Stop Confusing Owner Pay With Real Profit

Ryan Haylett

You think you're making a hundred and fifty grand a year, but the reality is, you might actually be losing money. If you walked away tomorrow, your business would collapse, or worse, you'd have to pay someone else more than the business even makes just to keep the lights on. We see this all the time with service businesses doing, say, five hundred thousand in revenue, and the owner is looking at a hundred and fifty thousand left over in the bank account, thinking they are absolutely crushing it.

Dave Rowley

Wait, a hundred and fifty grand on five hundred thousand in revenue? That's a thirty percent margin. To most people, that looks like a incredibly healthy business. What's the catch there?

Ryan Haylett

The catch is what we call the- the- the profit illusion. It's the difference between SDE—Seller's Discretionary Earnings—and true EBITDA, or operating profit. SDE is basically everything the business spits out to one owner-operator. It's your salary, your perks, your- your distributions, all lumped together. But EBITDA, real business profit, has to account for what it actually costs to replace you. If you are working sixty hours a week running the day-to-day operations, doing the sales, managing the team, you aren't just an owner receiving profit. You are an employee. And you are probably underpaying yourself.

Dave Rowley

Right, so you're subsidizing the business with cheap labor. Your own. If you had to step out because, I don't know, you want to actually retire, or you get sick, you have to hire a general manager. What does a good manager cost? A hundred grand? A hundred and fifteen thousand plus benefits?

Ryan Haylett

Exactly. At least a hundred and fifteen thousand. So if you subtract that hundred and fifteen thousand replacement cost from that hundred and fifty thousand of leftover cash, your actual, true operating profit is thirty-five thousand dollars. On five hundred grand in revenue, that's not a thirty percent margin anymore. That is a razor-thin seven percent margin. One bad month, one client leaving, and you are deep in the red.

Dave Rowley

That is a massive wake-up call. Because when you're in the day-to-day, you don't think about that replacement cost. You just see the cash in the bank. But basically, you've just bought yourself a highly stressful, sixty-hour-a-week job that pays a slightly above-average salary, rather than actually building a valuable, scalable business asset.

Ryan Haylett

Yes! You've built a job, not a business. And because you are subsidizing that job with your own free time, your pricing is probably way too low. You can't scale because you can't afford to hire anyone to take over your tasks at the prices you are currently charging customers.

Dave Rowley

Okay, so how do we break out of this trap? If someone is listening to this right now and realizing, oh crap, my thirty percent margin is actually seven percent, how do they fix the math?

Ryan Haylett

The very first step is to perform a- a thorough audit of your actual hours. For one week, write down everything you do. Are you spending ten hours on bookkeeping? Fifteen hours on account management? Twenty hours on actual service delivery? Write it all down. Then, assign a realistic, market-rate replacement wage to each of those roles. Don't use a discount. Use what you would actually have to pay a qualified professional on the open market to do that exact job.

Dave Rowley

So if a bookkeeper costs thirty-five dollars an hour, and an account manager costs seventy-five thousand a year, you calculate those fractional costs based on the hours you actually spent doing them.

Ryan Haylett

Precisely. Multiply the hours by those market rates, add them up, and that gives you your total replacement cost. Now, you take your current net profit and you subtract that number. This is what we call running a shadow P&L—a shadow profit and loss statement. It shows you the cold, hard truth of what your business actually makes when it's not relying on your exploited labor.

Dave Rowley

And once you see that real, probably depressing number, that's your trigger to re-price your services. Your prices have to be high enough to absorb that replacement cost and still leave a healthy ten to fifteen percent true EBITDA margin on top. Otherwise, you're just running a charity for your clients at the expense of your own retirement.

Ryan Haylett

Right on. If you can't afford to pay someone else to do the work and still make a profit, your business model is broken. So, here are three highly practical, quick wins you can implement this week to start fixing this.

Dave Rowley

First, do that hourly audit. Track your time for the next five business days. Every single hour. No cheating.

Ryan Haylett

Second, build that shadow P&L. Take your last three months of financials, subtract your calculated replacement cost, and find your true operating margin.

Dave Rowley

And third, open a separate Owner's Pay bank account. This week. Transfer a fixed, market-rate wage for your labor into that account every single pay period, and leave the actual business profits in the main operating account. Stop treating your business bank account like a personal piggy bank.

Ryan Haylett

Do those three things, and you'll finally see the real financial health of your company. If you need help untangling your business math, setting up your strategy, or building the systems to actually scale past this bottleneck, go to modularity.us. We help businesses design technology, websites, marketing, and growth strategies that actually work. See ya next time.

Dave Rowley

Talk soon.