From: alexhormozi
Becoming financially ready and prepared for an audit is crucial for increasing a business’s value and attracting investors [00:01:12]. The ultimate goal is to transform a business that simply “makes money” into an incredibly valuable asset that can change one’s life and family’s life financially [00:01:20].
Understanding Business Value
The value of a business from an investor’s perspective is determined by three key variables:
- Increasing the number of customers [00:02:02].
- Increasing Lifetime Gross Profit per customer, which is the amount of profit generated from customers over their stay with the business [00:02:09].
- Decreasing risk – How likely is it that the business’s success will continue in the future [00:02:30]?
These three elements combined equal a term called Enterprise Value [00:02:40]. By increasing these variables, businesses can unlock higher levels of Enterprise Value [00:02:47].
Automated Metric Tracking
Automated metric tracking is essential for making sound business decisions and presenting a valuable asset to potential investors [00:41:19].
“Every business needs to have metrics because if you don’t have data, you can’t make good decisions and you’d be amazed how much smarter you seem if you have data to support what you do.” [00:41:19]
Challenges without Metrics
Without proper data collection and reporting, businesses often resort to guessing for decisions [00:42:57]. This lack of data makes it impossible to understand fundamental aspects like:
- Lifetime gross profit [00:43:36].
- Customer acquisition sources and costs per lead [00:43:39].
- Revenue percentage contributed by each customer [00:43:41].
Implementation Steps
- Choose a Platform: Transition from manual methods (like Google Sheets) to integrated CRM systems such as Salesforce or HubSpot [00:43:02]. This investment is crucial for scaling from a small to a medium-sized business [00:43:15].
- Identify Key Performance Indicators (KPIs): Determine what specific data points are critical to track [00:47:14].
- Assign Ownership: Designate a specific person responsible for implementing and managing the data platform [00:47:22].
- Develop a Game Plan: Utilize the “theory of constraints” by identifying the smallest metric (the bottleneck) whose improvement will yield the most significant overall throughput [00:47:29].
An example of improving metrics can be seen with a portfolio company:
- Show Rate: Increased from 50% to 70% (a 40% improvement on the original number) [00:46:08].
- Close Rate: Improved from 27% to 30.8% (a 14% improvement) [00:46:32].
These improvements are often a result of systematic adherence to best practices, implementing many small, incremental changes rather than relying on “silver bullets” [00:46:41].
High Cash Flow, Profitable, and Growing with a Good Story
Investors seek businesses that are already in motion and demonstrating sustained growth [00:48:45].
- High Cash Flow: The business should generate cash in excess of what’s needed for reinvestment to remain competitive and grow [00:48:58].
- Profitability: While a business can be profitable on paper (e.g., waiting 90 days for payment), high cash flow means the money is available [00:49:06].
- Growth: The business gets bigger each month or year [00:49:22].
- Good Story: A compelling narrative helps investors understand the business’s alignment with market trends (e.g., AI integration or resistance) and future growth potential [00:53:22].
For most self-funded small and medium-sized businesses, cash flow and profitability are crucial, as unlike venture-backed companies, they don’t have a large reserve to sustain years without profit [00:50:07]. Founders are encouraged to take a fixed amount of cash out of the business monthly to de-risk themselves, balancing growth with personal financial stability [00:51:08]. This highlights personal financial habits and strategies and balancing life priorities and financial goals.
Optimizing Profitability
A key strategy to boost profitability and cash flow, especially in brick-and-mortar businesses, is to analyze the entire product suite for:
- Absolute Gross Profit: The total profit generated by a product or service [00:54:30].
- Gross Margin: The profit as a percentage of revenue [00:54:32].
- Sales Volume: The frequency with which each product is sold [00:54:43].
By identifying high-profit, high-margin products that are not sold most often, businesses can reorganize their sales process to emphasize these items and potentially de-emphasize less profitable ones [00:54:56].
Audit-Ready Financials
Audit-ready financials demonstrate to a buyer that the reported profit figures are verifiable by a third party [00:55:57]. Without this, profit figures can be perceived as arbitrary [00:55:53].
Levels of Financial Sophistication
- General Financials: In the beginning, basic financial management is often outsourced to a bookkeeper or accountant [00:56:33].
- Upgrading to GAAP: Transitioning from cash-based accounting (money in, money out) to Generally Accepted Accounting Principles (GAAP) [00:56:53]. GAAP smooths out financials, recognizing revenue and costs over time, making it easier to analyze year-over-year performance [00:57:20].
- Audit-Ready Financials: Having books prepared in a way that a third-party auditor can easily verify the financial data and produce a “quality of earnings” report [00:57:34].
Many founders struggle with knowing their true profit or cash flow because they lack a robust finance function [00:58:31]. This highlights the importance of financial discipline and long-term planning and taking responsibility for one’s personal financial situation.
EBITDA Thresholds for Investors
Institutional investors typically seek companies with at least $5 million in EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), which is essentially profit [00:59:34]. Businesses reaching this scale usually have a professional management team capable of operating without the direct involvement of the owner [00:59:51].
For perspective, public companies have much higher price-to-earnings ratios (multiples on earnings) due to their perceived reliability and growth potential:
- Netflix: 44x earnings [00:32:13]
- Microsoft: 29x earnings [00:32:22]
- Amazon: 310x earnings (partially due to reinvestment in growth, slim margins by design, and vast expansion opportunities) [00:32:27]
Small businesses (under $10 million/year) are typically valued at 1 to 4 times earnings [00:33:01]. However, exceeding $10 million/year in revenue and $2 million/year in profit can increase this multiple [00:33:07].
For companies with the right tools, systems, and plans, revenue can increase by 1.8x and profit by 3.01x on average within 12 months [01:01:13]. Over 24 months, average revenue increases by 2.8x and profit by 4.7x [01:02:11]. This demonstrates the significant value unlocked by focusing on financial readiness and optimization.