“Cash is a choice and debt is a choice.”

In episode #96 of Mission to Grow, the Asure podcast that serves as small business owners’ guide to cash, compliance and the War for Talent, speaker, entrepreneur, and financial expert, Greg Crabtree, sits down with host Mike Vannoy to explore the world of Growth Capital. Greg explains what the cost to power ratio is, how changing your billing cycle can free up revenue, and when it makes sense to borrow vs spend your own cash.

• A common area where business owners get themselves into trouble is by trying to apply a method or practice from a different category of business to their own. If funding strategies don’t line up, businesses can quickly find themselves losing money.
• There are three capital types, light, moderate, and heavy. Capital light businesses hold no inventory or accounts receivable and get paid upon service. Moderate businesses hold either inventory or accounts receivable, and heavy businesses hold both.
• The cash to power ratio is between your trade capital amounts and your profits. If trade capital is 10% and profit is 5%, you will lose 5% of your revenue before making your first dollar. By decreasing trade capital and increasing profit, you access funds sooner.
• Growth is something that should be pursued, but not at the expense of the business. If you are looking to drive new revenue, but don’t have a line of credit available or cash on hand, prioritize growing your cash on hand first.
• One of the best ways to free up capital is to lengthen out how long it takes you to pay your suppliers, while at the same time shortening your payment times with your customers. If you can try to bill them as soon as services are rendered.
• Borrowed capital can be dangerous, but there are times where it makes sense. If you are buying a productive asset like a van or cnc machine, financing the purchase allows you to keep two months of business expenses in cash on hand.
• Businesses need to start with profitability, and profitability comes from understanding the data behind your business. Once you know the data you can identify which areas are making or losing you money.

Explore our Payroll & HR solutions that boost back-office efficiency to enable your business to scale.

 

Read the Transcript:

Greg Crabtree:
You got to get profitable with what you got. So it starts with profitability and I got to get to my profit target first, and then I get to my best possible cash flow, my trade capital percentage second, and then I decide I’m not thinking about growth, I’m just trying to optimize what’s in my hands that I’m doing. Because why would you grow a business is broken, it ain’t going to get better by growing it.

Mike Vannoy:

Welcome to Mission to Grow the Small Business Guide to Cash Compliance and the War for Talent. I’m your host, Mike Vannoy. Each week we’ll bring you experts in accounting, finance, human resources, benefits, employment law and more. You’ll learn ways to access capital through creative financing and tax strategies. Tactical information you need to stay compliant with ever-changing employment laws and people strategies you need to win. The War for Talent Mission to grow is sponsored by Assure. Assure helps more than 100,000 businesses get access to capital, stay compliant and develop the talent they need to grow. Enjoy the show Growth Capital, scaling your business profitably. So we talk all the time on the show, there’s two types of capital that businesses need to grow their business. You need human capital. How do you acquire and retain and develop a productive workforce, especially in today’s world where there’s a war for talent, but the other is more obvious perhaps, but I think probably even less understood.
That’s financial Capital. Have a great guest on today to talk about this subject. He’s a guest speaker. He is an entrepreneur, he’s a financial expert. His firm has been named an Inc 5,000 list. He’s presented over 15 countries. He’s a frequent speaker to groups like eo, scaling Up, Vistage and ACETech, author of Simple Numbers, straight Talk, big Profits and Simple Numbers 2.0 rules for smart Scaling great books I’ve read both. Highly recommend he’s a partner at Car Riggs in Ingram, a top 25 accounting and advisory firm. Welcome back to the show, Greg Crabtree. So for everybody else’s kind of joking here with Greg before the show, I almost think of Greg as like Dave Ramsey is to personal finance, but Greg is to small business owners and mid-size companies. You get past the gap accounting, the debits, the credits, the double entry accounting stuff that I think just unnecessarily confuses business owners and just talks straight talk in real world practical terms.
So I say it as a compliment and I think it’s maybe a great intro to today, growth capital. So I think when entrepreneurs, business owners think about growth capital, they might think, okay, how do I go get a loan or maybe I got an angel investor and I’m just going to start on advertising campaign. I’m going to hire some sales reps, I’m going to develop new product. And I think no surprise that that happens with very mixed results. Sometimes you get growth, sometimes you don’t. Sometimes it’s profitable growth, sometimes it’s very unprofitable growth and you have a pretty practical plan for how businesses should be thinking about this. So Greg, what do you think the number one mistake businesses make when they start acquiring in dare I say isolating growth capital?

Greg Crabtree:
Well, I mean there’s a couple of issues. Number one is people misapply concept when they don’t have the same type of business that the example they heard or were told, they don’t have that type of business, that type of capital structure. And so in our research of privately held businesses, I mean essentially you fall into one of three capital profiles. You’re either capital light, capital moderate, capital heavy. So what do I mean by that? So a capital light business, which everybody would love to have. I don’t carry accounts receivable, I don’t carry inventory, so I get paid upon service. I might even get paid in advance for my product or service. That’s a capital light business. The only capital typically that I’m required to fund the business is my two months of operating cash. And so that’s a business that actually ought to achieve greater than a hundred percent return on invested capital as a target, typically closer to one 50. So you invest a million dollars in a capital like business and you’re making a million and a half a year profit, that’s a pretty good deal, but those are execution heavy businesses.

Mike Vannoy:
Can you give a couple examples of what that might look like?

Greg Crabtree:
I mean typically, so a software as a service kind of business. Now you had a ramp of you spent money kind of build it up, but at the end of the day, I mean I’m getting paid for something at the first of the month and I’m billing in advance. One of my favorite models that exist is it managed service provider companies. Those companies bill at the first of the month on a per seat basis, they have a staff. So they carry no receivables, they don’t carry even any equipment anymore. Everything is they just resell server space. Typically a IT managed service provider business only has the two much cash as their capital and if they hit their profit target, we have a lot of clients in that industry, they should be 150% return on invested capital. So that’s a good example, but a lot of service businesses have adopted a similar model to the IT MSPs. There are several digital marketing agencies have tried to adopt same kind of model. And it does work if you’re a good agency, there’s law practices that are specialty practices, specialty service practices, not like a personal injury or something like that. But if you have a particular practice focus of a specialty, you would bill in advance. You’re not waiting to get paid. And so when you have market power that people come to you and you can bill in advance, you really take a significant capital component out of the equation.
So capital moderate, capital moderate is you have one of two things. I either carry accounts receivable or I carry inventory but I don’t carry both. Typically those kinds of businesses need to target about a 65 to 75% return on invested capital. So for some reason the market won’t let you bill in advance so you have to carry accounts receivable or you’re carrying inventory, but I get paid upon a sale of what I have in inventory so I don’t have to carry receivables. So that’s a capital moderate business

Mike Vannoy:
And then I’m going to stop you. Give me a couple examples of a capital moderate business then.

Greg Crabtree:
I mean like a retail store retail business, a wholesaler, a wholesaler that sells one of our clients is in the remainder product business. So they carry inventory, but when they sell stuff you have to pay for it. They’re not waiting to get paid. So they’re dealing in an industry where we ain’t giving you terms. So you want this inventory, which is a high potential margin for the reseller. Hey, you got to pay in advance before they ship it.

Mike Vannoy:
So maybe a retailer, they got to carry the inventory.

Greg Crabtree:
A retailer, they carry inventory but they don’t carry receivables

Mike Vannoy:
And maybe a service business that’s so competitive or mature, you can’t charge in advance but you don’t carry inventory. But you might build net 30 on your services.

Greg Crabtree:
And so like I said, so in a services, like I said, where competition requires you to provide terms. Now the other thing that will force you to provide terms is a smaller niche business might be able to get paid in advance and stay ahead, but as you move upscale with bigger customers, especially the fortune 1000 customers, those guys are going to beat you in the head and you’ll start giving ’em 60 and 90 day terms
And that’s not necessarily all good. So you got to understand terms come with where you are in the market and as you play upscale or down and then the heaviest one is the worst one and the hardest that you target a 50% return on invested capital is I sell on account and I’m carrying inventory. So I have finished goods, I’m either a wholesaler, reseller, maybe a manufacturer, but I’m carrying inventory and I’m carrying receivables waiting to be paid. And so the first thing when you think about capital signature is you have to think of am I light noted or heavy? And then that establishes. Then the target on the other side though, and this is where accounting fails the entrepreneur, the things I just described, refer to what we refer to as trade capital. Now traditionally the industry is referred to that as working capital.
I made a slight modification of working capital. I consider the common term of working capital, which is current assets that are either cash or turn into cash within a 12 month period minus current liabilities which will have to be paid within the next 12 months, which includes my current debt service as well. The net of those is what’s traditionally and called working capital. What we decided though is that number is mixing things that shouldn’t be mixed. So we take working capital and exclude cash and debt. And so what we’ll have left over is what we call trade capital. And it is a powerful, powerful understanding of your capital signature of your business. Trade capital, like I said, is current assets minus current liabilities, but ignore cash and ignore debt and these are the things that turn over in your business. AR inventory work in progress minus accounts payable deferred revenue. If I can bill in advance accrued expenses where maybe I owe commissions but I can delay paying them for one reason or another.

Mike Vannoy:
So the rationale for separating out debt in cash is things like AR and inventory, they churn, they turn,

Greg Crabtree:
They turn. Cash is a choice and debt is a choice,

Mike Vannoy:
Right? That makes good sense.

Greg Crabtree:
Trade capital are forces of the market. Cash and debt are choices that you make of how you fund the business, whether or not you keep cash in the business, whether you take distributions, all of those things. And so you’ve got to isolate things that are dissimilar and those trade capital things work off of each other.

Mike Vannoy:
And then I think what build adage you can’t improve, what you can’t measure, what you don’t measure. So if you isolate cash and debt, which really, even if it doesn’t feel like at times it is your choice how you deal with those things. If it’s inventory in AR for example, those are things that you can work, you can drive your DSO down

Greg Crabtree:
And I can play them off of each other
And more than likely I actually play them off of the other side. So I’m netting an asset with a liability, which is actually the right way to look at it because accountants, we put assets on the left and liabilities on the right. Well no, we need to net the functional things that connect together is a more effective presentation. And what we look for is once we get that trade capital number isolated, we look at it as a percentage of revenue. And so this is what we refer to as the cash power ratio, CPR, the cash power ratio is when I have trade capital of 10% to revenue on an average basis and we monitor this on a running basis, we look is it getting higher, is it getting lower? And most people have a very consistent signature of that number. When my trade capital is at 10% and my profit is at 5%, the next million dollars that I grow, I’m going to burn 5% of cash of that revenue before I collect the first positive dollar to my bank account.
So that is a very quick way of understanding the cashflow consequences of growth. Now what is powerful is once we unlock this metric and showed it to entrepreneurs on a consistent monthly basis in our calls, guess what? The Hawthorne principle kicked in that thing that you look at will move just merely by looking at it and that 10% trade capital and the 5% profit once we showed it to them over and over every month, all of a sudden trade capital comes to seven, profit goes to 10 and we’re now 3% cashflow positive on every new sale. That’s powerful. That is a big, big, big difference in how you grow a business.

Mike Vannoy:
Where does the light bulb first come on for folks to start managing their business in this way?

Greg Crabtree:
Well, I mean the first thing we have to show them the data. This is not a traditional financial presentation. The accountants go around the world. I mean, gosh, if I showed you a cash flow statement, your eyes would roll back in your head and you would lay down on the floor and do the dying bug and it’s like, I don’t know what that means. It’s like, no listen, for every million dollars in new revenue, I’ve got to put 10% of my money into that. So where’s the a hundred thousand dollars? Oh wait a minute, I get profit off of that. So that is money that comes back to me, but I’m only getting profit at 5%. So where’s my $50,000 of cash going to come from because I’m tapped out on my line and my cash balance is at zero. Well that’s called don’t grow.
We better hold things steady, let the cash catch up, build cash and then I can now the investment game. But there again, if I can get their head around turning over AR inventory AP and deferred revenue netting it because I get them to do more because I net the number and show them, listen, you got four options to work with, pick one of them that’s the most sensitive that you can affect. Don’t try to affect something the market’s not going to let you affect. And there’s all kinds of techniques. I mean even though a customer crams down 60 days terms to you in ar, okay, well maybe I can find a way to bill faster so that that 60 is effectively 45 and then I can get my vendors to help me. I’ll give you a great example. One of our clients was a Amazon reseller and so this guy ended up buying out his partners and so he went to his vendor, his vendors required him to pay in 30 days. Now he’s selling through Amazon, which fortunately pays every two weeks. And so what you do sell, I mean from that standpoint, as long as there’s no hiccups in the issue, it works out really well, but he’s still negative a half a month in cash flow and this guy lives off of a 3% gross margin.
I’m sorry, a 3% profit margin, 3% profit to revenue. And so about a 13% gross margin. So Amazon resellers are high velocity, low margin businesses. I mean, and you’re dealing with fractions and velocity in that kind of business and there’s a lot of ones like that. It’s not just Amazon resellers. And so brilliantly he goes to his suppliers and he says, Hey, if you guys will give me 75 days instead of 30, I think I can sell 10 times as much. What do you think? Now he had a good rep with him and they said, okay, we’ll test it out, prove it to us. Guess what he did. Now what does that mean? He went from having to put his money in to fund growth, okay, remember he’s only at 3% profit. He would be approximately 10% trade capital percentage, so that’s a negative 7% cashflow differential for every million dollars that he wants to grow in revenue, he’s having to come up with 70,000 in cash that he doesn’t have. That’s not good. He solved the problem, went to his vendors and said, listen, we can make this a win-win, give me 75 days and I’ll sell more of your stuff because I know I can do that. Because what

Mike Vannoy:
Was holding him back wasn’t demand in his ability to sell it was his available cash to buy inventory and

Greg Crabtree:
Turn it Exactly. And he was good at buying just what the market needed and having it high velocity turnover. So what happened was is he now is cashflow positive on a sale. His trade capital percentage was in essence 1% and his profit percentage was three. He was cashflow positive, 2% on every new sale. His vendors essentially funded 100% of his inventory and half of his ar and he grew without borrowing a single dime from his, it never touched his line of credit to grow.

Mike Vannoy:
So that’s brilliant. I love it.

Greg Crabtree:
Exactly. Now you may not get your vendors to agree to that. You may not be able to execute like he did to prove it, but those are techniques that are there for the taking for the people that are good at executing and good at treating their network of stakeholders. Your customers are a stakeholder or your vendors are a stakeholder, your bank is a stakeholder. You got to treat all these people fairly and say there has to be a logical reason as to why you structure it that way.

Mike Vannoy:
And so honestly, that just works for any business. That technique works for any business who if the demand is there and you can turn the inventory, whatever that inventory is, what about, you mentioned another tactic. So on one hand everybody can get the concept. I’m going to go to my vendors and see if they’ll lengthen terms. That’s a good thing. What about, you mentioned how do I bill faster? What are some techniques that folks can use to get a bigger window, bigger cache window on the front side of that

Greg Crabtree:
We call it be qbo bill, quickly bill often
I’m telling you, I just go nuts when I see somebody that waits to the end of the month to then send an invoice. Unless somebody is forcing you into that, I want to bill on a much faster basis. Contractors, a lot of times that we work in the contract industry of, it doesn’t matter if it’s engineering, construction, whatever type of contractor you are where there’s materials and labor. Well, when I deploy materials, I should get paid by the, I can send an invoice immediately for my deployment of materials. Now generally I’ve got a supplier that’s giving me terms on that, but as soon as I deploy it, I’m issuing an invoice for materials and so I should get paid for those materials before I have to pay the vendor. If I wait and bill the materials when I’ve done my labor, I’m now 30 days late in getting paid for those materials

Mike Vannoy:
Right

Greg Crabtree:
Now. People, I mean a lot of it’s just being honest. Just listen, I’m doing this work for your benefit. I need to bill you and start the clock running. So I’m getting paid roughly about the time I’ve got to release payment on your behalf. And what’s unfair about that? Now granted now as you move up into the big boy and you got to put your big boy pants on. Yeah, I mean if you go deal with Hitachi, they’re going to cram down 90 day terms on you and might even pay you in one 20 just because they feel like it. And it’s like I’ve had clients that chose to not do business with those companies. Dell computer was one of the worst. Dell loved to beat their chest about their negative 22 day cash cycle days, which meant on average Dell collected a dollar from their customer 22 days before they had to pay anybody and it was just abusive. And so the fairness doctrine to me is listen, have the cash, my customer’s cash needs to get to me when I’m incurring costs for the benefit of my customer and we’re treating everybody in the ecosystem fairly. And that works.

Mike Vannoy:
It almost sounds too obvious. Oh here’s, here’s how you solve your growth, your capital needs for growth just to negotiate with your vendors to pay them slower, negotiate with your customers to get them to pay you faster. What are entrepreneurs missing to?

Greg Crabtree:
They lack the discipline to follow through. They lack the ability to actually prove credibility to customers and vendors to do things that they said. And so to get those exceptional terms, those generally move towards the exceptional businesses in that industry that do what they say and say what they do. And if you can’t do those things, then you’re going to get the worst terms. You’re not going to be trusted. Because here’s the thing in my bio you may mention I’ve spoken in 15 countries around the world and a lot of those are not first world countries. The thing I found about business is labor efficiency concepts that we talk about all the time are really the same internationally as they are in the US and Canada and Australia, any of the developed markets, the only thing that is different about business internationally in a third world country are terms, so generally in the third world country, I spoke in the United Arab Emirates right before Covid and I was speaking to the EO chapter in Oman, one of the Emirates, and I was talking to the guys and they were saying, yeah, a lot of ’em did business with the government and the government traditionally paid in about six months to a year in many cases.
But yet the government was trying to tout entrepreneurism. And I said, listen guys, you just need to have you come back and talk to your finance minister and I can help them tout improve entrepreneurism. If the government becomes the best payer, the market will coalesce around that. And there’s no Oman had the money. I mean they got plenty of oil and the government budget was profitable at $60 a barrel was their strike price to where they had plenty of money. So cash was not an issue. This was just lack of understanding of the ecosystem of how entrepreneurism works. And so when I need trade credit and confidence that when I submit an invoice and we can complain about the US federal government all we want, but they’re a really good payer, they pay in a structured way in a very quick period of time. That is world-class.
And so that helps. People do not understand every time that there’s a government shutdown and that payment system becomes fractured because of government budget, government bills being withheld for just a couple of weeks, it sends ripples throughout the US economy back because the US government’s the biggest customer to the whole economy by a long shot. And so that is a shock to the cashflow system. But if you get to where there’s trust, trust with the customer, trust with a vendor, you’re in the middle as the provider of product or service or both. Then the only difference between a third world economy and a first world economy is the third world economy margin takes this long to go through a transaction cycle from start of transaction to completion in finance in a first world economy. It goes through this fast.

Mike Vannoy:
That’s really insightful. I want to spend call it the last half, back half of our conversation on exactly that because I suspect a lot of people probably listening today thinking, oh, growth capital, I’m going to get some great ideas from some new ways to get loans. And there’s how credible is your story is going to lend itself a lot to that. So I want to spend some time talking about that. But this is not a show on factoring right In creative finance techniques. Well

Greg Crabtree:
Those are drunk driver rate financing.
So really the idea what we teach is how to grow out of your own cashflow. And even if you have a difficult cashflow signature to trade capital to profit, we can still teach those businesses how to grow. We their own cash and stay off the line of credit. One of the classic misunderstandings of what a line of credit is there for a line of credit is there for a temporary disruption in normal activity. And if you go talk to a banker, a line of credit that does not go to zero for 30 consecutive days and a 12 month period is called an evergreen loan by the regulators, which means I have borrowed capital, which is very dangerous. Borrowed capital is betting with somebody else’s money and you still have to pay the bookie.
And so the idea is we want to teach people to, our philosophy of a fully capitalized business is having two months of operating expenses with zero drawn on a line of credit. Now I’m okay with term debt against a productive asset. I go buy a vehicle, fine finance it over six years. I go buy a CSC machine, fine finance it over five, six years. If I go buy a work truck, fine a building, fine. You got your normal for when you get to real estate, you got to put 20% down so that that’s your capital contribution. But the rest of it’s fine.
And once again, that’s what we call infrastructure capital. And the thing is, there are very few businesses in the US that have much in the way of infrastructure capital anymore. We are a very service industry dominant economy. But there are some that do and we have some that do that. And what we teach them is, listen, don’t blow my cash trying to pay cash for equipment that could be financed over its useful life. I want to serve my cash for my buffer, my buffer. I’m my own line of credit in essence. Because the reason why we came up with a two month core capital target is I studied four years of our client’s data when I was writing the first book and I said, what is the deepest negative cashflow that any business experiences in a three to four year period and it was two months worth of cash or two months worth of operating expenses.
Things you don’t get terms on labor and opex not cost a good sold that you get terms from a vendor. And the number has proven flawless since for the last 15 years we’ve now, I came up with that number to get people to get off their line of credit and hold cash in the business. Now I get clients trying to lobby for three and four months, so I’ve got ’em on the other end of the spectrum. And I said, no, no, no, no, no. Any dollar amount above the two months is excess cash that you’re only getting your overnight interest rate on. But up to the two months number, I’m getting a 50 75 or a hundred percent return on that money because it’s core to the business and it’s is included. And when we do return on invested capital calculations, we put the two month cash number in there, whether you have it or not, I’m not letting you create a high return on invested capital that’s leveraged through line of credit. Fine if it’s leveraged on an operating piece of equipment as long as you need that piece of equipment and it can continue to be productive.

Mike Vannoy:
I think a lot of people probably think, okay, maybe it’s a bit of an old school, but still pretty common brick and mortar retail kind of a business. You gave examples, Hey, buying some equipment, buying a building, some real estate, I need a service truck. Maybe I need to fund payroll for it. So maybe I have a five location business and I’m going to open a six location somewhere else.

Greg Crabtree:
Well, let me give you a location example. So this is one guy, it’s not a client of mine, but he was in the audience in a presentation I was giving in Omaha, Nebraska, and he has a series of 15 transmission stores. And I said, Pete, I’m going to use you as an example. He said, lemme see how close I can get to the numbers. I said, you’re thinking about opening the 16th location. Great. So what that means is it’s going to cost you about a million dollars for the dirt and put up a metal building for that location and you got to put down 200,000 and the bank will finance 800,000. I said, let’s start there. Is that a pretty good guess? He says, yep, that’s exactly what we aim for. He said, great. Okay, step one. So the 200,000 that I’ve got to put in of my own money for the down payment that’s invested capital, it says now you’ve got some operating losses when the store opens, I’ve got some other stuff to get the store ready. So I’m going to spend about $200,000 to get the store open before it breaks even by typically the third to fourth month of the business,

Mike Vannoy:
Which would be pretty fast I would

Greg Crabtree:
Think. Yeah, it was pretty fast. But once again, that’s a business that there’s not enough of. And so they get there pretty quick. He smiled, he says, yeah, yeah, that’s exactly the number we use. Alright, so that’s 400,000
Input. So that business, we want a minimum 50% return on invested capital and I’ll take more, but that’s one where I want a minimum 50% return. So the success for that store is taking 400,000 times 50% is 200,000. I need 200,000 in annual profit for that to be a success. 200,000 divided by 12 is $16,833 a month. I said, you hit success when the store hits $16,800 a month on a continual basis or more in profit. And Pete kind of paused and he said, well, what you just told me in two minutes took me 35 years to figure out.
But that’s it. I mean, yeah, there’s a lot of nuance. There’s energy, there’s culture, there’s all of these other things of business, but I mean the physics of entrepreneurial finance have been staring at us in plain sight for decades and people just keep wanting to try to come up with the easy button solution and it’s not there. These are fundamentals that have characteristics that when you look at every type of business that you’re doing, you have to stay within those characteristics and you have to use those targets or else you are playing Russian roulette in a really high stakes propo.

Mike Vannoy:
That’s what just keeps going through my mind. That’s the perfect example. Russian roulette, I’m sure somebody’s going go to YouTube and they’re going to type in growth capital and they’re going to find this video and it’s not going to be techniques to go convince the banker to loan you money, but I think that’s, I’ve seen a lot of pitch decks and that’s really what they are, whether it’s,

Greg Crabtree:
But you know what, Mike? When people follow these principles, the banks don’t have any problem loaning you money when you need it.

Mike Vannoy:
And that’s exactly where I was going to go. It’s like if your pitch deck is all about, Hey, here, here’s the total addressable market. Here’s how this massive market enough, all I need is this one little percentage slice. That’s all. Okay, that’s interesting.

Greg Crabtree:
When I came up with these principles of return invested capital, my profit target labor efficiency ratio, core capital target, I’ve not had to worry about loan covenant documents for my clients. I mean, I’ll tell you, only 20% of our, I’ve talked about before, our a hundred company model that we track for our economic data of our clients all across the us, only 20% of those clients have anything drawn on a line of credit. I mean, that’s how these people have bought in to this idea and it create success because they’re not living on the edge of their line because they understand those principles. I don’t have to worry about what the covenant says because they’ll meet every covenant that the bank can think of for the most part. But when you’re flying close to the sun, I mean you’re having to go to the bank and beg for forgiveness because you missed a covenant and you hope that things will turn around and they won’t take your house.

Mike Vannoy:
So how does a business, what’s other than being a client of yours, and if that happens as a result of the show, awesome. That’s not necessarily the intent of the show. The intent of the show is to provide good information. How do businesses get there? It seems like the first thing, you’ve got to understand your own numbers first, you have to understand your own cash power ratio, right? You’ve, you’ve got to understand what type of a business you are. Where do you start? If you’re an entrepreneur,

Greg Crabtree:
It’s a phrase we repeat often every day you got to get profitable with what you got. It starts with profitability. And I got to get to my profit target first, and then I get to my best possible cash flow, my trade capital percentage second, and then I decide I’m not thinking about growth. I’m just trying to optimize what’s in my hands that I’m doing. Because why would you grow a business is broken, it ain’t going to get better by growing it. You got to fix it where it sits.

Mike Vannoy:
How often do you see business owners, and I confess I’ve been in ’em where I’ve thought about, oh, we’re just got to get scale and I’m going to worry about margin later. And then margin never materialized. How often do you see that where the business doesn’t really understand even how they, I don’t want to say it in a silly way, but do they really understand whether they’re making money or not and whether they have something that can scale?

Greg Crabtree:
Our initial interaction with a new client is, I would say 80% of ’em don’t really have a clear picture of their financial standing because traditional financial statements are opaque. You just can’t. They don’t talk. They’re mute. And so what we do in our simple numbers structure is to get the data to tell a story. And when the data can tell its story, then it’s like, oh gosh, it’s sick. How do we fix this? Well, there’s a cure. You may not like the cure it. And then as you understand the targets and everything that you’ve got to go get, then you move into more of the finesse of lines of business, what we call the profit queue. What’s the profitability of each customer relationship? What’s the profitability by project, by location, by team member or by team in all of those. And so as you really start to take people from survivable, either there was one client, I mean we literally, they were a 55 million in revenue losing two and a half million a year in income, two and a half million loss.
I mean, so they’re not long for this world. And we basically dug into their product matrix and showed them the skews that they had to stop selling or fix, take your pick, but here’s the fix solution. Here’s the stop solution. But we got them to drop from 55 million to 35 million in revenue, but be a million dollars profitable. Do you want to be 55 million and lose two and a half million or you going to be 35 million and make a million? Which one do you want? Because the 55 million business is losing two and a half million isn’t worth anything. It’s worth less than zero,

Mike Vannoy:
Right? Unless you are growing with positive cashflow on that loss, you’re out of business eventually. So

Greg Crabtree:
I mean, there’s occasionally, there’s some times where you are so bad, you’ve got good revenue that you’re so bad at executing it, somebody will buy you out of a problem, but generally they’re smart enough to not give you the value for what they know how to do. A good buyer knows that.

Mike Vannoy:
And there are exceptions that come out of the software world where salesforce com is a multibillion dollar company. They’ve never had a dime of profit, but the revenue line goes like this and right?

Greg Crabtree:
Yeah. But those are ones that are generally funded by other people’s money. Hundred percent. I have some clients that have some other people’s money investments, but very few. I gravitate to the entrepreneur, Hey, I got skin in the game. I’m the funder. I’m the one at risk. And you can’t pull off the stupid.com.

Mike Vannoy:
And I think those things are, I’ll say guilty. Those things are shiny objects that sometimes entrepreneurs I think aim at and clinging to and think that they can do that. But the reality is, you make a really big point about this in your books. It’s about profit. It’s not about revenue. Revenue is a vanity number. It’s all about profits. You don’t have profit, you don’t have a model that you can grow.

Greg Crabtree:
And actually what we’ve gravitated to more so is establishing targeted percentages of profit to gross margin, which we think is a far clearer, more comparable number across all different lines of business than forget about revenue is just a starting point for math, your top line should be gross margin, which is revenue minus cogs without any of your labor. You can put subcontractors in there, but you can’t put your labor in it. Gross margin is those pass throughs. That’s your true economic top line. And then your pre-tax profit for the US companies, because most US companies that are private or flow throughs, that taxes paid at the entrepreneur level personally. And so we focus on pre-tax profit because it’s the same thing as a bond yield. I mean, if I buy a million dollar treasury bond, what’s my interest income? Well, it’s taxable. Okay, well, it’s no different than a business. If I invest a million dollars in a business, so you invest a million dollars in a two year US treasury, it’s probably right around 5% right? Now, if I invest a million dollars into a good business with a 50% return on invested capital, that’s $500,000 annually. It’s making, that’s why a privately held business that’s well run in a market that’s needed is the best investment you’ll ever make
Because like I said, the low end is 50%. Our a hundred company model, the average return invested capital is 75%. That’s on a billion dollars of revenue.

Mike Vannoy:
Greg, we could probably spend a few hours talking about some of the best practices on optimizing. Well,

Greg Crabtree:
The next discussion, here’s the, so what I’ve talked about today is capital that physically we can account for on the balance sheet. Our next discussion though is there’s a fourth version of capital. So on the balance sheet you have your trade capital, which are those net things. Our infrastructure capital, which is the fixed assets minus the debt, is connected to it. And then we have your core capital target, which is the two months cash number with zero drawn line of credit. Those three net numbers makes up everything on your balance sheet. The sum of them is your invested capital. It excludes the trash on your balance sheet of due from shareholder assets that you loan to a related party. You purchase something in the business that has nothing to do with the business. So it’s excluding that kind of trash that sometimes builds up on entrepreneur’s balance sheets. So that’s the business in its purest form, but there’s a fourth capital, and we’ll tease this for next time, it’s called Launch capital. Now I named the baby because there wasn’t a name for it. And the launch capital lives on your p and l because accounting does not have rules. And we’ve created some techniques to deal with this of I am intentionally spending money to lower profitability in this accounting period to get the economic gain in a future accounting period.

Mike Vannoy:
Yes.

Greg Crabtree:
Nobody stuck a gun to my head and made me spend it. I chose to lower profitability myself to hire a person who wasn’t fully utilized to invest in technology, to run a more efficient business, to spend surge money on marketing to penetrate a market, all of those count, because that’s

Mike Vannoy:
A complimentary product line.

Greg Crabtree:Exactly. Product dev, product development. We have got clients who do that. Those are launch capital concepts that we need a whole episode to just unpack that. But to me, all of our clients grow their business far, far more so through Launch Capital investing on the p and l than balance sheet investing. And that’s actually, that’s the secret kernel of growth in entrepreneurism.

Mike Vannoy:
So I for sure want to make that our next conversation. That’s super interesting. I think it is, to me, I suspect it will be to other entrepreneurs. I think the punchline for today, we can maybe unpack a couple more use cases. The punchline is if you want to grow your business and you’re looking for growth capital, whether it’s debt or otherwise, you can’t do it unless you have first of profitable business. You got to know your numbers, how you’re making it, and you have to understand your own cash flow in a good, healthy business, by definition, should be able to fund its own growth. And if it’s not, you don’t realize that you have your baby’s sick. Is that a fair way to

Greg Crabtree:
Look at it? Absolutely. Yeah. Bessie’s not giving milk. So we got to get Bessy healthy. You can keep your cow healthy and milk it every day, or you can starve it and have one barbecue dinner.

Mike Vannoy:
So if you’re an entrepreneur, you’re working your tail off, you’re trying to, maybe it’s too much of a throwaway phrase. You’re trying to grow your business and you keep working harder and harder and it’s not happening. The reality is your business is sick and you don’t know it,

Greg Crabtree:
Right? Yeah. The easy path entrepreneurs try to hit the easy button and go get more cash rather than fix their profitability problem. And I am telling you, if you can hit your profitability target, there’s a way to fund the business. That’s easy. But if you can’t hit your profitability target, then nobody’s going to fund you. And at the end of the day, the best funding is self-funding because once you go through a couple of cycles and you get it to where your cashflow on growth, then you’re fine. You’ll never talk to your banker again except to get football tickets when you need them. I’m a net depositor. I’m not a borrower.

Mike Vannoy:
Yeah,

Greg Crabtree:
Yeah. That’s a great tent. But anyway. Alright, well, I’m going to have to wrap up, but like I said, we’ll tease them with the launch capital because I think that’s really the secret sauce of how you grow a business. More so than anything,

Mike Vannoy:
Greg enjoyed the conversation and I think we captured the foundation and next time we’ll talk about Launch Capital. Thank you.

Greg Crabtree:
Alright, sounds good. Alright, thanks.

Mike Vannoy:
Thanks to everybody else for joining today. If you enjoyed today, subscribe, like, share, comment. Until next time, thanks. That’s it for this episode of Mission to Grow. Thanks for joining us today. For show notes and more episodes, visit us@missiontogrow.com. If you found this content valuable, I invite you to share it with a friend that subscribe to the show. If you really want to help, I’d love it if you left a five star review on Apple Podcasts, YouTube, or wherever you listen. Mission to Grow is sponsored by Asure. Asure helps more than 100,000 businesses get access to capital, stay compliant, and develop the talent they need to grow. To learn more about how Asure can help your business grow, visit asuresoftware.com