Fred Parrish | The Biggest Cash Flow Drivers

Adam LeanPodcast

Just because you’re good at your craft or profession doesn’t mean you can run a successful business. In fact, too many small businesses are forced to shut down, notes author and business consultant, Fred Parrish.

Why? Because the owners didn’t understand the financial side of the business, even if they provided great service and had plenty of satisfied customers… not to mention plenty of cash coming in the door.

Fred talks about how to actually run a business as an entrepreneur – instead of taking on a job in your own company. 

It’s all about cash flow, says Fred. And we talk about how to measure it so you can do the forecasting you need to make important decisions that will impact your business’s future and help it grow sustainably.

Tune in to discover…

  • What to do when high revenues still result in dwindling profits
  • The two things you must understand to solve your cash flow problem
  • The biggest mistake business owners make when collecting on invoices
  • Expenses to pay attention to – and those you can ignore
  • And more

Listen now…

Mentioned in this episode:

Transcript

Adam Lean: Welcome to P is for Profit, a podcast for small business owners that make business concepts easy to understand, so that you can be a better business owner and own a better business. And today’s episode, we’re going to be talking with Fred Parrish, Fred co-wrote a book with Michael Gerber called the E Myth: CFO. So the E Myth: CFO book is just one book and a series of follow up books that Michael is doing from his original book called The E Myth Revisited. Now, if you haven’t read this book, I highly recommend it is probably one of my top 10 business books. The concept of this book is simple. The E Myth or The Entrepreneurial Myth is that most people who know a craft and Michael calls it the technical work of a business can successfully run a business that does the technical work. This is a myth because it’s just not true. Just because you’re an expert, let’s say at plumbing, does not mean that you can run a successful plumbing business and this is the E myth or the entrepreneurial myth that Michael talks about. The same thing with dentists just because you know, dentistry doesn’t mean that you can run a successful dentist practice. The book walks you through how to actually become though the entrepreneur that owns a business instead of a job. So it’s a very good book, I highly recommend it to any small business owner. Well, today, my guest, Fred Parrish, he got with Michael and co-wrote another book called The E myth, CFO that simply says that every business needs someone like a CFO, or Chief Financial Officer, helping them improve the profit and cash flow their business. If you don’t have somebody like this, then you’re the CFO. And this book simply tells you how to become your own CFO. So let’s jump into the interview with Fred. And let’s find out a little bit more about him and the book and how you can become your own CFO.

Fred, welcome to the show.

Fred Parrish: Thanks, Adam. Thanks for having me on.

Adam: Yeah, so I’m really excited to be speaking with you, you help business owners improve essentially the profitability and the cash flow of their business, which obviously, the two most important things. And you co-wrote a book with the guy who wrote The E Myth Revisited by Michael Gerber and, and you developed this software, and I’m, there’s so much information that I want to understand about, you know, how you operate and how you help businesses. So let’s dive in.

So but first, tell us a little bit about your background, and how you know, what led you to write a book and, and in developing this software? 

The E Myth: CFO

Fred: Yeah, it’s, it’s, unfortunately, it’s a long story, let me give you the Reader’s Digest version. And I have a background in Accounting and Finance, started my first job right out of school as a staff, accountant. But I’ve had positions from staff accountant to CEO, and companies from startup to 5 billion in revenue. And so you know, both domestic and international, I’ve worked with companies in about 100 different industries. And it’s interesting that I also have a background in programming, which is what we called coding back in the 80s when the world was still flat. So a, and so with the confluence of all of that experience and training, it was interesting when I started working with small companies, and I saw that they were having a lot of very common problems.

And so as I mentioned in the presence preface, basically, in the book, and a note from Fred, I mentioned that, I noticed too many businesses were struggling, and a lot of them actually were going out of business for no other reason, then they could not see what was coming. And so I decided there had to be a better way for small business owners who by the way, most of the time, don’t have a financial management background, they either know how to sell something or make something to be sold. And that’s where they focus their time. So we decided that we would develop tools to enable those nonfinancial business owners to really get a good handle on the financial operations in the business, which in turn, improves profitability, and more importantly, cash flow.

Adam: So the book that he wrote, or is called The E myth: The Chief Financial Officer and the subtitle is why most small businesses run out of money and what to do about it. So why do most small businesses run out of money? Well, in my experience, it’s for lack of planning. And I don’t mean, you know, the operational planning, I don’t mean strategic planning, I mean, the ability to quantify all of those things that they do plan. And so it’s building that financial, operational plan that supports all of the other actions that you’re taking. So if you know today, within a reasonable certainty, what your cash balances are going to be next week, next month, next year, you can see difficulties coming way before you actually run upon them. And so let me give you a really good example of this.

Why Planning Matters

Fred: So let’s say that we’re looking at our cash flow today. And we recognize that we have a $60,000 problem. But we’ve got six months to solve that problem, that then translates into a $10,000 per month problem. But if we run up on that problem without having any advanced notice, it’s a $60,000 problem. And so it gives us the ability to, to manage it, much ahead of that event. And it is not nearly as onerous or painful on the business or the business owner to address those problems. So the more we know about what’s coming, the better able we are to address it.

Adam: So, using that same example, how would a business owner who’s really not maybe not financially savvy, they’re more of an expert at what business is, then financials or business? How would they know even if there’s a $60,000 problem in six months from now?

Fred: Well, it is, it’s not a terribly difficult thing to do. Now, obviously, you can be as sophisticated as you want to about how you go about doing those things. But even if you just sit down with a piece of paper, or be in the old adage on the back of a napkin, and just write out what you expect your receipts to be over time, and then the timing of your disbursements, as they relate to those timeframes, whether it’s weekly or monthly, I would say that monthly is not a short enough time frame, I think weekly is the better way to look at it. But you can just start to line those things up. And even if you’re you’re only looking at 30 days, or 60 days, start somewhere, and the more you do it, and the more disciplined you are in that activity, the better you will become at really doing that plan. And it is, it is a little difficult to get started. But if you want to ensure that you have enough notice on issues that are coming in the future, and you want to make sure that your company survives, you really absolutely have to do this.

Adam: So let’s dive in a little bit more on the cash flow side of things. So what you know, say they say that a business owner recognizes that they have potential cash flow difficulties using the exercise you just described. And also in the book, what are the biggest drivers of cash flow that they should be paying attention to?

Cash Flow Drivers

Fred: Well, first of all, the most difficult thing to do in projecting cash flow is estimating, when you’re actually going to receive payment for your services or your products, the timing of that cash is critical. And so you need to understand as best you can, if you build $1 today, when do you expect to collect it in the future, and be realistic about that don’t be, you know, our clients are or customer has 30-day terms, well, they may have 30-day terms, but they almost never pay in 30 days, and even if they try to pay in 30 days, depending on how you get the payments, it may be 30 days, it may be 40 days, it may be 25 days, in fact, but understand what the specific dynamics are associated with your revenue and when that will be collected. And then the next step down from that would be your disbursements, the payments of your expenses. And in almost every company I, in fact, I can’t think of one right now, where payroll is not the largest controllable expense they have.

So that is where you start. If you have people in your company, if it’s if you’re just a solopreneur, then is your issue. And you can manage that the details are not quite as onerous. And you can do the planning a whole lot easier. But if you have payroll, which means you have payroll taxes, and you have benefits, and you have a whole host of other items that are associated with that, depending on the type of business you’re in, and then I would go down the list from the largest dollar amount down to the smallest dollar amounts. And even for if you just start with maybe the first five largest expense items that you have, and line up the timing of those disbursements in this forecast that you’re doing. And then if you want to just group everything else in one line item, that’s perfectly fine. Again, you start somewhere, you start with the details that you can manage on a reasonable basis. And you just get better over time and you get more and more detailed. If you have some experience using spreadsheets, Excel, for example. Start there. And again, the more you do it, the better you will become at building those assumptions, the technical term for when these things are going to happen. And the more accurate that forecast is going to become, which usually gives you better information about those future events.

Adam: So, I mean, it really sounds like, from a cash flow standpoint, the two most important things are receivables and payables. You can go out and sell, you can sell the product or the service. But if you don’t collect there, you know, what’s the point?

Fred: Right? Well, and it’s even worse, if you actually do not collect on some amount of revenue that you have build, it is actually worse than if you never build it. Because to produce revenue, you have to incur the expense, and how, if you’re not going to collect it, don’t do it. Because at least that way, you don’t incur the expense. But you have to have every intention of collecting that AR and you need to stay on top of it. One thing that I try to teach people just right out of the box, and that is if you have accounts receivable, and if you wait 60 days, let’s say to start collecting that AR that’s past new, you will guarantee that you always have a car that is 60 days old or older. And the longer you wait, the harder it is to collect if you start even before it’s due. And let me give you an example. Let’s say we have a customer that, again, has 30-day terms, and we have issued them an invoice for $100. Maybe we call them on the 25th day and say just touching base, I want to make sure there’s not going to be any issues, do you need some more information? Did I give you everything needed in order for you to pay that invoice on time? And then if they don’t pay on 30 days,  you just call and say I just want to make sure there’s not an issue? Is there anything more that I can do to help you in cutting that check, and I come by and pick that up or however that payment is made? Is there something that is hindering you, that I can address as the business owner that will help you make that payment. And so stay on top of the AR. Do not let it go for 45, 60 even 90 days, and the biggest mistake people make. It is waiting too long to collect on an invoice that is outstanding.

Adam: Yeah, I completely agree. So shifting from cash flow to profitability. And what should a non-financial business owner pay attention to the most to improve profitability?

Improving Profitability

Fred: Okay, well, the way I go about it in this is after about 40 years of doing this, we have a very specific process we go through every single month is the exact same process. As you know, Adam, the E myth is all about process and system. Correct. So we have a process. Again, that is the same for every company that we work with, it is the same every month. And we rely on the data to indicate what that conversation is going to be. So what I do is I look at the P&L, and I start with revenue at the top of the P&L then I look at the cost of sales, which is the next section. And then I look at those line items that are again, in descending order highest to lowest.

If for example, we have $50 of office supply expense every month, I’m not going to pay a whole lot of attention to that. Because if I manage that really closely, it might save me five bucks, or maybe $10 a month, it’s not worth the effort. Unless you’ve got everything else that is perfectly managed. And we both know that’s probably not the case. But in manufacturing companies, for example, that cost a sales component, where you’ve got direct materials, direct labor, some overhead items, if it’s a distribution company, you have inventory that you’re managing, and that cost of sales, and you’ve got the direct labor that’s doing the picking and packing and shipping. If it’s a technology company, you probably have some professionals that you are hiring either on a W2 basis, or maybe they’re 1099 people. But those are going to be your biggest expense items. And so pay attention to the larger items first, and work your way down the list. Find ways to gain efficiencies in how those numbers are managed.

And again, those numbers translate into actual operational components. And those may be people that might be equipment that might be materials, whatever it is, manage those aspects, again, on a descending order highest to lowest.

Adam: So if let’s take, for example, a service-based business.Heating and Air company, how important is it to take for the business owner to or should the business owner take the time to to do Job Costing to match employee and supplies and materials to actual specific jobs?

Fred: Well, it can be important to do that. And if you have the time to build what I call a standard job. So let’s say we have a plumbing company. And I’ll give you an example of a plumbing company that we worked with a few years ago, a plumbing company has texts that they put in the field, right. And so which with each tech, there’s usually a vehicle, they’re usually inventory supplies equipment, that this individual and maybe it’s a team, maybe it’s a tech and an apprentice working together depends on what they’re trying to do and how the company is organized. So first of all, you’ve got the labor component that you have to manage, then you have the material component. And those two items in that plumbing company, again, are the biggest cause other than possibly the owners salary, again, depending on how large the company is. But we want to maintain those activities within a specific range of a percentage of revenue. So when I look at cost of sales, the dollar costs associated with delivering a product or service or producing a product.

Again, if it’s a manufacturing company, you want to look at those items as a percentage of revenue. So that as revenue goes up and down, those costs probably are going to follow revenue. So they’re going to go up, that revenue goes up, they’re going to go down if revenue goes down. And so don’t look at them as a fixed cost, because that will get you confused and wrapped around the axle so to speak. But I would pay attention to those and determine what actions will produce the best results. And let me just give you a quick example again, of a plumbing company we worked with, to company up in the northeast, it actually is a franchise business. But they were making a profit on their P&L. But they were having all kinds of problems meeting vendor payments, they had problems with the IRS, they had problems with the state on sales tax. And they had just a big pile of debt. And they could not understand why they had this net profit on their p&l, but they were having all this trouble with their cash flow. And so what we did very quickly is we just looked at the business and we said okay, well, you’re making about $3,000 a month in profit, which is a good thing. But you have payments that are going out in the form of vendor and tax and debt payments, there’s 13,000 a month. And they could not they couldn’t connect those dots, they felt the pain. They knew they were having problems, but they could not understand why. So it’s that non-financial mindset. He’s out, you know, doing the plumbing and managing his tax and trying to bring the revenue in and his wife was doing the bookkeeping and taking care of the customers. And they could not see why they had a problem.

So what we did in that particular case, because we could model the business, we could understand the financial dynamics. And we did that forecasting, we said, okay, we’re not going to cut anything here. Actually, what we’re going to do is we’re going to increase the number of tags ads for, we’re going to increase that by two. So we’re going to increase your text by 50%, You almost had a heart attack only said that, because we had, so we had to buy a truck. For each, we had to stock it with inventory stuck, it was equipment supplies, it took us three months timeframe to get these texts trained and up to a level where they can produce the amount of monthly revenue that was required. But here’s what happened. When we looked at the business initially, they were literally out of business in six months or less. And there was no recovery. But then we said, okay, we’re going to do these things. And we brought one tech on, it was in July, and the next tech was in late September, early October. So 30 days, I’m in sorry, 90 days apart. within that same six months, when they were going to be out of business, we had increased the revenue by 40%. And we had increased their cash flow by 500%, in the same amount of time, they would have been busy. Now that’s the power of being able to do these forecasts and understanding what your actions mean in terms of future results.

Adam: And that makes complete sense. What separates successful business owners from those that just always seem to struggle?

Fred: Yeah, it is sometimes is just an innate ability to be quite honest with you, Adam, I know I will tell you that, again, I’ve been at this for right at 40 years. And I can count on one hand and not use all my fingers to name the number of people who fall into that category. Or they just no matter what they do, they just know how to make money. And it’s just an innate ability, to understand the business well enough and know what their actions are going to produce. Those people are are few and far between the other business owners who are struggling all the time is because again, they cannot see what’s coming. And so they are left to just react to problems that pop up every day, weekend and weekend. And they don’t have the ability to plan what is going to happen and you know, next week, next month, next year, and be able to address problems again, like we said at the very beginning of the conversation in a much more timely way that gives them enough runway to address a problem when it is not a huge problem.

It is much smaller, if you can break it up into pieces over time. And I think that most small business owners to be honest with you, they think that revenue will solve all their problems. You know, it’s the syndrome that all I need is a bigger truck. I just need to be able to sell more stuff. And everything’s going to be okay. Well, maybe not. Because if you’re selling the wrong thing, you’re selling it at the wrong price. Because your cost structure is out of wind, you’re selling yourself out of business. And so you do need to understand, like you asked the question about job costing, you do need to understand what your gross margin is no gross margin is, you know, is your total revenue minus your total direct costs. And those are the costs that it takes to produce whatever it is you’re selling, whether it’s a product or service. And so if you know what that gross margin is, you can manage to it if you’ve got a gross margin that is five or 10%, maybe even 20%, those are very low gross margins. If you haven’t gross margin is 70 or 80%. Like most companies out, obviously, that’s much better, because you have a whole lot more room to cover your overhead costs which fall below that line. So in my mind, they really need to understand as best they can. What those direct costs are, what does it take to produce whatever it is we’re delivering. And once you understand that, what are the other overhead items that is going to take to deliver that product or service?

Adam: Yeah, this is very good information. So you created software called the Prophet Beacon, so, explain the benefit to a business owner by checking that out and also explain why you created it.

Fred: Yeah, again, it is, well, the prophet beacon actually is an automated Chief Financial Officer. And so the reason we created that is for the non-financial business owners. It does all the really hard finance, it does all the financial analysis that determines the operating analytics. And that’s, that’s a word a lot of people are not going to understand. But what I mean by that is the idea that we have certain fixed costs and certain variable costs that exist in any business, it doesn’t matter what you’re doing. The variable costs are again like I said a few minutes ago, are like those direct costs.

So if you have materials, let’s say you’re manufacturing some kind of widget, and your direct material costs, let’s just say it’s, I don’t know some metal that goes into this thing that you’re manufacturing. And for every one of these widgets that you produce, that metal cost 40% of what you’re selling it for. So if you sell it for $1, you’ve got 40 cents of metal in that widget, if your revenue goes up by $1,000, then your cost of materials is going to go up by 400. It’s just automatic, because of the way that relates to your revenue. So those are variable costs, your fixed costs are like rent, rent is probably the best example. It doesn’t matter what your revenue level is, your rent is still going to be, I don’t know, $2,000 a month until it changes and it changes based on the contract that you have with your landlord. So you have fixed and variable costs.

And you need to understand how those relate to the overall operations world, the prophet beacon does all of that automatically in the code of the software. And so we can go now I know the software better than anyone but I have been able to go from setting up a brand new user, a brand new company, loading data from QuickBooks, adjusting some assumptions, like I think my revenue this year is going to be 10% more than last year, and next year is gonna be 5% more than this year, some expensive assumption, that kind of thing. And produce a two-year monthly P&L, and two-year weekly cash flow with a dashboard with charts that show you certain aspects of those reports in a fully dynamic model, which that means that we can actually go in and make changes in the model. And it will update the charts to show you what those changes were produced. But I’ve been able to do that in eight minutes. And the financial model that is created by the software, if you were to build if you had an outsource CFO, for example, come in and build that for you and Excel, it would take 4050 hours to build the model. And then you would have to get the data into it on a regular basis. So it’s extremely efficient. It’s designed to be as simple as someone wants it to be I mean, I’m sorry, needs to be and as sophisticated as someone wants it to be and everything in between.

Adam: Where can people find that? The Prophet Beacon?

Fred: Yeah, if they just go to theProphetbeacon.com. All one word, the prophet beacon dot com, and you can go on there as a 30-day free trial. If you register for a subscription, we get an email, you’ll get an email back, and we will actually get online will set up a time to walk you through show you how the software works help you load the data help you get started. So that you understand what it is that you’re looking at where all the functions are in the software, and how to go about doing this on your own. If you want your bookkeeper or your accountant to do this for you, maybe you’ve got a CPA that does your accounting and bookkeeping for you. We’re happy to show whoever it is that you want to do that work.

And we have, we have business owners who use it directly for themselves. We have bookkeepers within companies who are doing this kind of work. And then we are actually training CPE as an accountant to provide a financial advisory service that they can bundle with everything else that they’re doing because we just want to get this capability and to that small business owners hands, because they are the people who need the most work the most help. And they have the least resources to go out and pay somebody 2, 3, 4 hundred bucks an hour to come in and do that work for them.

Adam: Yeah, I agree. Excellent. So and in the book. I mean, I thought it was a fantastic book. And you know, I’m a financial person, but I think any business owner needs to read this because you have I mean, you make the point in the book over and over that, that you if you don’t have a CFO, you don’t have an outsourced CFO, you have to be your own CFO. And right and whether you like it or not, you are exactly right. Yeah, and you clearly explain how to do that. And so where was the best place for people to buy the book?

Fred: Yeah, they can go on Amazon. They can go to our website to get some more information and the same place the Prophetbeacon.com, there’s a book page there, where they can get more information. They can contact me directly if they have any questions. I’m more than happy to answer those. They can either go to the contact page on the website and send an email that way I will see it or if they want my email address is fparrish@profit-experts.com, feel free to email me and more than happy to help however we can.

Adam: Well, Fred, thank you so much. This has been an absolute pleasure having you on the show. I really appreciate it.

Fred: Well, thanks, Adam. It’s fun. It’s great talking to you. And as you can tell I really like talking about these things.