Simple Numbers review: are you really making a profit?

Simple Numbers, Straight Talk, Big Profits is Greg Crabtree's, and it contains one idea we would put in front of every owner we meet. It also contains a set of thresholds that get quoted constantly in Australia and do not transfer here without work. Both halves are worth going through, because two of our own tools are built on the first and deliberately decline to print the second.

The idea that is worth the whole book

Pay yourself a market wage for the job you actually do, then look at the profit.

That is it. Most owners have never seen their profit with a proper cost for their own labour in it, which means the profit line is partly a measure of how much of their own time they are giving away. Crabtree's framing is that until the owner's role is costed at market, the profit figure is not a number about the business at all.

It is also exactly what a buyer or a credit team does to your accounts before they decide anything. So you may as well look at the figure they are going to look at, some years before they do.

The four numbers

The framework hangs on four measures. These are his figures, from his own current site rather than from the secondary summaries, which are not always the same thing.

Separately he publishes bands for pre-tax profit as a share of revenue, measured after that market-based owner salary: 5% a business on life support, 10% the standard for financial health rather than a stretch, and 15% a robust position with room to invest.

The core capital number has the most visible working behind it. He describes looking at fifty company data sets and asking what the deepest negative cash month over three years looked like, and concluding that none of the surviving businesses had used more than two months of operating expenses plus payroll. That is a real derivation, and it is more than most rules of thumb come with.

What does not transfer, and why we say so

Two problems, and they are different sizes.

The samples are not published

Fifty data sets is a description of a method, not a dataset. For the labour efficiency ratio there is not even that: the basis is described as small business data across a range of industries, with no sample size, composition or industry mix given. It is a careful practitioner's observation across his own client engagements, which is a legitimate thing to publish and is not the same as something you can go and check.

The standard we hold any benchmark to is that a reader can download the source data and audit it. These figures do not clear it. Not clearing it does not make them wrong.

The labour ratio is not measuring the same thing here

This one is arithmetic rather than judgement. Crabtree's labour figure is wages, with payroll taxes and benefits sitting in operating expenses. An Australian employer carries superannuation, workers compensation and payroll tax on top of every wage. A ratio worked the Australian way and a target of 2.0 built on wages alone are not the same measurement, so putting the second across the first would be a comparison the arithmetic does not support.

So when we look at a business's labour ratio, we name his target, attribute it to him, and do not draw it across your figures. We show the ratio both ways, on wages alone and with on-costs loaded, and compare you to your own best and weakest periods instead.

What we took

The owner wage adjustment, in full, and one detail that most implementations get wrong. Where the owner's pay ran through the payroll it has to be added back before the market rate is charged, or the role gets costed twice. Where it was taken as distributions, dividends or a trust entitlement it never reduced reported profit, so nothing is added back. Getting that backwards overstates real profit by an entire salary, and it is the single most common error we see in owner-prepared numbers.

The core capital test, in full. Two months of operating expenses plus payroll, held in cash, net of anything drawn on the line, because cash sitting beside a drawn overdraft is borrowed money rather than a reserve.

The 5, 10 and 15 per cent bands, with his name attached to them on the page and a note that they rest on US client data whose sample has never been published. Attributed, not asserted.

The lending view

A credit team will normalise the owner's wage whether you have or not, so a business that has already done it presents a set of accounts that needs no explaining. That is worth more than it sounds. The gap between a reported margin and a real one is a conversation, and every conversation in a credit file is a place the answer can go the other way.

The core capital idea reads well from the same desk for a different reason. A business holding two months of costs in cash with nothing drawn is a business that can absorb a bad quarter without asking anyone, and the absence of a permanently drawn overdraft is one of the quieter positives in a file.

Worth reading?

Yes, for the owner wage discipline and the four forces of cash flow, which put tax and debt ahead of building a reserve and distributions last. Read the thresholds as one experienced practitioner's observations from another market rather than as standards, and be careful with the labour ratio in particular, because the definition underneath it is not the one your payroll produces.