In this episode: This episode opens a 10-part series on building and protecting wealth: cash, insurance, investing, taxes and estate planning, each covered first for the business and then for you personally. Jon Peyton starts with business cash, using the three core financial statements to decide whether to reinvest a dollar or distribute it, and how much cash to keep in reserve.
Key insights
- Three statements tell you how healthy the business is: the cash flow statement, the balance sheet and the income statement.
- Judge a reinvestment by everything it changes. A new machine can cost more up front and still win once lost production is counted.
- Every marketing dollar should come back as more than a dollar, unless it’s a deliberate loss leader that brings in repeat customers.
- Keep roughly four to six months of operating expenses in reserve, depending on the business and where the economy is in its cycle.
- How your company is taxed affects what it costs to hold cash in the business, so plan reserves with your CPA.
Episode timeline
- 0:00 A 10-part series on building and protecting wealth
- 2:03 The three statements that show business health
- 2:51 Reinvest or distribute?
- 3:24 The shoe machine: repair or replace?
- 7:31 Counting lost production
- 9:41 Measuring return on ad spend
- 11:25 When a loss leader makes sense
- 13:19 The balance sheet and weathering a storm
- 15:41 How much cash to keep in reserve
- 18:16 An example reserve calculation
- 19:16 Holding cash in an S corp versus a C corp
- 20:36 What the income statement tells you
- 24:07 Marketing as a share of revenue
The episode in brief
A series on wealth. Over the next 10 episodes, Jon breaks wealth into five areas: cash, insurance, investing, taxes and estate. Each topic gets two episodes, one for the business and one for you personally. He starts with business cash.
Three statements tell the story. The income statement, balance sheet and cash flow statement, and ratios built from them, show whether you’re putting your money to work wisely. Say you have $100,000 of extra cash. You can distribute it to yourself, which is the next episode’s subject, or keep it in the business. If you keep it, where should it go?
Repair or replace? Jon walks through an example. An aging machine costs $10,000 a year in repairs, and its slower output loses about $12,000 a year in sales. Keeping it for 10 years looks cheaper on repairs alone. But a new $100,000 machine with lower upkeep recovers that lost production, so its net cost over the decade is far lower. Count opportunity cost, too: the same money might do more in labor or another part of the business.
Make marketing earn its keep. Every dollar spent on ads should return more than a dollar, though returns fall off as you saturate a market. The exception is a deliberate loss leader. If a campaign brings in customers who buy again and again through low-cost follow-up email, a first sale that loses money can pay off over time.
Keep a reserve. In a recession or a pandemic, banks may not lend to a business whose numbers are falling, so your own cash is your best protection. Jon suggests four months of operating expenses at minimum, rising toward six as the economy matures and a downturn looks more likely. A business spending $300,000 a year, for example, would hold about $100,000, growing toward $150,000. Whether the company is taxed as an S corp or a C corp affects how that retained cash is taxed, so set the target with your CPA.
The income statement shows profitability. It tells you whether your reinvestments paid off, how you compare with your industry, and where to aim next year. Track where every customer came from so you can tie marketing spend to revenue. Jon notes that growing companies often reinvest around 5% to 7% of revenue in marketing, and high-growth companies sometimes more. Grow faster than your systems can support, though, and the business can buckle under its own success.
Key action items
- Review all three statements monthly. Look at the income statement, balance sheet and cash flow statement together, not just the bank balance.
- Run a repair-or-replace analysis. For your most important piece of equipment or system, compare upkeep plus lost output against the cost of replacing it.
- Track lead sources. Ask every new customer how they found you, and connect each marketing dollar to revenue.
- Set a cash reserve target. Agree with your CPA on a target of four to six months of operating expenses, and on how it should be held for tax purposes.
Listen next: Episode 26: How Entrepreneurs Should Manage Their Personal Cash
Value Creation Consultancy™ has since merged into Founder’s Accounting™.
Tax rules, rates and limits mentioned reflect the law at the time of recording in 2022 and may have changed since.
This episode is educational and isn’t legal, tax or financial advice. Speak with your own attorney and advisers about your situation.