Tag: Break Even Point

Posted on

Business – Revisiting the E-Myth Revisited

Welcome back! I was talking with Kevin@DeliberateConsulting.com about things we should do differently in our business (disclaimer: Kevin & I are partners/investors, along with others, in a high-end door manufacturing business). One of the things he brought up was that all of the partners should have read Michael Gerber’s “The E-Myth Revisited: Why Most Small Businesses Don’t Work and What to Do About It” [http://a.co/d/5JhEnwk] before we decided to invest in a business. Kevin also suggested I write a blog post about it and how it can help you in business.

 

The E-Myth Revisited

 

emyth

 

The E-Myth Revisited is a wonderful book that provides guidance for individuals having an “Entrepreneurial Seizure” as the book’s author, Michael Gerber, puts it. It provides a mix of case history, told as an on-going narrative of a client, and guidelines for successfully organizing an entrepreneurial idea into a business operation manual. It tells how you should work ON your business before you work IN your business. AND, your goal should NOT be an employee of your business, doing things yourself.

 

I’ve mentioned the E-Myth before:

BUSINESS – WE DON’T NEED NO STINKING PROCESSES!…OR DO WE?

MY RESPONSES TO TIM FERRISS’ “TRIBE OF MENTORS” QUESTIONS

 

I would like to know more about my readers. If you could spare about 2 minutes of your time, please take a survey to tell me what you like about the blog. Just click here to take the survey.

 

Business Buying, Two Years Post-E. Seizure

 

I did not read the E-Myth until after we had already purchased the business and were off to the races. I shared it with the other investors, indicating how important it was that we follow its recommendations. Kevin read it and as indicated by the prompt for this post, he feels the same.

 

Looking back, I have to agree with Kevin. We should all have read the book before deciding to buy a business together. We did not understand how to operate the business. What little “processes” we received from the previous owner were a jumbled bag WTF? and Huh? And, on top of that, the partner directly involved in the business adopted everything wholesale, becoming too mired in the day-to-day to view anything strategically.

 

This is exactly what the book is designed to avoid. If we had spent more time understanding how the business operated and put in systems & processes to optimize its operation prior to purchase, we would be a lot further ahead.

 

We are slowly getting things on track and working to bring efficiency to the operation. Only time will tell if we will be successful.

 

Lessons Learned

 

Kevin and I are starting to collect lessons learned so we can apply that to future business endeavors, investment advice, and consulting efforts.

 

Below are some, in no particular order:

  • Read the E-Myth Revisited
  • Put together your operating manual
  • Understand you costs
  • Create an operating agreement defining who will do what
  • Stick to your operating agreement
  • Understand Cash Flow

 

Please email me, comment below, contact me on LinkedIn, Twitter, or my Facebook page to share your Lessons Learned in operating a business.

 

And, as always, let me know what you think in the comments. Ask questions, tell your story.

If you like my posts, please share them with others and subscribe to this blog.

Posted on

Business Finance – Understanding Cash Flow

An infographic representation of Cash Flow.

 

Today I want to go over Cash Flow and why it is critical to business finance.
There are four basic reporting metrics for business finance:
  • Balance Sheet – Statement of financial position, reporting a company’s assets, liabilities, and owners’ equity at a given point in time.
  • Income Statement – Statement of revenue and expense or profit & loss.
  • Equity Statement – Statement of changes in equity or retained earnings.
  • Cash Flow Statement – Statement of a company’s cash inflows and outflows during a given period of time.

 

I will cover the first three in more detail with later posts because I want to talk about Cash Flow and the Cash Flow statement.

 

Cash Flow
Cash Flow is the total amount of money coming into a business (revenue, income, investments, loans, etc.) and the total amount of money going out of a business (bills, expenses, wages, capital purchases, etc.) over a given period of time. It can be a year, a quarter, a month, or any time period you want to look at. For my purposes, monthly reporting is preferred, as it coincides with other regular monthly financial reports.
Doesn’t the profit & loss report show you the same information?
While reporting similar information, Cash Flow & Profit & Loss Reports serve different purposes. The Cash Flow report gives you an understanding of how you are bringing money into your business and how you are spending it while the P & L report shows you revenue earned and expenses paid.
OK, that still sounds similar, you say.
It may be easier to understand if you look at it from the perspective of different accounting methods. Businesses use either the Cash Basis or the Accrual Basis methods.

“Cash basis – Revenue is recorded when cash is received from customers, and expenses are recorded when cash is paid to suppliers and employees.

 

Accrual basis – Revenue is recorded when earned and expenses are recorded when consumed.”

If you are operating on the Cash Basis method, your revenue and expenses are recorded into your accounting system when they occur. In this case, your P & L and Cash Flow Reports should show almost the same information for a given period, with minor differences like loan principle repayments not showing up on a P & L.
In the case of the Accrual Method, you might earn revenue in a given month, but you won’t see the money from it until the invoice gets paid, which may be a month down the line. As for expenses, you may be paying for supplies immediately, but can’t show them on the P & L until the revenue is earned. So, you are potentially paying for supplies in one month, showing revenue in the next month, and not actually getting paid until the third month.  In this scenario, the P & L would show the expense & revenue in the second month, but the Cash Flow would show the outflow of the expense in the first month, no activity (with respect to the subject order) in the second month, and would show the revenue inflow (invoice being paid) in the third month.
Because of this, you should be looking at both reports to better understand what is going on in the business.
Why is Cash Flow important?
 
To be a successful business, you want to have positive cash flow…that means that you have more money coming in every month than you are paying out in expenses, wages, and bills. This seems like a “DUH!!!” statement, but without looking at both your P & L AND Cash Flow reports, it would be hard to make sure you are able to bring in more cash than pay out in expenses.
Without regularly reviewing the Cash Flow statement, you might think you are breaking even or close to it, until you realize that your bank account has steadily been dropping and you really were not even close to breaking even.
And, as always, let me know what you think in the comments. Ask questions, tell your story.
If you like my posts, please share them with others and subscribe to this blog.
Posted on

REI – Analyzing a Property as a Rental

This week is a bit of a follow-up to last week’s article about finding your breakeven point. I covered what you needed to look at and why it was a good idea to know what your breakeven point was before you get into a business. Now I will apply similar principles to Real Estate Investing.

Today, I am going to go over what I look at when I evaluate a property to add to my portfolio. My strategy for real estate investing is Buy and Hold, meaning that I buy properties and intend to keep them long term, renting them out to tenants.

Cost Assumptions

For cost assumptions, I use the asking price, and an estimated cost of improvements (rehabbing property) & estimated closing costs (approximately 3% of price of property).

Finance Assumptions

Use a mortgage calculator to determine monthly debt service payment. Set the desired term (15 yrs, 20 yrs, 30 yrs, etc.), down payment, and interest rate.

Gross Rents

Gross Rents are the total rents expected to be collected on a monthly basis. This can be rent form a single-family home or a multi-family property such as a duplex, triplex, or larger apartment property.

Vacancy

To account for vacancy and deduct a percentage from your gross rent before deducting expenses. I generally use a conservative vacancy percentage like 10%. While I will more than likely not  have 10% vacancy in a year, accounting for it helps me to ensure the  property will always  cash flow.

 

Expenses

So, once I have a property to analyze, the first thing I do is verify the expenses. For the most part, the costs should be relatively the same, with the exception of property taxes.
I account for the following expenses:

  • Property Taxes
  • Insurance
  • Maintenance & Repairs
  • Utilities
  • Advertising
  • Administrative
  • Variable Cost Property Management
  • Lawn Care / Landscaping
  • CAPEX

Property Taxes can usually be found on the local parish or county assessor’s website. You just have to search for the property address and all of the details for the property are listed. Who owns it, what municipal assessed value is, what the property has sold for, and what the city and parish/county taxes are estimated at for the current year.

Insurance can be estimated by getting a quote from your insurance agent/provider or if you have a similar property, you already have an idea what the cost is.

Maintenance & Repairs covers anything short of replacing major components of the property.
Utilities are what you expect to pay for utilities while doing turnover or when the property is unoccupied between tenants.

Advertising is the costs for paid advertising to attract tenants.

Administrative are the costs for anything administrative to do with operating the property as a rental. This covers book keeping, accounts payable, accounts receivable, etc.

Variable Cost Property Management is a percentage of gross rents paid to a property manager to manage the property. I account for this as an expense even though I manage my own properties so in the event I decide to engage a property manager, I already have that cost covered and don’t have to worry about adding a PM cutting into my cash flow.

Lawn Care/Landscaping covers grass-cutting when the property is not occupied and/or if the property is a multi-family property where the tenants don’t normally take care of the lawn.

CAPEX is an amount put aside to cover major repairs such as replacing the roof, appliances, flooring, plumbing, electrical, etc. That way, you have the money to cover these repairs instead of worrying where to get the money from.

 

 

The Analysis

Once I have gross rents, vacancy, cost assumptions, and expense values collected, then the analysis of the property can begin. I use a spreadsheet to conduct my analysis and it is set up to tell me what I need to know. There are inputs for all of the items listed so far.
I enter the asking price, my desired finance terms, estimated gross rents, and estimated expenses.
I then evaluate whether or not my targets are met at the property’s asking price. If it does not, I then start adjusting the price downward until I reach my target numbers.
For me to consider a property a good deal, it must meet the following criteria:
Cash flow >$100 per door and have >12% Cash on Cash Return, if financed
Cash flow >$400 per door and have >6% Cash on Cash Return, if purchased cash
Be in a decent neighborhood

Cash Flow
Cash Flow is the amount of money from gross rents (revenue) remaining after expenses and debt service are covered.
Cash on Cash Return 
Cash on Cash Return is the annual amount of return you get compared to the amount of cash you spent to acquire the property.



By comparing gross rents, total costs, expenses, debt service, and returns I am able to decide if a property will be a money-making addition to my portfolio. By continuing to add properties to my portfolio that cash flow, I get closer to my “Freedom Number”. Where my passive rental income covers my personal costs and expenses, so I don’t have to worry about needing a job.

And, as always, let me know what you think in the comments. Ask questions, tell your story.

If you like my posts, please share them with others and subscribe to this blog.

Posted on

Business Finance: Knowing Your Costs or How to Find the Break-Even Point of Your Business

 

“The break-even point (BEP) in economics, business—and specifically cost accounting—is the point at which total cost and total revenue are equal.”

This week’s topic is knowing your costs for your business or the Break-Even Point (BEP).

Before starting a business (or buying one), you should understand what your Break Even Point is. The BEP is where you have enough revenue coming in to cover all of your expenses. It means $0 in profit, but also that all expenses are covered.

Knowing what your BEP is can be beneficial in evaluating how much of your product or service you will have to sell to begin generating profit. It is always better to have this information before engaging in a business rather than trying to figure it out after you are already involved.

Direct Expenses

When determining the BEP, there are some differences between how to calculate this information for a Service Business and a Manufactured Products Business.

  • Service Businesses are fairly easy in that you only need to tally up your direct expenses. This could be done on a monthly basis, but if you have expenses that come up at different times of the year, it is easier to estimate a total annual expense and divide it by 12 to give you a monthly expense amount. (At least that is what I have found when analyzing rental properties).
  • Manufactured Products Businesses are slightly more complicated in that you need to understand what the Gross Profit (GP) on the products are. Gross Profit is the Total Sale Price minus the Cost Of Goods Sold (COGS – materials, labor to assemble). Once you know what your GP is, you will be able to calculate the BEP for the product.
Indirect Expenses

The next step is to gather all of your indirect expenses. This can include rent, utilities, sales, and distribution expenses. Anything that is not directly involved in the provision of a service or the manufacturing of a product.

Once you have all of your numbers, you can calculate your BEP.

For Service Businesses, your BEP is the sum of your direct and indirect expenses. If you bring in enough revenue to cover just those expenses, you have broken even.

For Manufactured Products Businesses, you simply divide your indirect expenses by your GP % to arrive at your BEP.

Example: Indirect Costs: $20,000; GP: 31%; $20,000/0.31= $64,516.13

As I stated above, it is a good idea to have this information before you are involved in a business. Once you understand where you stand with reference to a BEP, you can start to work on optimizing you costs & methodologies to increase efficiencies, lower costs, and lower the overall BEP for that business.

And, as always, let me know what you think in the comments. Ask questions, tell your story.

If you like my posts, please share them with others and subscribe to this blog.

Verified by MonsterInsights