Your Origami Monthly Report is a simple and succinct summary of the most important numbers in your monthly financial statements. These posts help you understand and use the information in this report to manage and steer your business.
Thanks to Kris Sparrow, CPA, co-founder of Origami, and Partner at Origami Professional Corporation, for authoring this post.
Over the past summer, you may have noticed emails from us delivering your monthly financial statements. These emails were our way of initiating a long conversation about the financial health of your business, a topic we're deeply passionate about. We want to express our gratitude to all of you who provided feedback over the last few months – your input was invaluable.
From this feedback, we've reaffirmed something we already knew but may not have fully acknowledged: small business owners are exceptionally busy individuals, often lacking the time and desire to become financial statement experts.
Malcolm Forbes once described an interaction between his father, founder of Forbes Magazine, B.C. Forbes, and his accountant who said excitedly: “Mr. Forbes, the ledger shows a slight profit this month!” only to be answered by Mr. Forbes: “Young man, I don’t give a damn what your books show. Do we have any money in the bank?”
We challenged ourselves to present the information in the financial statements which we knew could really help our clients in a way that was not only meaningful but actionable.
Moving forward, instead of inundating you with traditional financial statements that make your eyes glaze over, we will distill everything down to what matters most for managing your business. What follows is a description of the beta version of that analysis. 3 Key Numbers, tied to meaningful targets, sent out to you monthly. We would very much like to hear what you think of it. We will be iterating on it for the foreseeable future and would love to incorporate your feedback.
Real Profit
This figure represents the percentage of your trailing twelve-month Real Sales that you retain after covering expenses, including a fair market salary for yourself.
It has been our experience that many small business owners choose to compensate themselves at a less than fair market value. We think this is nuts. For almost everyone, any tax deferral advantages from doing so can be replicated by contribution to a tax deferred savings account (RRSP in Canada) and while it is normal for there to be a start up period where the business can’t afford to pay its founders fair market salaries, paying owners working in the business what their market contribution is worth needs to be a top financial priority.
Why trailing twelve months? Due to factors like seasonality and accounting quirks such as year-end entries that condense a full year's activity into a single month, we calculate the Key Numbers off of your last twelve months of operations. We encourage you to manage with this time frame in mind.
The absolute minimum Real Profit you should aim for is 10%. Anything lower jeopardizes both your and your employees' livelihoods. While at the 10% level the Real Profit is best thought of as a margin of safety, it is much more than that.
In an economic sense, your business purchases inputs (labor, material, and/or services) and converts them into something your customers find valuable. That conversion, the value that you add to your inputs, is what sets you apart as an operator. Your Real Profit, then, is how the market values what you bring to the table.
In a more pragmatic sense, Real Profit is the fount of all future growth. The old adage “you need to spend money to make money” is very much true. Whether the money you spend to fuel growth comes from retained profit or from financing, Real Profit is of prime importance to both your bank account balance and the friendliness of your bank’s lending officers!
Traditional financial statements report profit as the “bottom line,” the residual left over after subtracting one group of numbers from another. We put it first because it isn’t a mere difference you have to passively accept. If your business is structured properly — and we are committed to help you structure your business properly — the Real Profit is the starting point. The entire game is to rig the business so you achieve your goals just as a casino rigs their business to achieve theirs. If you want to always win, emulate “the house.”
By default, the target will be set at the recommended minimum of 10% or at Real Profit plus 1% if Real Profit is greater than or equal to 10%. If you’d prefer a different target for your business please let your Origami CPA know so they can make the change.
Real Sales
This is the amount of sales you retain after deducting expenses for subcontractors, materials, and merchandise. We use the term "Real Sales" to underscore that sales should be evaluated after accounting for your direct costs. Why? Small businesses often have less control over their input costs compared to larger enterprises. So we prefer to view sales after factoring in these costs. This figure often aligns with the traditional Gross Profit measure in accounting, but it may differ when a business classifies labor costs as a cost of goods sold. Notably, labor costs are excluded from the calculation of Real Sales to facilitate the determination of a Salary Cap.
Unlike Real Profit, the Real Sales target is not changeable. It is the mathematically certain amount of Real Sales you’ll need to achieve to reach your profit goal, given your current expenses.
Salary Cap
We've borrowed the term "Salary Cap" from North American professional sports. Given your Real Profit objectives, the Salary Cap is the maximum amount you can afford to pay yourself and your staff at your current level of Real Sales. If you consistently operate at or below the Salary Cap, you're on track to meet your goals, and we will find ourselves fighting the urge to hit you with an air high five at every opportunity. If you are operating over your Salary Cap, it is time to boost Real Sales and exercise caution when hiring.
Like Real Sales the Salary Cap is also not changeable. It is the mathematically certain amount of salary you can afford to pay yourself and your employees while still achieving your profit goal, given your current sales.
We still love and admire the traditional financial statements and encourage our clients - who we also love and admire - to review theirs (a great primer for doing so can be found here). But if you only ever review the Key Numbers, set meaningful targets, and manage to achieve them, we are confident that you will achieve success. The game will be rigged in your favor.