Sunday, April 24, 2016

Why is the Gross Margin one of the most important things to watch? Client Question- David C Barnett

Hi there again, It’s David Barnett from  This week I was asked what I thought was an important number to keep an eye on when managing a business.  Watch the video here:  My answer was: the gross profit (or gross margin.)  Why?

Simply put, the business can’t function over the long term if we don’t charge the right price for our product or service.  The gross profit is what is left over after we pay for the direct expenses of serving the customer.  In construction this would be the tradesmen and the materials.  In a restaurant it would be the cost of the food and paper supplies. 

The problem we run into when we have an income statement which simply has a sales figure and then all the expenses deducted is that we can’t verify that our pricing is correct over a short period such as a week or a month.  In the video, I demonstrate with an actual income statement like this.  If it’s impossible for a business manager to constantly check and ensure the target gross profit is being met, then problems can creep in over time.

For example, you may implement a pricing strategy that is used to quote projects.  If the cost of your supplies and labour are slowly creeping up and you don’t change your pricing formula, the gross profit will start to shrink.  This may mean shortages of cash to pay bills.  You may mis-interpret this as a receivables problem when in reality it’s a margin issue.  Most worrisome is the fact that businesspeople who don’t actively manage from their financials often are unaware of issues until they are pointed out in annual financial statements.  This could mean trying to respond to a problem up to 18 months after the issue has begun.

If an income statement is set up properly, a good manager can check weekly or monthly and make sure the gross profit is on track.  Other issues can also become apparent.  The video was inspired by a conversation with a UK businessman who thought his business had suddenly become more profitable.  He thought it was great.  What he didn’t realize was that one of his suppliers had neglected to send him some invoices.  When they fixed their oversight, he had put himself into a hole by spending money that really wasn’t his.

If his income statement had been properly structured and he was reviewing it weekly, he would have noticed the sudden drop in costs.  This would have led to inquiries and the billing issue would have been discovered before he spent the money on something else.

Now what about all those overhead expenses that have to be paid for out of the gross profit?  Well if the gross profit is under control and day-to-day operations are profitable, we can then examine the overheads on a regular basis to see if any start to get out of line. 

Another big reason to have a properly structured income statement is so that a potential buyer can easily compare the business to peers.   This is called benchmarking and it’s an important part of the evaluation process.  If the business activity is transparent and easy to understand, the business can be better managed and can be sold more expediently.  It’s also likely to fetch a better price than an equivalent business with more muddled books.

If you’re interested in learning more about buying and selling businesses, managing businesses, or local investing, visit my blog at  While you’re there, sign up for my insiders list and be amongst the first to receive my new videos each week by e-mail.  If you think you may need my help with a project, you can reach me for short consultations at or contact me at (506) 381-8416 or to discuss a project.  

Sunday, April 17, 2016

Where do we find operating capital and what should it cost? Viewer Question- David C Barnett

Watch the video:

This week I got a small business finance management question from Phil, who asks: What about working capital? Where can I get it and what is the cost?

Before we get into that though, what do we mean by working capital? Working capital is the money that you have to invest in a business to get your products or services from the point where you start working on your raw materials or start creating your services, up until to the point where your customers pay you. As the business grows, the operating capital may have to grow, and if we don’t grow too quickly and we are profitable we should be able to grow the operating capital as we grow our profits and grow our business. This is financing working capital through Retained Earnings, sometimes this is called ‘bootstrapping.’

If we are starting up a new business or if we are growing too rapidly, we may not be able to afford bootstrapping and may need outside sources of operating capital.

For example, let’s say I buy raw goods and I have to pay for the goods when I get them. Then it takes me 30 days to transform them into my finished products. Say its 10,000$ worth of stuff for this example. It takes me a month in order to turn them into my finished products, and then I sell it immediately to my customer, and he takes 30 days to pay me.   So I’ve got $10,000 tied up for two months before I get paid and my cost recovery as well as my profit is received.

So if I sell $10,000 worth of products every month, how much operating capital do I need? Well it’s not 10,000 because when my goods that I bought is at the beginning of the month are completed. I then sell them; I start waiting to get paid but on that day I have to buy another 10,000 worth of product to start working on for the next month’s deliveries. So I actually need $20,000 worth of working capital for a company that has sales of $10,000 a month if we have to spend the money up front and collect sixty days later from customers.

So where do we get operating capital?  First we’re going to start by looking at the balance sheet.

Assets are on one side of the balance sheet and your assets always have to equal your liabilities and your equity which are on the other side.

On the assets side you have cash in the bank, receivables, inventory and work in progress.  On the other side are liabilities; you’ve got payables, this is money you owe your suppliers, lines of credits and credit cards.

I’m not discussing loans here because typically bank loans are for capital goods, things that you use over a long period of time.  Usually when we’re talking about operating capital a bank will create a line of credit and they’ll secure that with a lien against certain assets typically inventory and receivables. The idea being that the line of credit goes up and down over time whereas a loan is usually secured against a fixed asset that we know has a longer life and maybe we’re going to pay for over several years.

In the equity section, we have retained profits (or earnings) which is simply the profits of the company that we haven’t removed. We leave that money in the company to help the company grow, remember when I mentioned bootstrapping?

The owner’s contributions also appear in the equity section.  It’s the money the owner’s put into the business to help it function.

When you start off a business of course you don’t have any retained profits but you probably have some money of your own that you put in to help to get going.

Next you go to the bank and say ‘look I need some inventory’ and let’s say the bank agrees that the inventory is a certain nature that they don’t mind making a loan. What we call fungible inventory that’s non-perishable so two-by-fours for example are fungible. It doesn’t matter who made them or how old they are, they still two-by-four pieces of wood.

Non-perishable means that it doesn’t have an expiry date that’s upcoming. So for example, it’s much more difficult to get the banker to give you an inventory financing for lettuce, because if we don’t sell it in time it goes rotten and then the value of your inventory disappears. It’s difficult to get inventory loans against for example: ladies dresses because at the end of the season they may no longer be fashionable or suitable for the time of the year and all of that sudden your inventory again has no value, so if your inventory meets certain criteria you can get a line of credit.

Now the question was what were the different costs for different sources of operating capital, so payables is money that we owe suppliers and payables typically we get 30 days before we have to pay our suppliers in certain industries some industries go longer 45, 60 even 90 days or longer and you can negotiate sometimes those terms. So really you can finance operating capital from payables for 0%, because it’s literally your suppliers investing money in your business and depending on your relationship with them. They have the power to be very generous with or maybe if you’re someone who doesn’t pay your bills on time and they get frustrated with you, then of course they demand cash on deliveries, COD which means you don’t have access to this type of working capital at all.

Credit cards if used wisely can be 0%, why do I say they’re 0%? simple. You use a credit card to buy some goods, when the statement arrives you have a certain number of days to pay it in full on time and if you are set up in proper order and you pay that credit card in full every month on time, you never pay any interest charges. If you are not well organized and disciplined, then you know 9 to 29% is the cost.  If you want to learn more how to properly use credit cards in a business, then you should read my book Credit Card Advantage is available from Amazon and from the website.

So what is the cost of equity? Basically you have to know what sort of return you demand of your business and if your business is struggling to grow and you’re just starting off you’re probably not demanding much of a return in your business.  In bigger companies they often look at the return on equity as one of their key performance indicators. In big publicly-traded companies, shareholders often demand a certain dividend based on their investments in the shares. So they can actually calculate the cost of this source of capital as well.

However, a lot of the time our challenge with operating capital is not actually a challenge with operating capital, it is a challenge with cash-management.  In the example I started off with, you buy $10,000 worth of inventory, your cash goes down by $10,000, your inventory goes up by $10,000, you then spent thirty days converting that into your finished product, so then the inventory goes down by $10,000 and your work in progress goes up by $10,000, these are all still assets. We’re just changing where on the balance sheet or what form these assets take. We then shipped the products to our customer we send them a bill, it changes from work in progress back to inventory briefly, finished goods and then changes into a receivable.

So again the capital is just changing its form on the asset side, so a lot of the times in a small business you might have a whole bunch of receivables. On paper you might have enough operating capital but it’s not in the right form, so there are other ways that we can convert the form of capital.

For example, if you have a lot of receivables and you need cash, you can use a process called factoring. What factoring is you convert a receivable by selling the receivable, so your customer no longer owes you the money, they now owe it to the factoring company and the factoring company pays you an advance on that receivable so $1,000 receivable if you sell it to the factor they might give you $800 today. So now we’re moved money from the receivable line into the cash line and when the customer ultimately pays the factor, they may withhold $30 or 3% fee for example, then send the other $170 to you.

This is the same goal that companies have when they accept credit cards as payment.  They’re also paying a 2-4% fee in exchange for immediately having cash and not a receivable.

So if you’re relying on it, month in and month out every month, you could look at it from an annualized point of view and say that you know it costs over 30% but with factoring a lot of companies that do factoring in some parts of the year or they factor certain customers but not other except just to give themselves the amount of liquidity or cash in hand, that they need to keep things functioning.

Changing Inventory into cash would look like a liquidation sale.

I hope that answers your question. All the assets except cash are uses of operating capital so we’re use our capital literally to finance receivables, the inventory and the work in progress.  The liabilities and equity are actually our sources of operating capital. Where we get money to help our business go.

If there are any other questions about this kind of stuff, please don’t hesitate to send me an email Don’t forget to visit my blog site. to sign up for my email list.  Email subscribers always get my latest videos first.  Thanks. 

Friday, April 15, 2016

Live Workshops New Dates announced.

I've got several dates coming up for Live and Live Online Workshops including Boston, MA.

If you want the advantage of this information along with the opportunity to meet me and other participants, sign up now.  I've been doing these workshops for years and always offer a money back guarantee.  (which nobody has ever asked for)  Join me today.

Business Buyer Advantage (9hr)
April 30- Moncton, NB
May 28- Saint John, NB
June 11- Boston, MA
June 25- Halifax, NS

How To Buy an Existing Business (3hr)
May 31- Charlottetown, PEI

How to Get Out of My Business
June 14- Online
June 24- Halifax, NS

Reserve your seats now as most events have early booking discounts.

Saturday, April 9, 2016

How To Sell My Own Business- #1 in Entrepreneurship on Amazon - David C Barnett

Thanks to my readers for such a successful launch day.  

How To Sell My Own Business got all the way to #1 in Entrepreneurship last week. 

If you missed it, get your copy on here:

or get the .pdf here:

Sunday, April 3, 2016

Awful story of a couple trying to buy a business who wasted thousands of dollars. Don't make this mistake - David C Barnett

Don't be like this couple.  If you're going to buy a business (which is smarter than starting one) then you need to know what you're doing to avoid costly mistakes.  Watch:


Oh hey guys, it’s Dave Barnett from I wanted to take just a few moments here today to tell you an absolutely terrifying story about a couple who were trying to buy a business and it coincided perfectly with the fact that this video will be coming out on April 1st. Which is the day my new business buyer website is launching.
I was referred a couple who were trying to buy a business by someone in the audience actually. So this couple had found a business that was for sale and they wanted help analyzing the business to see if it was a good deal or as if it was priced realistically. They asked among others where could they find such answers and one of you out there referred them to me. Thank you.
I looked at the business with them, showed them why the business is worth about a quarter of the asking price. That’s right. The seller was asking four times more than the business was worth. And they quickly decided that this wasn’t for them and weren’t even going to try to negotiate a price to it because the seller was unreasonable.
I thought that was the end of the story but I had recently been speaking to them and have discovered that before they met with me, they had actually paid a fee to the seller in order to get the financial statements. So this is often referred to as ‘’Pay to Peek’’ and basically the way that it works is a person who has a business to sells is approached, the buyer says, ‘I want to buy your business’.  The seller says, 'You want my information, it is confidential. I want you to put non-refundable money upfront to show me that you are serious before I show you my financial statements.'
So this is kind of like a real estate agent saying ‘Hey you might like to buy this house, but if you want to look inside you have to pay me a hundred dollars’’ and it is absolutely insane. No one should ever do this. But this couple did not know that. In fact they went directly to their lawyer and they asked their lawyer if this was a real, legitimate and normal thing to do. Their lawyer said that it was! Their lawyer also said that they needed a proper NDA and they needed a proper contract that would support that this money was actually a deposit toward an eventual purchase.  The lawyer did the paper work and then charged them a fee as well.
When I heard this story I quickly searched the Internet and I discovered that their lawyer is actually a very well known lawyer in the fields of immigration and real estate. Not in the field of business or business brokerage or helping people buy businesses.
Here’s the thing, I saw a really great quote the other day. It had been about real estate investing but it applies just as equally to buying a business and I believe the quote was something like ‘ In real estate investing you’re going to pay for your education one way or another. You either pay for someone to teach you how to do it or you pay through costly mistakes.’ In this case, this couple literally paid thousands of dollars to learn that you should never give money or a non-refundable deposit before you’re allowed to look at the financials of the business.
Now, if instead of spending that money they had done my course Business Buyer Advantage they would have learned about 500 things that you need to know to buy a business. One of which is how to hire the proper professionals to help you. So they would have learned that their lawyer was not a lawyer to help them in these circumstances. That’s number one.
Number two, they would have learned not to give someone a non-refundable deposit before you get the chance to look at the business financials. Looking at a business is basically looking at financials, because that’s what a business is. It is an economic engine with sales and expenses and hopefully profit at the end. Without seeing that, you’re not able to examine the business. You can’t just go and look at the four walls and say that this business is something you want to buy.
April first is a big day because my new Business Buyer Advantage is going online, the website goes live that walks people through the three steps of my buyer program. It is also the day that my 21 Stupid Things That People do When Trying to Buy a Business, special report is live and available for sale. You can get that from Amazon or from my website As well, I’ve got 3 things that have been released today April first for people trying to sell a business have gone live and I will talk to you about that more in next week’s video. If you want to take a peek and look ahead you can always check out the website
Thanks and we’ll see you next time. Don’t forget to subscribe, like, follow and share so you can help bring my information to others.
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