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Eliminating Distortions in Your Data

Aug 14, 2018 by Greg Crabtree 0 Comments

Greg Crabtree blog

 

It is not uncommon for every business owner to start a discussion about their P&L statement with “well, that net income number is not correct,” then go on to list all of the things they would change if their accountant didn't make them do it that way.

Business owners need to take back responsibility and control of their financial reporting in financial literacy training and follow these simple principles to make their P&L a useful document.

 

Distortion #1 – Owner Compensation Distortion

You should get paid a market-based wage for what you do, and a return (dividend) for what you own.  Most entrepreneurs mix their ownership with their job role in the business, not realizing that it creates significant distortion in the true profitability of the business.

If you are an S corporation, you may be motivated to avoid payroll taxes on wages and just take distributions.  Unfortunately, the IRS knows about that and will give you a nasty payroll tax bill and a headache to boot. 

If you have multiple shareholders working in the business, make sure everyone is being paid for the job they do and not getting a paycheck based on their ownership.  As an owner, you get to pick any job you want to do, but the market picks your pay.  You may choose to over or under pay yourself, but all that does is create distorted net income on the P&L.

 

Take action: Stop thinking small and pay yourself the right salary so your P&L tells you the true economic output of your business.  If you need to take distributions beyond your wage, we need to discuss why you are consuming more than you make!

 

Distortion #2 – Revenue is Vanity!

When entrepreneurs get together, I notice that they all talk about revenue but rarely about profit.  I want you to stop talking about revenue internally and become a  “Gross Margin” talker.  My definition of Gross Margin is Revenue minus any Direct Costs that do not include labor.  My reasoning for this is most direct costs are really “pass through” costs that you get paid for in advance or get terms from the vendors, essentially meaning you do not pay for them until you get paid.

Think of a construction contractor.  They may tell you they did $20 million in revenue, but they really had $17 million in material and subcontractors. They are really a $3 million services business.  The same would be true for a marketing firm.  I want them to celebrate a $50,000 services contract that uses no freelancers more than a $100,000 contract that uses $80,000 of subcontractors.

It may hurt your pride a bit to talk about Gross Margin instead of Revenue, but you will start to realize that Gross Margin is the true top line of your business engine. It will make your marketing strategy simpler in determining what your customer looks like and your team will understand they perform in relation to Gross Margin, not Revenue.

 

Take action: Teach your team to think Gross Margin.  If your accounting data does not report on Gross Margin now, adjust your bookkeeping process to never report on Revenue without Gross Margin, even if you have to use a good enough estimate.

 

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Topics: Entrepreneurship, Financial Literacy

Written by Greg Crabtree

Greg Crabtree, speaker, author, entrepreneur and financial expert. Greg’s firm, Crabtree, Rowe & Berger, is a CPA firm dedicated to helping entrepreneurs build the economic engine of their business. In 2011, Greg’s first book “Simple Numbers, Straight Talk, Big Profits” shares his core principles of how to turn your business into a wealth building engine. In 2014, Greg contributed a chapter to Verne Harnish’s book, “Scaling Up” on how to improve profits though labor efficiency. Greg is a frequent speaker to groups like EO, Gazelles, and ACETECH. Greg also chairs the EO@Wharton Executive education program for the last 3 years

About The Great Game of Business

Our approach to running a company was developed to help close one of the biggest gaps in business: the gap between managers and employees. We call our open-book approach The Great Game of Business. What lies at the heart of The Game is a very simple proposition: The best, most efficient, most profitable way to operate a business is to give everybody in the company a voice in saying how the company is run and a stake in the outcome. Let us teach you how to develop a culture of ownership, where employees think, act and feel like owners.