Guillaume: Hello everyone, Guillaume Le Tual here, host of the E-commerce Wizards Podcast where I feature top leaders in e-commerce and business. Today’s guest is Shawn Johal. He’s the CEO of Elevation Leaders. He’s a certified scaling up coach, which is the methodology of Verne Harnish. And he’s an international best-selling author. So I’m very happy to have Shawn here again for a second time. This is the second portion of the series we’re doing. We’re talking about the four pillars of scaling up with this methodology by Verne Harnish, which is an amazing book. I have great respect for it and we partially use it in-house here, but not nearly as much as well with a certified scaling up code. So, in the first episode, we talked about three of the four pillars. We talked about people, strategy, execution, and we were missing the fourth pillar which is cash, and that’s why we’re back here.
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Shawn: Hey, thanks for having me again, Guillaume. I really appreciate it.
Guillaume: Alright, so this framework is awesome. The scaling up can be used by, I guess, companies of almost any size. But it’s perfect especially once you cross that 250-employee threshold and you’re getting into the much larger companies space than some other competing frameworks such as EOS, which is specifically made just for 10 to 250 employees. You just are not applicable anymore because it’s the larger scale stuff now. EOS is a spin-off of the original which is scaling up but anyway it was made for smaller companies. So let’s talk about this, because cash as Byrne says, The Entrepreneurial Law of gravity is that growth sucks cash, which is so true. So let’s talk about this. What’s your advice for businesses?
Shawn: So there are so many different levels that we’re going to talk about cash today. And I think what’s really important for businesses to understand is, cash is very undervalued and underrated. And I say this, people understand cash, they know how important it is, but yet in businesses it is the last thing we seem to work on. It’s really crazy when we get in there as a scaling-up coach, we start asking very specific questions about cash flow, operating expenses, volume, about the cost of goods sold. People really know little about those things. So the first thing is to really understand and diagnose two major elements when you’re going into the cash and discussing this. We like to call the first element the power of one, but what we’re going to do through the power of one is we’re going to look at the seven levers that we consider to be the most important for every business. Can you guess what those seven levers Guillaume? Would you have an idea?
Guillaume: That’s a difficult one. Well, the seven levers, for sure, you’ll have your sales, that’s a top line.
Shawn: Yeah. We consider that volume.
Guillaume: The volume, then you’ll have your production costs giving the gross profit.
Shawn: Yeah, so when we look at the seven levers, you have your volume, and you have pricing. So we’re looking at those and how they affect your business overall. So that’s the first relationship, there’s going to be a few different relationships. So price versus volume. Why is it so important? When I speak to so many different entrepreneurs and so many companies, I always ask them, what are you trying to accomplish? And they always say the same thing, “I’m trying to increase my revenue”. I said, okay, so how are you going to increase revenue? I want to get more volume, I want more clients if that’s how we’re going to grow, the thing is, that might not be the best solution. The best solution might be reviewing your entire pricing structure and actually seeing, are you charging the right amount for your services? Maybe you’re charging completely the wrong amount. And if you haven’t got the pricing right, not only are you not growing from a revenue perspective, but you’re probably hurting your bottom line.
So we really have to make companies understand the difference between price and volume and how it affects their business. The next two levers are the cost of goods sold versus overhead. Again, these are two things that have a lot of differences based on the type of business you have. My business is more of a traditional LED lighting business where we have products and we have inventory. We’re going to have differences in our cost of goods sold versus overhead based on other companies. You know we have a big warehouse so the difference in costs comes in. You have to see how you can play with those numbers and how you can reduce them. Then the next three, so you have your first four, the next three are receivables, payables, and then work in progress or inventory based on the type of business that you have. If you’re more of a service business, you’ll have more work in progress. If you are a more traditional business, you may have some inventory. So we take those seven levers, and we teach our clients basically, how each one of those levers is affecting their business. And if you could only adjust one of those levers by 1%. Or just picture this Guillaume, that you’re doing a 1% increase on volume, 1% on price, you’re doing a 1% reduction on the cost of goods sold, 1% reduction on overhead, one day, receivables are cut down by one-day payables are increased by one day, and your inventory is cut down by one day, just those seven levers in any business and represent not only hundreds of 1000s but in larger businesses this could represent millions of dollars of bottom-line directly. So we really go through that first portion and teach people how to look at those seven levers and how they impact their business specifically.
Guillaume: Alright, so of course, when possible either to raise the price or to restructure the whole offer. Because sometimes you may say, well, just raise the minimum order and actually what I need is a certain amount of volume per customer to even accept the customer. And sometimes a lower hourly rate, if it’s a service company, might be fine, as long as they commit that 5000 or $10,000 of services per month or more.
Shawn: Yeah, exactly. And not all levers are made equally. So that’s where when we do this exercise, we’ll actually take, for example, your company’s numbers Guillaume, we’re going to input into my software called Cash Flow story. And that’s going to pop out all the information about your business. It’s actually going to tell us the relationship between volume and price for your specific business. And that’s going to be different for every business, but for your business price might be 1.8 times more important than volume, or volume might be three times more important than price. Until you know that information, you don’t know what you’re doing from a sales perspective. You don’t know if you should be going after more volume, or you should be increasing your prices. So that’s where we’ll help businesses out there figure that part out.
Guillaume: Yeah. Well, it depends on how much you can scale up the volume processing, or how large of a market can you possibly get or how much more market penetration you can make, or how many more leads per month you can get and so on, to see if you can actually process that much more volume. If the expertise is extremely rare you have to hunt down every single engineer that you recruit to offer the service. Well, maybe actually, it’s more of a price game that positions the marketing differently presenting differently to showcase a higher value so that we can charge more. And that’s a different kind of approach. Okay, so those seven levers are very interesting, anything else specifically about this? Otherwise, we’ll move the discussion to financing.
Shawn: The last thing I’ll say about the seven levers is what we call “the power of one” because you could increase or decrease by 1%. But realistically, you probably want to do different types of adjustments. I have always explained to companies to have an open mind with what you may want to do for your business, a 4% price increase, no volume increase, a 2% reduction of cost of goods sold, no effect on the overhead, you’re going to play with the numbers and other ratios. It’s not always going to be perfect for every single business, it’s not going to be the same formula. You want to be open-minded and flexible to be able to adapt and adjust based on what it is you’re trying to accomplish.
Guillaume: Right. A very good point. And of course, work in progress inventory, you always want to have as little as possible of that stuff as a strict minimum so that the business does not suffer from lack of inventory, and so on. If we talk about financing, because I said it in the first episode of this series and I’ll say it again this time, but you did scale up an eight-figure lighting company there. So I’m pretty sure you have some experience in financing.
Shawn: We’ve had to go through it a lot of times. Financing for us was an absolute Achilles heel for a long time. So it was a very big challenge when we started our business, and we were coming from bankruptcy. So we didn’t have a very good reputation in the marketplace. We didn’t have a lot of money. But when we actually started our business, we couldn’t get any bank funding, we did not have any traditional financing. We had to go to something called factoring. Is there any of your audience and listeners who know what factoring is?
Guillaume: I know what it is.
Shawn: So factoring, is obviously you’re borrowing on your receivables and your inventory, but the company that’s giving you the factoring basically owns that. And what they do as you know, as you sell a little bit more of your inventory they give you a little more availability. The problem is that we’re talking about an eight to 10% interest rate compared to the traditional bank which is anywhere between two and four percent. So it was a disastrous interest rate. We had no choice to go in this direction because we just did not have the financial capabilities to show the bank that we had leverage.
So we had to start out that way. It took a little bit of time, but over time, as we built our credibility in the marketplace, as we made our payments, even with this factoring company, we eventually got ourselves into our bank. TD bank supported us, I don’t mind mentioning them because they’ve been a great partner for us. They really helped us take that next step into more traditional financing, if you want to call it that. We never looked for outside sources on our own Guillaume. We wanted to keep it for private business, we wanted to do financing internally, we felt it was easier to do it that way and grow organically and work with the bank.
The number one lesson that we learned through financing is, and this is easy to say but not easy to do, you should be asking for as much money as possible when things are going well. This is something that entrepreneurs and businesses don’t do. What happens is you have some available line of credit, you have some financing options, but then you hit a wall. What happens is you start freaking out, and you had an amazing opportunity. Whatever happens, you need to bring in more financing but now you’re against the clock and you’re against the wall or you’re stuck. And now you’re going to the bank, and now you’re begging them to help you. “Hey, can you please help me? I really have this opportunity, but I need more money”. That’s not a good time, you’re not putting yourself in a favorable position.
I would tell your listeners that what’s more important to do is make sure that when things are positive and cash flow healthy, that’s when you should be working hardest to increase your lines of credit, increase your financing opportunities. Go to the BDC, go to investment, you know IQ, whoever your local government is, whoever’s in your local area helping with financing. There are always organizations. Get that availability and having your back pocket, have it there available to you. So that one day when you do need the money, you’ll already have it available. You’re not chasing at that point, which is a very dangerous game.
Guillaume: I totally agree, especially on the line of credit. You should get as big a line of credit as you can possibly get. That’s pretty much it. And then, of course, use it with discipline. But that definitely is the best, because you have all that amount preauthorized. You only use what you need to use and then refund it as soon as something’s positive. And if you are a fast-growing company, the banker might even allow you to go over their traditional ratio of which percentage they want to give versus the business volume in terms of the line of the credit limit.
So some interesting things. And did you also work with any of the government agencies, like you mentioned, like investors market back-to-back investment, or other ways of fundraising and so on?
Shawn: We were always keeping a very close eye and in touch with them, we made sure we had excellent relationships. We never got into a situation where we actually needed to work with them directly. Now we’re looking at financing our building and doing a big expansion, and of course, we’re going to start looking to those partners to see what makes sense of what’s available to us. But I would say as a CEO of a business, you should always be speaking to all of the agencies in your neck of the woods, not only the popular ones. A lot of times there’s ones we don’t know that much about, you know, like the under the underground or a little bit under the radar that could actually offer quite a bit of financing.
Grants are always available out there. I would really encourage people to go out there and find out what’s available to them. It’s always shocking to me to find out how much can be done. Just to give you a perspective, when we go into companies to work with them on scaling up, a lot of clients say, it’s a bit expensive, what can we do? The government will actually subsidize 50% of our mandates. So you know mandates costing $40,000 annually the government will actually provide $20,000 of funding for that strategic planning because they know how much it is going to help the business. So those types of funds are always available to business owners. That’s something that you should be constantly looking at. The most profitable and savvy entrepreneurs I know, always have one hand in the government. They always have their pulse on the grants available and they’re always constantly going for more money, making sure that they’re funding their business in a different way. And a lot of that is free money, it really is.
Guillaume: Yeah, you have to, otherwise you’re not competing in a fair way in the sense that it’s not favoring you. This is because your competitors are asking for the free money from the government that they want to give. Which is of course part of various plans and initiatives that they have to see improve the digital transformation in the country. They have programs for that, they open up to 50% of that amount for each company. The same thing for training like you were saying here executive training and training within the companies they have a budget for that year. Here in Canada typically if you ask for money around the month of April, that’s the start of the new year, they don’t follow the calendar. The new year begins in the month of April which is when all the money comes in from the tax return. So that’s the best time to ask the government right after April, they have plenty of money to spend. Towards the end of the year, maybe it won’t work, ask again after April, and it’s a lot of work. It also takes some time to start all that paperwork, filing for grants, subsidies, and all that stuff. It’s very good to have someone you can delegate that to as an entrepreneur. But as an entrepreneur, you must know which programs are available.
Guillaume: We’ve got to take time to learn about that. Did you use any other kind of convention subsidies, salaries?
Shawn: We used that. Going along our history we were given a subsidy when we wanted to change our ERP system. They were offering a subsidy that helped us analyze and understand exactly what we wanted to do on that end. HR, planning resources, there were some available on that end as well, quite a bit marketing, bringing in marketing helped digital marketing, especially a lot of funding available there. It’s almost unlimited when you start researching and finding out what’s out there. I mean, the government’s really there to help small businesses thrive. Their goal is to help you have that success, and have that ability to hire more people. If you can show them that you’re trying to do a business, which most skin-yellow companies are, you should have a good opportunity to pick up some funds there.
Guillaume: Do you have any kind of anecdotes or learned stories from raising money like this or working with those agencies?
Shawn: What I would say is be a master relationship builder. So what I’ve come to realize, because a lot of my clients, you know, they work on this, and what happens is, we often see the government as a bit of a barrier, seemingly limiting us in some way. You have to change your mindset, to me, the mentality should be, the absolute goal of the government is to be successful, those small businesses have to make money, they have to hire people, they have to be profitable, they’re actually there to help make that happen. But as an entrepreneur, your absolute number one goal is to build those key relationships. Because as much as it’s the government and its structure, I’ve noticed it’s actually very subjective. It’s very much based on a relationship, it’s based on that government person, knowing that you have a need, that they can help, you have to have that relationship with them constantly. And again, not going in when you’re in a desperate situation or in a bad spot, build it when you don’t need it so that the day that you do need it, you can turn to that person and say I need your help.
This is what we’re looking to do. We think we can have some great opportunities here, whether it’s strategic planning, whether it’s marketing, whether it’s sales, whether it’s HR, and then they will come in and offer you a helping hand. So build those relationships. I’ve always noticed that within our own business, the LED lighting business, we invited a person from the government to our company for coffee. We gave him a whole tour of our facilities, we introduced them to every single one of our employees, and we showed them our three-year, one-year, 90-day plans. We just gave the person a full overview of what we’re trying to do as a business and they were blown away. They said no one does this, no one takes the time to meet us and to really show us their business. And they gave us about $50,000 in subsidies at that point. It makes a difference, so you have to make the effort.
Guillaume: Yeah. It’s a two-hour sales pitch, with a visit for $50,000 free money from the government. Sure that does well.
Shawn: Yeah, absolutely. I totally agree.
Guillaume: And while we’re talking about relationships with either bankers or those other agencies from various governments in whichever country, you need to learn what’s available in your country. Here in Canada, this is how it works with your commercial banker; even though you have a commercial director to sign for your case, they’d never have the true final approval from a check and control point of view. They always go and present your file for credit approval. So even though they have titles of directors here in Canada from whichever bank you work with, it is not that director that approves your credit request. But your relationship with that director is extremely important because they go pitch your request to the credit bureau of the bank. So they can make a big difference for you and it depends on how good or how well the pitch or how much effort they want to put in this and how much trust they have in you and your company for that bank to finance or not finance. So that’s a little personal experience from the relationship-building point of view.
Shawn: Yeah, totally agree with you.
Guillaume: What else comes to mind when it comes to cash?
Shawn: Yeah, there’s a whole other element that we need to speak about that is absolutely crucial for any business. It’s what we call your cash conversion cycle. So the cash conversion cycle basically is the cycle between the day that money goes out of your bank account in order to pay your suppliers, to pay your employees, and any other money that goes out of your bank account, and the day that money comes into your bank account. So there’s a cycle there. There’s always a gap between that cycle unless you have an incredible business model, which I’ll explain in a second, most companies don’t have that. It exists, but not everybody has it.
So, I’m gonna give you an example of one of the worst cash conversion cycles that have ever existed on the face of this planet. Again, that was my personal business LED lighting company, we had the worst cash conversion cycle that ever existed. Let me explain. We had to pay deposits to our suppliers overseas. So our supplier overseas is saying listen before we even start making your product we want 50%. Let’s say we have a $100,000 production order, we give them 50%, so that is $50,000. Nothing has happened at this point, except for $50,000 going out of my bank account. Then they say okay, we’ll start ordering some parts, we’ll start making your order for you. The whole order takes 90 days to be made. So now 90 days later, my $50,000 hasn’t done anything for me. Then 90 days later they call us to say we are now ready to ship your order, we want you to pay the balance of 50% because that was how the rules worked. But now you’ve paid 100% which is $100,000 and there’s still nothing even near arriving at our factory. 40 days later, give or take, we get the stock, we unload it and repack in order to re-ship it to our clients, and then we were giving them anywhere between 45 and 60 days’ terms. So when you look at that cycle, that’s about eight months.
Shawn: So there’s literally nothing worse. There’s no company, I think that could have a worse cash conversion than that. So when we started looking into that, we were working on scaling up, we said you know what, this is a disaster. There’s a cheaper model.
Guillaume: Because if you scale up too fast with this you can actually go bankrupt. Because each time you order your cash flow goes in the negative at first by 50k, then by 100k. So how many orders of minus 100k can your company take before its pink crop and cannot sustain this?
Shawn: Exactly right Guillaume, you have to be funding it all. You’re funding your own business so much that you need a lot of line of credit visibility, you need a lot of cash on hand, and that’s not ideal at all. So we looked at that and wondered, what are we going to do about this? We had to improve it and so we made some massive changes. The first thing we did is that we were dealing with about 25 different suppliers. We can scale that down to four suppliers. That consolidation really allowed us to have buying power. Home Depots are one of our biggest clients, both in Canada and the US, we had the volume but we were spreading that volume out too much. By going to four main suppliers from 25, it gave us a lot of buying power. Then with that buying power, we started buying more we started saying listen, we’re buying more from you and you’ve been dealing with us for a few years. You don’t need a deposit from us, there’s no way you need that. You should build trust with us without a deposit. Eventually, they agreed.
Then we started negotiating again and said listen, why do you need us to pay you before it leaves overseas? Can’t we just pay you when that arrives? You haven’t even released the paperwork yet, there’s no risk for you. They said okay, I guess you’re right. With time, through the negotiations, we eliminated about four months from our cycle. Then we really kept going at him and said listen, now that we have a great relationship, why don’t you just give us 30-day terms once the stuff arrives. And so now we’ve gotten to that point where we’re actually getting about 30-day terms when the things arrive, which is very unheard of from things coming from overseas.
And then with our own clients, we told them we can’t accept 60-day payments anymore. It has to be anywhere between 15 and 30 days. We became very strict on payment terms, and we had quick payment discounts available to the client. So we eliminated about six months out of that cycle. Now our cycle is down to about a month and a half to two months. And that has just been revolutionary for our cash flow. It has been unbelievable
Guillaume: Yeah, it’s an amazing difference. Eight months to like two months or so. And of course, if you’re in a service business, you can sometimes just get prepaid, but now we’re talking about product business. As soon as you have product business with manufacturing overseas, there’s always those kinds of delays and congratulations on your negotiation. It’s true. You’re the first one that actually tells me that negotiated 30 days after arrival overseas, arriving here, onshore. Maybe somebody else has, but they didn’t tell me.
Shawn: Yeah, exactly. I want to come back to the example of a company like Dell computer. The thing is, we look at the successful companies and we often forget, we don’t know the stories about what they went through. Dell computer had a 64 Day Cash Conversion Cycle. They had the same model as I did. They would take an order from the client, they would start ordering their computer parts. They would start making the computer, they would ship it to the client and then they would give them terms. That’s about it, it was about 64 days what they calculated. I’m sure that day that Michael Dell decided to do this, is all of his clients got very upset and they were freaking out. But he said, you know what? You have to pay for your computer in advance from now on. He said to people, instead of getting 64-day terms, you’re just going to pay, once you pay me for the computer, then I’ll make it and I’ll deliver it to you.
He went from plus 64 days to minus 21 days, he did an 85 day improvement in his cash conversion cycle. And he was getting all that cash in advance, taking three weeks to build the computer and shipping it to the client. That was really incredible how he flipped the table and that’s why Dell is so successful today. They say that the single most specific reason they’re as successful as they are, is because of that cash conversion cycle improvement that they did, by flipping it and making sure clients were paying in advance, it really transforms your entire business, if you can figure out ways to do that.
Guillaume: Because then you’re truly scalable. Each new order comes in reinforces your position, and you have more money available to you to hire, to order parts, to grow, do whatever you want to do. Of course, if it takes them 21 days to ship the computer to the customer, once the order is placed, that gives him his minus 21 days of cash conversion cycle because it was prepaid. And then the merchandise is only done 21 days after from all the expenses of labor and parts coming together progressively typically. If he can even negotiate with his supplier to have a net 30 Day term or a net 60 Day term, to pay them even longer. So, it’s always a question that you pay as slow as possible, and that you get paid as fast as possible and everybody’s playing that game. But then it can be also a strategic advantage with some key suppliers to offer them extremely reliable terms, or full time freelancers in other countries or something like that. They say we are going to pay you fixed every month or every two weeks or whatever. And they trust you that the money is coming in like clockwork, and then you can negotiate other kinds of discounts, because you’re reliable, you’re securing their cash flow and stuff like that.
Shawn: Absolutely. The thing we’re talking about, this cash conversion cycle, it really does get into the strategic thinking of your business, because I’ll give you another great example. When you’re thinking about how to improve cash in your business, it might go through sales, it might go through product, there’s going to be a lot of different divisions, a lot of different departments that this can go through. And let’s take one of the most incredible classic examples of all time, Costco. Depending on the age of your listener, some of them might not remember, there was a time where Costco did not have a membership. There was a time where you could just walk in and start buying things at Costco. It didn’t last very long but it was just before the membership model launched for them. They launched a membership model quickly after that. You think about this resect in two years ago, 2017, 2018, Costco from their membership alone, how much do you think it brought in?
Guillaume: I know, I can cheat. I know half the profit comes just from the yearly membership card and they can even finance the next Costco store, just from the sales of membership card of the previous Costco.
Shawn: Yeah, it’s actually $2.9 billion. So just to be clear, $2.9 billion dollars of bottom-line profit. This is not revenue, this is bottom-line profit comes from their membership cards and it’s gone up now. Because that’s from two and a half years ago. That was a model that now you think about, it’s so obvious.
Guillaume: Yeah, but it’s mind blowing at the same time, because most stores struggle to even get customers to walk in the store, and they will not want to put the barrier for entry. So, it is amazing.
Shawn: Yeah, it really is. As a business, you have to look at your business, you have to think what can we do differently? What can we charge for, that could make a lot of sense and that could work? There’s so many examples out there. I have a client as a construction company, they started telling their clients overnight, they said, “You know what? We’re really being stuck with our cash flow here. From now on, we expect the client to pay for the materials in advance. Not for the whole project of what we’re going to actually deliver but the materials, which usually account for about 40% of the order”. So now they’re asking that deposit from their client in an industry which doesn’t do that. And they said, “If you don’t want to do it, go to our competitor.” But they’re so good at what they do, they deliver an amazing service, they have an amazing product, and clients now are paying it. So now whenever they get an order, they’re getting 40% and it’s for the material good. They no longer have to take material good costs out of their own cash flow. They’re funding it through their clients and their clients are happy to do it because they’re getting such a great service. And things are going very fast in an industry where right now things are backed up and there’s a lot of lack of materials. It’s actually stabilizing the price for them because of the fact that they have all this funding, they’re able to get better pricing in the market from their suppliers. It’s like this domino effect, we’re all afraid to do it. We all think our customers are going to freak out. But at the end of the day when you really get good at what you do, you can start charging those type of things. You got to look at your own business and say, “Okay, what can I change in my model to make sure cash comes in quicker and that I could protect my bottom line?”
Guillaume: Exactly. Very often, it’s just to go past the mental blockage and to actually try it with customers. To dare to try it without being reckless, and sometimes might not agree, there could be a little bit of intuition here. But it is important to dare to have that conversation also, it’s not that risky for the customer to pay the materials. They are buying the materials, and then they will own it. You can have in your contracts, a property clause that says the material belongs to you. You’re just funneling the cash for us, we’re going to buy it, we’re going to deliver it at your construction projects place. Why would I pay your material? You can push back on this, it’s your material. There’s all kinds of ways of doing this. It’s the same as getting prepay for anything else, or you have some kind of large deposit or to renegotiate a better payment schedule makes a huge difference for a company. For example, in our industry, we often have people doing stuff like milestones of 25%, for example. Then if you ask them, what’s your net profit margin after taxes? Well, it might or might not be 25%. So you’re telling me that you’re letting the client keep hostage 100% of your profits until you have delivered milestone four of four? It doesn’t make any sense to me. So purposely keep that last milestone smaller, like 10%, that you let the guy have as hostage payment if you wish, but you don’t let that client have 100% of your profit hostage.
Shawn: I totally agree with you, I think what’s most important is that you don’t limit yourself to just the financial part of your business, there’s four main cycles that all businesses have. You need to look in all four cycles, you have your sales cycle, so how you going in landing your sale, you have cycles of production, and inventory work in progress. That’s a different cycle, you have delivery cycles, how you can actually deliver. That doesn’t mean just transport, that means actually delivering your service or your product. And then you have the billing and payment cycle. It’s very important to look at all four cycles, and really see in those four cycles where you can find more improved cash acceleration strategies.
Guillaume: For sure, as soon as you have a sale, you would want to collect something, it’s going to allow you to celebrate the sale that there’s an influx of money, pays faster commission to the sales staff, which is more motivating, maybe there’s another earnout for sale staff later, based on building but at least they have a cash right now. Just makes sense.
Shawn: Yep, exactly.
Guillaume: So, I had exactly that in mind, the cash conversion cycle as a discussion or you have variation on this as well like your inventory turnover rate. How many times per year does your inventory turnover? Is it two times, is it every year and a half or three times a year? Which is in many degrees very similar to your cash conversion cycle.
Shawn: Yeah, it is very similar. And that’s where you got to find the right metrics for your business as well. It always comes down to profitability, and bottom line. But if you’re going to calculate, for example, in a more traditional business like ours, we calculate how many orders we can ship out on time and complete. The thing is, that information is only as good as the counterbalance. The counter balance is exactly what you just said, inventory turns. If we tell our operations team, “Listen, we need you to calculate how quickly you ship all the orders and how complete they are”, but we give them unlimited amount of dollars for inventory, then we’re going to be in a terrible cash flow position. So, you have to match both together. We want the highest percentage of on time and complete orders compared to the inventory turns. We’d like to have months of inventory on stock so we’ll usually say, “Okay, you could have anywhere between 2.4 and 2.9 months of inventory”. We know when it starts getting into over 3, 3.2, we’re in trouble. When we start getting over 4 it’s like a red flag. We’re always measuring that, compared to how quickly we’re shipping and how well we’re shipping. That’s another thing to keep in mind when you’re looking at cash, looking at your conversions. There’s often two metrics to look at, you’re often not looking at one metric. There should be a counter balancing metric on the other end as well.
Guillaume: Are you familiar with the throughput accounting?
Shawn: Yeah, we’ve seen a bit of throughput accounting.
Guillaume: That’s another thing that’s interesting to look at. There’s a book called The Goal by Mr. Goldratt. Really great book, and it’s fun. It’s in the novel form. So, it’s actually entertaining instead of being dry business theory. And it would change you from doing your accounting from the cost world to the throughput world, which is how much do you produce, how much leaves the factory and what is your actual cost? Not the direct cost, the way it’s typically calculated, but the cost to actually get the goods out. All kinds of delays that he shows you, the calculation, you say, Okay, the cost for example of having an always available employee of $30 per hour. You say, the guy could actually sometime not be there and stuff like that through micro optimize locally. But you’re missing the big picture and if this guy is not available all the time and that main machine, which is a bottleneck stops producing, that is actually it’s a $30,000 per hour loss, if that machine is not running at all the time. You’re $30 per hour of micro-optimization is misplaced. This guy should always be there, even if he’s reading a book or something. There are all kinds of additional calculation that he gets you into that are really amazing. So, the throughput accounting, the book, The Goal, really worked.
Shawn: I want to warn your audience when you’re going to start listening to this book or reading it, whether it’s audio or whether it’s in reading format, there’s a lot of cheesy parts, get ready. The guy has a funny relationship with his wife. It really is like a novel, and it’s really funny. But he also speaks a lot in that book about The Theory of Constraints and I think that’s something that’s another favorite. Theory of constraints and really understanding. Looking at examples, he obviously doesn’t give this example, but it goes hand in hand. The iPod, I remember when I was working at Radio Shack, or The Source, that’s what it got changed to. I was working there during my university days. We used to sell mp3 players. No one really understood how they worked. A real techie person would come in, they spent $100, $150, they can only get 32 songs on this mp3 player. We didn’t really know where they were getting the music and how they were getting it onto the mp3 player, and we were selling these things. Next thing you know, Apple and Steve Jobs launches the iPod. What was the constraint that he solved there, was a number of songs on the small device. He got Toshiba, and he convinced them to give him exclusivity on the chip, he was able to get 1000 songs onto an iPod compared to 32 or 64. It’s an exponential 20 time increase of number of songs on there. And by solving that constraint, now someone said, “You know what? I could have all of my favorite songs on me when I’m walking, when I’m running, or when I’m out and about on public transport.” Those type of ideas, once again, they were all originated from this book, The Goal, which is unbelievable when you think about it.
Guillaume: Yeah. I remember that Steve Jobs’ Keynote, 1000 songs in your pocket. You’re right, there was this constraint that we were solving and for a reasonable price, it’s still pricey, but it was reasonable price that you can afford, if you want it. It’s a pretty good tour of the cash question. There’s always more that you can discuss if you’re talking VC venture capital, or angel investors, seed rounds and all that stuff. I don’t have a lot of personal experience on those topics. We’re self-funded for the growth, I think you are to some degree self-funded, plus bank loans and so on for the growth. Is there anything else that comes to mind from the topic of cash?
Shawn: Those two models are very different. And like you mentioned it’s a whole other conversation, I work with a lot of clients that are VC funded, or that are full public market, it’s a different model. I think it’s a different concept, a different mentality, you have to actually be a different type of entrepreneur, because you have to potentially be willing to not only give up big chunks of your business, but also be willing to lose, in certain cases, money every single month. If you’re really going that route, especially publicly… We see so many companies in the public market that are actually losing money on a month-to-month basis, because they’re trying to grow so fast, and they’re churning and burning. I’ve always struggled with the model. For me, as a coach it’s going in there and trying to make people find profitable growth, it’s a struggle, but I have a couple of clients that actually go through that model. I would say the most important thing to keep in mind is define early, what you want to be as a business.
A lot of times those businesses that succeeded because they know that they want to be VC backed or they want to be on the public markets, and they want to get there as quickly as possible. It brings a whole other set of challenges, but it’s a different model. But I find challenging for people, sometimes they’re not sure what they want their model to be. And they get stuck in between two models. Do I want to be private? Do I want to be VC backed? Do I want to be full IPO? And when you get mixed up and confused about that, you end up making a lot of bad decisions along the way.
Guillaume: Whichever game you play, play that game only, go all in.
Shawn: Yeah, stick to your game, that’s why we always stuck to the private game. We didn’t want anything to do with the fast growth or growth just for the sake of growth thing. We wanted profitable growth. So yes, we grew at a pretty decent pace, but it was profitable, because we were coming from family bankruptcy and we were coming from a public company. So, we what came with that, the constraints, the limitations, the pressure, and we didn’t want that in our lives anymore. So, we made a decision to go in a whole other direction. Not to say, you never know where you’ll end up back again one day, and that’s going to be something to pursue, but pick your poison, and stick to it. You got to pick it, and you just try to run with it because if you start pivoting in the middle, or trying to switch, that’s where I see people get lost along the way.
Guillaume: Yeah, if you’re privately funded, you do want to generate a profit, then that is more important to the speed of the growth, you’ll have to chase profit at all costs, just some level of profitability. And if you’re VC backed, then like you said, it’s a completely different ballgame. And you can afford to lose money every month, because those are typically not the quarterly objective, it’s more like a how much market share can I grab this month? And we know we’ll be profitable within two years, three years. Or per cohort, you can say, “Okay, the 2021 cohort was profitable”. And you prove that the next year and then the next year. They just keep losing money in a global way but their per cohort analysis is actually profitable on past client acquisition, and they’re just growing at an incredibly fast rate because they’re raising money by the hundreds of millions. If you’re not playing that game, just go for profit.
Shawn: Yeah, exactly, just be clear.
Guillaume: Yeah, you’ll run out of money so be careful, if you’re growing very fast, and you’re losing money. Of course, it costs money to grow and when you’re in between sizes of company, you’re stable at one size, very profitable, you need to move to the next one. Happened to us, it was way less profitable, we’re making more money than when we were smaller, but then you take the time to restructure that or sometime it means you’re still too much in between, you need to grow a little bit more so that your model makes sense. You don’t stay stuck in between with a lot of added overhead, a new process and new system that are expensive per month, you need to reach the next threshold of stability and profitability with that new model in place.
Shawn: Totally agree with you. Be clear on your model and you want to stick to it. That’s the last thing I’ll mention for the cash flow, I think it’s really important. When you look at the way we design and scaling up, the model of cash was actually built in collaboration with Vern by two very smart individuals, Greg Crabtree who wrote Simple Numbers. Anybody wants to check out Greg, he’s a fantastic resource, that book Simple Numbers is absolutely worth reading for any one of your audience members. And the second person was Alan Meltzer. Alan Meltzer is the one who built Cash Flow Story. Those two individuals are cash gurus, they really helped build the model.
The one thing I will say about net profit, which I think would be a great last point to leave off on is, when you’re thinking about your net profit at the end of the year, this is how we really see the model. At 5% net profit, you’re near bankruptcy. That’s just not enough, it’s going to be dangerous, you’re too close to the red line, you’re not in a good position, you need to find yourself to be more profitable. 10% is your acceptable level, if you’re making 10% net profit per year, we consider that to be an acceptable level. 15% profit is what we should be aiming for, however, as a rule of thumb and it’s not the same for every company. But as a rule of thumb, when you get to 15% net profit, typically, your people are overextended. So, you probably don’t have quite enough staff, you’re probably pushing people a little too much, you’re probably burning out some of the individuals in your company, you’re probably stressed out as well, you’re happy because you’re making all this money.
But what you want to do is when you get to 15% net profit, you probably have to hire some more people, bring in more resources and structure. It will cost you money, but it’ll bring you back down, try not to go back under 10%, try to get back to that 10% area, and then rebuild from there to get back and you’re always fluctuating between 15% and 10%. That’s a general rule of thumb that we really teach and that Verne has taught us with Greg and with Alan Meltzer. I think it’s a good model to follow. There’s going to be companies out there that are wildly profitable. There’s going to be companies out there working in construction sheets, it’s a rough one, their profit and their net profit is very low but that’s kind of the industry you pick. That’s where you really want to be, always hovering between 10% and 15% net profit.
Guillaume: What type of company you are will change those numbers unless you just set that as a way to grow. For example, Amazon that never wants to post too much profit, they want to just keep reinvesting and that’s the infinite growth game. But it’s different for publicly backed companies. Some companies when they’re more specialized, they will try to aim for the 20% 25% net profit range and some that are more general, would be more like around the 15%. But also, if you’re a product-based business, it’s a different kind of numbers and then those 10% to 15% numbers are probably actually reality. Depending if you’re a service or product and if you’re a specialized industry are not. If you were to have some kind of specialized the cardiologist clinic, I’m pretty sure they can get more than 10%, 15% because they have such a high level of expertise, but you need to be ultra-specialized and then those higher percentage typically. If you look at Canada’s fastest growing Inc 500, they have a line there. More than 10% net profit or less. And they just tell you if it’s more or less. That’s sort of a threshold that investors look at. You want, if you can be above the 10% profit threshold.
Shawn: Absolutely, you’re right, there’s going to be exceptions. There are companies out there, that are going to make way more money than even the Apples of this world, they’re just wildly profitable. There are companies out there, and you should aim for that. You’re listening to this here because you want to learn it. You can do it, there’s ways to do it. In our coaching business, the model is very lucrative, works out really well, very little overhead. Again, it’s rare. When you start having a large team, or just having a lot of products and services to launch, the typical business, that’s the rule of thumb. So just be aware of it. If you’re hovering anywhere under 10% it is a little bit of a red flag. If you’re anywhere around 5% or less, you’re in major danger zone, because one big thing could happen and your business could just shut your doors. So be very careful with that.
Guillaume: I totally agree with that. Also, those are good numbers for quick scaling up, which is the whole goal here of scaling up system. If the profit is just too high, at one point it just means you’re not reinvesting enough in the growth of the company, the infrastructure and training the staff and so on. If you want to build world class systems and staff, you need to reinvest a lot of that money. Well, I think that was a very good discussion on this topic. Thank you, Shawn, for being here today.
Shawn: Thank you, Guillaume, it has been a real pleasure, it’s a great topic.
Guillaume: If people want to find you, where can they do that?
Shawn: The best places to go is the website at elevationleaders.com. You’ll have all the information there for what we do and you can also go to LinkedIn. I’m very active @shawnjohal at LinkedIn, you’ll definitely find me there talking and posting every day.
Guillaume: Alright, thanks again for being here today, Shawn.
Shawn: Sounds good, thank you.
Guillaume: Thank you