Rocky Lalvani  02:21
What I didn't realize, though, was that most business owners weren't looking at their financials. They weren't looking at the business of business. And I came to realize it's because many of them hate accounting, they don't want to do that. They want to do the parts of the business they love, and whatever it is that they might be doing. And the numbers part wasn't fun for them. As a matter of fact, what we're told math is hard, right? Which isn't true. It's just kind of that cultural thing. And I realized if business owners don't understand their financials, how can they make good decisions? How can they make the right decision with how they do things. And so that was kind of what brought me to this is, hey, you've got these skill sets, here's the need in the marketplace, how do we put them together, and then build a business. And rather than compete with all these other people and get put in a box, we kind of defined our own box. 

Rocky Lalvani  03:21
At the end of the day, you go into business, for what reason: To have time freedom and money freedom. And while it's easy to focus on revenue, it's really hard, I think, for a lot of people to focus on profit. And to even be able to define it upfront and make it happen at the beginning of a sale. And so we brought all that together. And that's what we help people do.

Cal Wilder  03:46
I know one particular system you often use is called Profit First. And I want to get into that in some detail. I have some vague knowledge of it. I think we have a couple of clients at SmartBooks who are using it. But I don't remember a whole lot other than seeing them have a lot of bank accounts and moving cash between bank accounts-- that didn't seem that exciting to me. But I love the idea of profitability and understanding what's really driving the profit of the business. So if you could give us some of the, you know, the background of philosophy behind this system to get us going, that would be really helpful.

Rocky Lalvani  04:21
Sure. So Profit First is nothing new. It's literally built on personal finance principles. The money comes in, you give the money a job, you spend the money to do that particular job. And when you run out of money in a particular category, then you've got to ask yourself, hey, how do I get through the next few days until more money comes in? Or what happened that I ran out of money here because clearly I didn't do what I thought I was going to do, and there's a problem with my financial system. 

Rocky Lalvani  04:54
And they're all-- what we're going to talk about all comes out of the book Profit First which is by Mike Michalowicz. Michael Michalowicz is also a serial entrepreneurs, a serial author, he's written a ton of books. He actually used to own a forensic-- it was more of a forensic data company. So like when Enron went bust, they actually investigated and he said, Yeah, they were guilty. He sold that company and he walked away with a lot of money. He thought he was a smart business guy. And within a couple of years, he lost it all to the point that they came for the keys to the house in the car. And he said, How did I screw this up so much? Like, what did I do wrong? 

Rocky Lalvani  05:40
And through that whole period of of realizing where the issues were and the problems were, he understood that he was given the wrong equation for profit. So we're all told sales minus expenses equals profit. Where does that leave profit? It's a leftover, an afterthought. He said, Well, no wonder we're not profitable. Why don't we do sales minus profit equals expenses. And so now we take our profit first. You were told to take your Profit First in business, right, pay yourself first? Now we actually do it. And we control our spending. You know, people are told you got to spend money to make money. I don't believe that's true. I believe there are better ways to do it. And it's shifting our perspective on money and how we look at things.

Cal Wilder  06:34
Alright, so how do you go about figuring out how profitable the business should be?

Rocky Lalvani  06:42
So first of all, I'm assuming most business owners do at least back of the napkin math to say, is my business going to be profitable? Right? Maybe they don't, hopefully they do. So I mean, if you say your business is going to be 10% profitable, then why don't you take the profit as soon as the cash comes in, and separate it. Because at the end of the day, that's when you make your profit when the sale happens. And when the money comes in? I think what happens too often is we spend our profits. Or maybe our math was wrong on the back of the napkin. Now, in the book, Mike gives you a chart. And it says, based on your revenue side, here's some targets. But these are targets. Some businesses do a lot better than average. Some-- they're constrained businesses, and they can't hit those targets. But I think the business owner should understand the model of business they're in, whether they're constrained, whether they have high margins. And this way they can best operate to maximize what they can do within the business model they have.

Cal Wilder  07:56
Right, because sometimes clients will ask, you know, can you what are the benchmarks that I should be aiming for. And that's really hard, because in small businesses, things are so dynamic. Depending on where you are, geographically, who your customers are, what your service or product offering is, you can segment the business into all kinds of niches. And it's very hard to generalize. So we always come back and say, Well, if you're a service industry business, you should probably aim to be doing at least 10%. And we get them to 10%. Then when you say okay, well, can we get to 12%? Can we get to 15%, and a lucky few of them can get to 20%, but not very many.

Rocky Lalvani  08:32
I think if you've got a business that's less than 10% profitable, I think long term, you're gonna run into trouble unless you've got massive, massive volume. And so you're making up the percentage in dollars. But otherwise, if you've got a low profit margin like that, the moment you hit a hiccup, you tend to blow up. And so I think you really should look at 10% being your minimum profit margin. Now, that's not to say you you begin at that today, one, you might have to take a year or two to get to 10, maybe three years to get to 10% profit margin takes time and that's okay.

Cal Wilder  09:20
So with Profit First, I get the first concept is you figure out what percentage of your revenue should be profit and you bank that in the owners bank account, right?

Rocky Lalvani  09:33
Let's just let's lay out there's five bank accounts. The first one is your income account. All your all your cash goes into your income account. So every time money comes into the business, it goes into the income account. Most business owners don't keep their QuickBooks up to date. So they don't always know how much money is in the bank except what they all do is they log into their bank account and go do I have money do I not have money. And so that first account says this is how much money came in. Now from that account, we distribute money. The first place we distributed is to the profit account, because profit does come first. The next place we distribute it is to the owners pay account. Because owners tend to pay themselves last. They underpay themselves, they don't pay themselves a market rate. We want you to pay yourself appropriately. The next bucket is the tax account. All right, the IRS has guns, they're coming after your money. Don't mess with them. Make sure you have the cash there to pay whatever the taxes are. And then what's left is your operating expenses. So now we're, we're constraining our expenses. And we're living within that amount. Now, if you're a new business, and you're starting this system, day one, you can't say, Oh, I'm going to put 10% in the profit account, unless you already are 10% profitable. You may only start with 1% in the profit account, because that's all you can do today. And that's okay. We believe in starting slow and building up over time. 

Rocky Lalvani  11:17
Basically, every time money comes into the account, on a set routine, and the routine could be once a week, twice a month, once a month, we don't do this daily, you move the money to the appropriate buckets, and then you go about life. And you keep an eye on your operating account. And that's what you live with when when it comes time to spend money, you gotta live within that operating account. And the reason this work is something called Parkinson's Law. Parkinson's Law basically says time and money will expand to whatever is allocated. So if you've got a project and they go, Well, what's your time frame in your budget, and you say six months, and $100,000, it's going to be six months and $100,000. You say, Oh, I've only got a one month and $20,000? Well, you'll figure out how you can get by in one month and $20,000. So what we're doing is, business owners have a tendency to throw money at problems instead of being resourceful. We're trying to stop you from throwing money at problems, and being a little bit more resourceful in thinking about what you need to do versus just doing it by spending money.

Cal Wilder  12:41
So nuts and bolts wise, how do you figure out how much should go into each of these bank accounts? I get you can, you know, earmark a certain percentage of revenue to the profit account? That's simple. But how do we know how much should go into Opex versus Tax versus Owner's Comp?

Rocky Lalvani  12:55
So we're recording this at the end of January. Sometime in April, hopefully you have a tax return. Right? So if you look at your tax return, you'll get a pretty good idea. You say okay, according to my tax return, this is how profitable I was. And the tax return-- what it says on your tax return doesn't equal cash. It just says, it's based on what the IRS determines your profit is, because you've got things like depreciation and loan payments and all that stuff that don't show up on the tax return. But come up with a percentage for your profit and put that there. If you look at how much you paid in taxes, both federal state local, your taxes for yourself on the business, come up with that number and what percentage of sales is it, that gives you a tax number. In the book, Mike just used a flat 15% for everything. For most businesses, 15% works, sometimes it's a lot lower. If you happen to be a highly profitable business, it is a lot higher, but on average, he uses 15%. You know how much you got paid. So that's a percentage of your total revenue. And now you have your starting point. And from there, as you said, we start to do that, we get comfortable, and then we just turn the dial a little bit. Maybe 1% more to pay or 1% more to profit 1% more to tax if you're a little short on tax, and you just keep turning the dial quarter by quarter. And you just tighten up. This is not about overnight change. It's about slow, steady change, to go from where you are to where you want to be.

Rocky Lalvani  13:12
How long have you been working with Profit First?

Rocky Lalvani  14:04
I've been with them about four and a half years.

Rocky Lalvani  14:14
Are there particular kinds of businesses that it seems to work particularly well with, or it's more challenging to use with other kinds of businesses.

Rocky Lalvani  15:05
It works best with business owners who want to be profitable. If you're not interested in being profitable, it's a waste of time. Right? Some businesses are constrained, right? If you're in a constrained business, it's going to be harder to implement Profit First.

Rocky Lalvani  15:26
Because it's commoditized, a lot of competition, supplier pricing problems. Is that what you mean by constrained?

Rocky Lalvani  15:33
Yes. In other words, let's say, for example, I have a pen in front of me, right? I'm buying this pen, and I'm selling this pen, and you know, everyone's going to price shop it. Right? So there's only so much margin there. If I go, and I put this pen on Amazon, now I gotta pay Amazon too, right. And now I'm really constrained in what I have to do. And so that's the question: Are you selling a commoditized product somewhere where you don't have pricing power? Somewhere where you're on someone else's platform, and they're sucking all your commission away? Or, yeah, and usually that's the case, that's a constrained business. Sometimes business owners constrain themselves by going, I can't charge that maybe in a service business when truly they could. So yeah, if you're in a business like that, that's constrained, it's going to be harder. But that said, it's all the more important that you do use Profit First. Because if you can only get 3% profit, you better hold on to it tight as can be.

Cal Wilder  16:44
Right. And if you're a small business, it's tough. That's a tough business model.

Rocky Lalvani  16:49
Yeah, but I don't think people talk about that. Business owners should go into business, especially those who go into E-commerce. Hey, this guy sold, my neighbor sold a million dollars in E-commerce, I'm gonna get in on it. You don't realize he sold a million dollars in E commerce. And he lost 50 grand? He doesn't even know he lost 50 grand, because he hasn't looked at his books, or he's constantly throwing money into the business. It might take him two or three years, and 150 grand and losses before he figures out there was a problem. And so I think that's part of the thing. People, people see the top line number, which we call vanity, and not many people see that bottom line number, which is sanity, and the reality is cashflow, right. And if you don't understand those, you know, and that's the other thing, if you've got a business, it's growing fast, people don't realize fast growing, businesses run out of cash very quickly. And when you run out of cash, business comes to a halt. You go out of business even though you had a million dollars in sales, and you were growing at 40% per year.

Cal Wilder  18:07
You throw in some bad debt, and it can get ugly real fast. 

Rocky Lalvani  18:10
It can. 

Cal Wilder  18:11
So I'm thinking back to the profit per system. I can appreciate how it forces resourcefulness because you have a constrained budget. You only have so many dollars to spend, so you've got to prioritize. And I suppose part of this is in reality, people may overspend or over commit, and then they get in a hole, and they have to, it forces them to prioritize and maybe do a little bit of zero based budgeting and figure out what they really shouldn't be spending money on if they are routinely overspending the Opex account, right?

Rocky Lalvani  18:43
It does. And that's all in the book.

Cal Wilder  18:51
Are there businesses that, putting aside owners that don't really care that much about profitability, are there other kinds of businesses or industries or models that it just doesn't work that well for?

Rocky Lalvani  19:01
No, I think it works in every model. I've got a variety different businesses in a variety different places. What we find now is that you have to adapt the framework to the business. And so that I think is where the issues come up. Their business is a little bit different, maybe it's seasonal, maybe it's it's got large bulk orders that need to be placed before the season starts. There could be a lot of different parameters specific to that business. And the question is, how do I model Profit First, and this this system to that particular business? And then I think the second thing is start slow, go slow. Everyone wants to do everything full speed ahead. And when you do that, I think what happens is if you get failure in the first Two or three months, people give up. And I think the third thing is not being systematic about doing this all the time, every time. And that's where we run into trouble. People don't actually sit down and do it consistently and deliberately. And if you don't, it's not gonna work. It takes discipline, it is very simple to do. But you got to have the discipline to do that simple stuff on a, on a regular basis that makes sense for you. And so as long as you do those things, it will work. And it depending on the business, it can work amazingly amazingly well.

Cal Wilder  20:50
Yeah, I've historically done like a very simplified, dumbed down version of that, I think, in the sense-- We have a lot of small businesses that are s-corps or LLCs with pass through taxation. And so the last thing we want is for them to get to the end of the year and not have cash to pay taxes. And then the other thing they want is to be able to take some distributions and know, How much can I take as a distribution - that's a common question. And so as at least a starting point, I'd encourage the client to have two bank accounts, the operating account, and then they're going to put their profit into a profit account. And out of that profit account, they're going to pay distributions to pay quarterly estimated taxes and they're going to pay distributions for net take home owner income. And if there's some money left over there, they might have to spend someone at the end of the year on their personal tax returns, but at least get them to parse it out. And now they've got an account that consists of profit, and they've got to pay, you know, 35-40% of that to the government for taxes and the rest of it, they might be able to pocket if they have reasonably good cash flow. 

Rocky Lalvani  21:59
The reason we like a separate tax account and a separate profit account is when you have a separate tax account, you know that this money is earmarked for taxes, the emotions of stroking the check, and the ability to stroke the check without emotions, kind of comes together. So you know, tax time comes in, the guy's like, Oh, what's $100,000 tax bill. Really, you look at your tax account and you go, There's 120k in there. You go, OK. It removes that. I'm like, Oh, I have more money in taxes than I need, bonus thumbs up, and I stroke the check. The reason we like a separate profit account is, we don't recommend taking more than half the profit account in any given quarter. And what it does is it starts to build up over time. So let's just say, quarter one, we were $25,000 in profit, right? We take 12 and a half, we leave 12 and a half. The next quarter, we have another $25,000 in profit. So now there's 37-five in the account, and you can take up to half, right, so that's 16-17 grand. But now there's 17 grand in the account. Next quarter comes along, now there's 25. Now you're at 42. So you know, you take 20-21, you leave 21. You're building a reserve balance inside of your business, so that if you do hit a hiccup, or you can't make payroll this month or something goes wrong, you have a cash cushion inside the business that you know will help you survive. And over time it continues to grow. When you take the profit out, we we tell people a) you should celebrate. So go have a little fun with your profit. And b) if you're in debt, use that profit to help you get out of debt. And so just good fiscal principles of that. And it just it creates discipline, and it takes the emotions out of all these decisions. And it makes it easy to make the decisions. And it also becomes rewarding. Because as you start to see those profit and tax accounts grow and grow and grow, you get a lot happier about your business.

Cal Wilder  24:25
Yes. So historically, I've been happy if clients could get up to a cash reserve, assuming they don't have debt, a cash reserve of one times their monthly operating expenses, if they're a little better than that and maybe get up to one and a half or two times. But it's often a struggle to get them to leave up to one time because they don't want to pay taxes on accumulated profit, right? And so how do you view that, with cash reserves?

Rocky Lalvani  24:52
First of all, just because, whether you take the money in or out of the business doesn't matter. In an s-corp you're gonna get taxed on profit, regardless of whether the cash is there or not. So the tax thing should not drive that. I would really love to see a business with three to six months of operating capital. And I know that might seem like a lot. But COVID happens, right? Sickness happens. Recessions happen. Life happens. And if you've got three to six months of operating cash flow, I assure you, it will give you enough sleep to figure out the problem. So that you can survive for another day. If you run yourself that lean, when times go bad, the bank calls and pulls your line. Everything else gets yanked. And so here you are in a tough situation. And on top of a tough situation, everyone else is now piling on to make it tougher. When you've got six months in the bank, it's like, hey, all right, things kind of suck at the moment, we got to make changes, it's gonna take me 60 days to make those changes. And to bring them about at least we can get through the next 60 days. And I can sleep through this, that literally what it's all about.

Rocky Lalvani  25:01
Yeah, I mean, I'd love for more more businesses to have that much capitalization, it just I don't see very many who will do what it takes to get there.

Rocky Lalvani  26:42
Hey, you know, I agree with that.

Cal Wilder  26:45
Becaue small businesses, they're started, they're undercapitalized by nature when they're started. They're bootstrapped. There's no big equity investment typically. So they start with zero equity. And then they've got to like build it month by month, by month by year by year by year to eventually get an actual cash reserve, right. It just takes time and discipline.

Rocky Lalvani  27:08
It does take time, and it does take discipline. But imagine, if you saved 2% every month, for the last five years, of your revenue. You know, that would be a massive cash balance reserve. And it just takes all the pressure off. It really does.

Cal Wilder  27:35
Well, it's always very painful to work with a client that has very little cash and negative cash flow. Because you spend all your time trying to get through the week or get through the month, just paying bills that need to get paid, figuring out how to make payroll, and you've done nothing that actually creates value for the business. All you've done is figure out how to keep the lights on for another month. And so that's always very painful when we're in that kind of a situation with a client that's struggling. They've got to fix the business model problem. And don't pay us to manage your weekly cash flow, because that's not creating any value really.

Rocky Lalvani  28:12
No, it's not. And, you know, if you're starting off, Profit First is kind of a habit. It's a behavior. It's kind of like going to the gym. The first time you go, you start with very low weights. And little by little you start lifting heavier and heavier weights, and you get better and better. But you have to have the discipline to show up all the time and do it. And if you do, you'll get strong. And when you get strong and you look in the mirror, you're happy and you're thrilled with you know how things are going. Profit First is almost like that reward system. Like I said, even if you start with 1% and you're taking $1 out of every $100, you're not gonna miss $1 out of every $100. But at the end of three months, if you if you had $100,000 in sales, now you've got some money starting to build up there. And little by little it will happen. You just have to have the patience and the discipline to do it.

Cal Wilder  29:18
Right. Now you are an enrolled agent with the IRS, right, although you might not want to admit that? Have you done tax returns in the past?

Rocky Lalvani  29:30
I have. I came to learn I don't love doing tax returns. What I love to do is tax planning. And I think part of the problem is this is another area business owners get in trouble. Right? The end of the year comes up. They call up their tax person. And maybe they've got a big tax bill due, and the tax person's like, Go buy a truck. Any so they go buy a truck. They wipe out their cash balance. Now they got payments. They spent $1 to save 30 cents. And they wonder why they're always in cashflow, crunch. All because they don't want to pay taxes. I hate paying taxes. But you know what, there are better ways to do this. Putting money into retirement accounts so that you build your own retirement base, your own security base, is a much smarter thing to do. And understanding that we don't make decisions to spend $1 to save 30 cents it-- that's just absurd. You have to be intelligent with how you do your taxes. I think the more important thing is preserving your cash and building your wealth. Versus if you got to pay the government a couple of bucks.

Cal Wilder  30:48
Yeah. You're probably familiar with Michael Crabtree, right? Simple Numbers. So he thinks it's a mark of pride if you have a large tax bill every year, because that means you're making a lot of money.

Rocky Lalvani  31:00
And it's true right. I see, you know, it's funny, in real estate, they have those 1031 exchanges, right. So somebody will go do a 1031 exchange to not pay taxes. First of all, they don't even realize how little the taxes might be. Even if you have a property, let's say I bought a property for 200,000. I improved it to 250. I sell it for 350. It's capital gains, it might be 10 or 15% on the $100,000 gain. And if you've got the depreciation, you're looking at 10-15 grand. Instead they'dd 1031 into another property for 400,000. And then when you sit down, you'd look at it you go, wait a minute, that property that you got forced to buy to not pay taxes, it wasn't worth 400 grand, it was worth 350. But you overpaid because you didn't want to pay the taxes. So you overpaid by more than the taxes just to do it. And now you own a property that you don't even love because you had to rush to do this for your tax reasons. And then they get stuck in another bad situation. And this happens all the time. There's an entire industry built up omn looking for suckers who don't want to pay taxes because they they sell them overpriced property.

Cal Wilder  32:25
Right, because what, you have like 60 days or 90 days or something to roll the money over so you have no time to go find the next property unless you were already looking, right?

Rocky Lalvani  32:34
Correct. And sometimes the deal falls through, now they gotta find another deal. Now they're under pressure. Oh, my God, oh, my god, like just pay the taxes.

Cal Wilder  32:47
There are some scenarios in which we are able to save clients some money, depending on their life situation, right? Sometimes it makes sense to employ their children up to you know, the $13,000 annual IRS threshold when it's --maybe you have to pay a little bit in state income tax-- but it's largely tax free for the first $13,000 if you have a legitimate job your child can do for the business. Or taking advantage of the Augusta rule to rent your house or property to the business for quarterly management meetings or something like that. So there are some some ways. But at the end of the day, I completely agree with you that I would never want to spend $1 to try to save 35 cents.

Rocky Lalvani  33:27
In both of those situations you were paying yourself the cash. You were not making somebody else rich. You're giving yourself the cash and getting a tax deduction for it. All in favor. Do things appropriately, that makes sense. Don't make other people rich so you can save a couple dollars. And if you really, really feel the need to do this, just pay me. I'll give you the tax deduction. I'll even take you out to a wonderful dinner like you've never had before. Because, you know, I I'm that kind of guy, I'll pay your taxes for you.

Cal Wilder  34:09
Alright, so Rocky, I want to dig into a little bit more about how we assess profitability and help small business owners understand profitability. Because, like you said, initially, the basic formula revenue minus expenses equals profit, or revenue minus profit equals expense. But there are a lot of different ways businesses can generate profit, right? And so, say you get a business that's like breakeven aspiring to get up to North of 10% and they hire you to help them understand their profitability and what they need to do to get more profitable. How do you go about engaging and doing that analysis help the client.

Rocky Lalvani  34:55
We have 12 different levers that we look at to understand where is the constraint in that business, and how can we fix it. So let's just do this simply. Maybe for that business, we might be able to increase prices 10% If we can increase prices 10%, that's going straight to profit, right? We literally solved it without any additional work.

Cal Wilder  35:23
Yeah pricing is always the easiest way on paper to be more profitable.

Rocky Lalvani  35:29
Now, are you in a constrained business or a non constrained business? If you're in a constrained business, figure out how to get out of the constraint? So let's just say I sell Nike shoes. I;m in a constrained business, right, unless I have some special Nike shoe. But what can I sell to get out of the constraint? Can I sell a shoe insert? Can I can I sell feet to your shoe laces that I'm buying for $1 and I'm selling for $12. Can Can I sell socks? What can I do to add on to it? So if we're in a constrained business, it's like, where do we pick up margin? If you're not in a constrained business, it's increasing prices, because a lot of business owners are afraid to do that. 

Rocky Lalvani  36:21
The next thing we do is do a quick expense audit. Because if I can find 10% savings on expenses, that just went to the bottom line. And so between like 10%, price increase and 10% spending cut, you almost got 18-19% profit right there. I'm not telling you to grind it out because I don't want to grind it out. I don't want you to grind it out. So those are the simple things. 

Rocky Lalvani  36:53
The other thing is to look at some of our biggest wasted expenses. And for me, number one is marketing. Are you getting a return on your marketing? You might you might be spending $10,000 on marketing across five different channels. Maybe three of those channels are bringing you all your leads, and two of them are doing nothing. If you haven't measured that, then maybe you need to get rid of the channels that aren't doing anything. That's money straight to the bottom line. The other thing is looking at your overall overhead. What people don't realize is, let's say I've got a business, that's $500,000 a year. And 200,000 is my cost of goods. 250,000 is my overhead. So in that business, we're at about 10% profit, we do half a million in sales 200,000 for my cost of goods, 250 to run the business, there's $50,000 profit. If I look at that business and go, well wait a minute, if we could increase sales by maybe 20%, but we could keep our overhead the same, then a lot of that money is going to drop straight to your bottom line to profit. So a lot of times just increasing the total revenue, even if you're increasing it 10% can drive profitability and make profits go up by 30-40-50%. I think the areas to look at this in, because I deal with a variety of businesses, if you're in the service business, and if your guys are only billable for five or six hours a day, well, you're wasting truck time, you're wasting all the infrastructure time. You go from five or six hours billable to seven hours billable every day, and now all of a sudden you're breaking out of the overhead and that's all dropping to profit. That might be something as simple is routing, like making sure you're not driving in circles. It might be simple as making sure the truck is properly loaded with the equipment, tools, supplies you need, and that they're organized, right? I can't tell you how often in the trades, we'll see a truck with $50,000 worth of unused parts just thrown in the back. That's cash leaking out of your business. So it's efficiencies. Look at your org chart. Is everybody in your organization doing what they're supposed to be doing, and is it providing value? Every organization's got somebody that does nothing more than create fires to put them out. Get rid of that person. We all have somebody we probably need to help move on and they're sucking our business dry and you don't realize it. So it's taking action on that. It could be debt-- debt service might be a problem. So let's work to get out of debt. That takes time. But over time, stay out of debt. There's so many different things within the business that that we have to look at, to figure out where exactly is the problem, and then how do we solve that particular problem?

Cal Wilder  40:34
What else? Anything else you want to mention while I've got you on the show here, Rocky?

Rocky Lalvani  40:38
I think people really need to spend time thinking about their business. And I find most business owners are too busy grinding it out. They're running all day. They're not taking the time to think and to optimize. The fastest way to be profitable is to think and to optimize. The other thing is, if you've got a business with a lot of different services or offerings, some of your offerings are probably highly profitable. And some of them lose you money. Figure out where your highly profitable offerings are, and start shifting all your marketing your efforts and your messaging to your highly profitable products, and get rid of the stuff that's not making you money. You know, if it's not serving you, just because it's generating revenue, does it mean it's generating profit. These are all the different levers. You have to go down, you have to take the time to think, and especially during COVID, a lot of people didn't pay attention to how their costs were shifting. And you might think that it's X, but when you actually go look at the bills-- because nobody tells you, when they increase prices, they just hammer you with the price increase-- you don't start checking on that you don't realize, oh, wow, that took away 10%. And now I gotta do something about it.

Cal Wilder  42:12
Right? We just just started working with a client that's in a trade. And they went a couple years without increasing prices, during the highest inflation we've had in the last 30 years or so. So their margins went from 16% to 0% over the previous three years. And now they've started increasing prices again, but instead of doing, you know, 5% annual increases, now they're doing like 15-20% all at once, which could be a little bit of a shock in the marketplace potentially.

Rocky Lalvani  42:45
It could be, it really depends. Honestly, in the height of COVID, in the beginning part, I was telling my business owners, pay attention, because if someone hasn't increased their prices, they're your new supplier. Go go pick up margin where were other people aren't paying attention?

Cal Wilder  43:08
One more specific question on Profit First. One of the things that has always held me back from fully embracing it was just all these bank accounts and the effort to move money back and forth between them, and who's going to do that? Maybe it's not that bad. What's your read on that situation with business owners or their bookkeepers actually staying on top of figuring out how much cash should be in each account and taking the time to move it every week or two, or at least once a month?

Rocky Lalvani  43:37
It sounds a lot more complicated than it is. If you think about it, you've got five accounts. The transactions are still the same amount of transactions. Once a week, or every other week or once a month, you look at how much is in your income account, and you move it to the other accounts. That creates four transactions. That's not a lot. Even if you did it once a week. It's 16 additional transactions, not the end of the world, right? It gives you discipline. It also allows you to feel your numbers. Because let's just you say I do it every Monday, and every Monday, when I go to do it, this usually eight to 12 grand in the bank account. If this week, there's only six, you'd be like, wait, what happened? You go, I don't need to look at my bookkeeping. I don't need to ask. I go wait a minute, Why is there only six? Now I go investigate? Oh, so and so didn't pay their bill. What do you mean so and so didn't pay? Nobody's telling you this stuff. And then as you're moving the money to the other accounts, you just start to feel Hey, my Opex usually has about this much in it. I just moved the money. It's thumbs up, thumbs down, and you just you get that feeling. It's not hard to do, it really isn't. I think people make it a bigger struggle than it is now. Profit First has partnered with Relay bank, it's not really a bank, it's Relay. I don't know what they call themselves. They're like a tech company on top of the bank. They will do all of this for you. So if you're willing to move banks, and you don't want to deal with it, they'll move the money for you. It integrates with your accounting software, it all gets done.

Cal Wilder  45:34
So you just you just configure Relay, say I want X percent to go into each of these four accounts every week, and it'll move the money for you. 

Rocky Lalvani  45:42

Cal Wilder  45:44
That's easy.

Rocky Lalvani  45:47
This stuff is not difficult. What's difficult is getting started. It's taking the first step. Once you do it, and you get set up, you'd be shocked at the results you can get over time. It works. There's no ifs, ands, and buts about it.

Cal Wilder  46:04
That's the magic of compounding. Even if you only get 1% or 2% better every week or every month, you know, over the course of years, you get a lot better.

Rocky Lalvani  46:13
Tou get a lot better. And that's it. I mean, this is nothing new. These are proven principles that are just being applied to business. That's it.

Cal Wilder  46:24
So Rockly, if folks want to get in touch with you outside of the podcast to talk about their own businesses, what's the best way for them to get a hold of you?

Rocky Lalvani  46:33
Can I ask them a favor first? If Cal brings you value, would you be so kind wherever you're listening to hit the like button. If you know another business owner, who should have heard this or some other show from Cal, why don't you go ahead and share it with them. Begin a conversation. Create your own conversations with other business owners so that you guys and women can figure out, how to improve in what you're doing and create partnerships like that. After you do that, and you show a little love, my website is ProfitComesFirst.com. My podcast is Profit Answer Man. We share all the stuff that we do for our clients and we bring you success stories, and other business owners, and bring you valuable information so that you can be more profitable.

Cal Wilder  47:25
That's great. This podcast is all about empowering healthy businesses. You can't have a healthy business that doesn't have healthy profits. That's part of the equation. So I really appreciate your time and your thoughts Rocky, and we'll be in touch.

Rocky Lalvani  47:40
Thank you so much for having me.

Cal Wilder  47:43
Reference show notes and find other episodes on EmpoweringHealthyBusiness.com. If you would like to have a one-on-one discussion with me, or possibly engage SmartBooks to help with your business, you can reach me at Cal@EmpoweringHealthyBusiness.com or message me on LinkedIn where I am easy to find. Until next time, this is Empowering Healthy Business, the podcast for small business owners, signing off.

Rocky's Background
The Origin and Philosophy of the Profit First System
Implementing Profit First
Building a Cash Reserve
Don't Spend $1 to Save 30 Cents of Taxes
Ways to Improve Profitability
Is Banking a Hassle with Profit First?