THE BLACK HOLE
Posted on March 20, 2020 by Frank Dane
In physics, a Black Hole is a celestial object that has a gravitational field so strong that nothing, not even light can escape it. A financial Black Hole can be thought of as something that continually consumes resources without continual replenishment, thereof, above the amounts being consumed. Greg Crabtree, in his powerful book, “Simple Numbers, Straight Talk, Big Profits,” (available on Amazon) refers to companies generating revenue in the range of $1 million to $5 million as being in the Black Hole.
In physics, once you are in a Black Hole, you cannot escape. For business, I prefer to think of companies in the $1 million to $5 million revenue range as being on the Event Horizon of a Black Hole. If you are on the Event Horizon and move any closer to the Black Hole (continued operations that are not generating enough resources, to replenish those being used plus required profits), the gravity/inertia will draw you into the Black Hole and like all matter and light your company will eventually disappear.
However, in the book, Mr. Crabtree shares knowledge, wisdom, and techniques on how to escape this fate.
Understanding a Business Black Hole
Based upon his experience Mr. Crabtree has concluded the following regarding the general health of a business operating in a Black Hole ($1 million to $5 million revenue range).
If a company’s Pretax Profit is 5% or less of sales revenue, the company is on life support. If a company’s Pretax Profit is 10% or higher, that indicates a “good business.” He refers to this 10% mark as the “new breakeven.” Finally, if a company is taking 15% or more of sales dollars to the Pretax Profit Line, he labels that as a “great business.” In his view, the “best businesses” tend to operate in the 10% to 15% range.
The most challenging place within the Black Hole revenue range is the $2 to $3.5 million sales bracket. He indicates that typically it is around this range where the company is outgrowing its infrastructure and needs additional staff, standard processes, and systems to scale up operations and emerge from the Black Hole. For more information on infrastructure creation, peak and outgrowth, see B2B CFO®’s book “The Danger Zone” (available for purchase here). A book for the entrepreneur who owns a growing business and needs guidance on avoiding or surviving the Danger Zone, which in many respects is analogous to avoiding the Black Hole.
Mr. Crabtree postulates that labor productivity is the key to surviving the Black Hole, and according to Mr. Crabtree, Gross Profit per labor dollar is the most important Key Performance Indicator in that regard. Generating a minimum target Gross Profit per labor dollar is necessary to ensure that the added labor dollar cost is generating enough Gross Profit to cover operating costs and still results in 10 to 15% of revenue making it to the Pretax Profit Line.
Using a Salary Cap Table
So how do we convert the above knowledge into actionable steps to escape the Black Hole?
Among the wealth of information in Simple Numbers, Mr. Crabtree demonstrates what he refers to as a Salary Cap Table. This technique helps set some broad general parameters and indicates a good starting point for a more detailed analysis. To demonstrate how this works, we need to use some numbers and delineate some assumptions. Assume you have reached the $3 million revenue level, and although you have manufacturing plant capacity to fulfill orders above $3 million annually, your employee utilization is maxed out. Although your desire for growth is frustrated, on the upside, you are taking 12% of your revenue to the Pretax Profit Line. Hence, according to Mr. Crabtree’s generalizations, you have a “good business.”
The Salary Cap Table is nothing more than a vertical formula where you solve for the dollar amount of labor required at a specified revenue level (growth targets) that will maintain the company’s Pretax Profit at an amount equal to or greater than 10% of its revenue. So, given the above assumptions and assuming your target revenue is $3.5 million, your Salary Cap Table would be constructed as presented below.
|SALARY CAP TABLE|
|Pretax Profit Scenarios||13%||14%||15%|
Step 1. Revenue: Specify Revenue Target.
Step 2. Pretax Profit: Multiply Revenue Target times applicable Pretax Profit %.
Step 3. Total Expenses: Subtract Pretax Profit from Revenue.
Step 4. Non-Salary Expenses: Starting with Historical Expenses Project Non-Salary Expenses.
Step 5. Salary/Wage Expense: Subtract Non-Salary Expense from Total Expenses.
Broad Conclusions and Sensitivity Analysis:
- All other things being equal, the company could incur $1,045,000 in Salary/Wage Expense and bring 13% of its revenue to the Pretax Profit Line.
- All other things being equal, the company could incur $1,010,000 in Salary/Wage Expense and bring 14% of its revenue to the Pretax Profit Line.
- All other things being equal, the company could incur $975,000 in Salary/Wage Expense and bring 15% of its revenue to the Pretax Profit Line.
Of course, all other things are seldom equal; however, this tool allows you to calculate some broad parameters within which to work as you strive to increase the amount of revenue that you bring to the Pretax Profit Line.
Financial Strategies for Business Success
The Salary Cap Table is just one of the relatively simple, yet powerful, techniques available to help you scale up your business. If you would like to know more about using financial metrics and techniques to help you make better business decisions and improve your bottom line, reach out to me and we can have a “Straight Talk” about “Simple Numbers” that could lead you to “Big Profits.”
My email address is: email@example.com and my phone number is: 503-810-1880.
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