The Key To Reaching Industry High Margins: The Reverse Income Method

Happy Sunday Operators!

I’ve been thinking more about tactical systems I use day to day to “keep things on the rails”. I’ve forgotten how many tools I have and use - until I get called into someone else’s business for help. Being exposed to their businesses helps give me beginner eyes again. Today is about one of those tools that came up in an all-day session!

If you have a nagging problem, growth impediment, or some other issue you’d like me to address - feel free to reply to this email and I can do a video response for you in the coming weeks.

I hope you enjoy today’s issue!

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The Key To Reaching Industry High Margins: The Reverse Income Method

Business success doesn't solely hinge on having the right playbook; it's all about execution and being willing to make necessary trade-offs.

The first step in scaling your small business effectively is creating both time and financial margin that you can reinvest into your business. Today, let's deep-dive into an advanced yet approachable method to establish a robust financial margin through what I call a "Reverse Income Statement Method"

What Margin Can Do For You

Before jumping into the method, let's understand why financial margin is critical. Not only does a financial cushion offer a safety net in volatile times, but it also allows you to:

• Invest in business improvements

• Hire the right talent

• Jumpstart your own flywheel of growth

Moreover, it forces you to create a unique business model, giving you a competitive edge. But beware, the journey is challenging; the trade-offs can be daunting.

However, if you're up to the challenge, the rewards can be game-changing.

Steps to Create a Reverse Income Statement

Step 1: Understand the Cost Levers

You should be intimately aware of the variable and fixed costs your business incurs. Are they direct costs related to production or overhead costs that maintain your business? Understand which are set by the market and which you can control. This foundational knowledge is crucial for what comes next.

Tactical Tip: Create a simple spreadsheet that lists all your costs. Categorize them as variable or fixed and direct or overhead. The clearer the picture, the better the strategy.

Step 2: Categorize Your Income Statement

Construct a generalized, common-sized Income Statement with 5-8 general categories. An example might be:

1. Revenue

2. Direct Variable Costs

3. Direct Fixed Costs

4. Overhead Variable Costs

5. Overhead Fixed Costs

6. Net Profit

Think of these as buckets that other general ledger accounts and expense categories are going to go into.

Step 3: Set an Aggressive Net Profit Goal

Based on your industry understanding, set an ambitious net profit goal—let's say 20%. This goal should stretch your capabilities while staying within the realm of possibility.

Step 4: Allocate the Remaining Percentages

With a 20% net profit target, allocate the remaining 80% among the other cost categories. This forms the skeleton of your ideal Income Statement.

Step 5: Identify Key Cost Levers

Dive deeper into each category and list the key cost levers. Identify whether you control the cost or if it's set by market forces.

Tactical Tip: I also, make a note of whether these costs are recurring or one-time.

Step 6: Adjust and Balance

As you identify these cost levers, re-balance the percentages across categories.

Tactical Tip: A practical approach is to choose one category as a "plug number" that adjusts to keep the allocations balanced. This should be where you have the most control (no matter how painful)

Step 7: Get Granular

The objective here is to be as detailed as possible. Your ideal Income Statement should contain:

1. Broad categories

2. Sub-categories specific to your business

3. Exact nominal expenses, which can be converted back to percentages

From Ideal to Real: Implementation

Creating an ideal Income Statement is just the beginning; the real work starts now.

Monitoring and Adjustment

1. Monthly Review: Every month, compare your actual performance with your ideal Income Statement.

2. Decision Points: For each variance, decide whether to:

   1. Update the percentage allocation.

   2. Cut the cost.

Starving the System for Innovation

This approach will force you into making difficult decisions, a concept referred to as "starving the system." Once you make those cuts, you'll find innovative ways to operate efficiently. This will not only give your business a competitive edge but also make it more resilient and agile.

Wrapping Up

Executing the Reverse Income Statement method may be arduous, but the benefits are immense. If done correctly, it will act as the catalyst in transforming your business into a more agile, innovative, and profitable entity.

The only question left is: are you prepared to make the tough trade-offs for such phenomenal growth?

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