However, there is an old saying: “Revenue is vanity, profit is sanity, and cash flow is king.” You do not pay bills or distributions with profit.

By giving the cash flow statement just a little more consideration, and tweaking 7 key financial levers outlined at the end of the chapter, a company can grow considerably faster using its own internally generated cash than by raising or borrowing external capital.

As a company scales up, the market demands better pricing (e.g., your largest customers now ask for discounts). When this is combined with the complexities and increasing costs that come with being a larger company, we often see gross margins shrink by 3% to 4% — from, say, 55.4% to 51.8%. At the $10 million or $100 million level, such a dip

Crabtree calculates gross margin to be revenue minus all NONLABOR direct costs. This definition of gross margin gives you the true economic top line of the business.

An excellent example of this distortion was a client that had two 50/50 owners. When Crabtree first looked at their books, they were boasting about 25% profitability. However, once he reclassified distributions to account for an equivalent market wage for the owners, their true profit was 3%! What happened next is the mind shift Crabtree likes to

This led to the Simple Numbers process, discussed in his book by the same name. His approach focuses on four keys to running a wealth-building business: 1. Clear the distortions. 2. Set appropriate profit targets. 3. Use labor efficiency to drive profitability. 4. Understand the 4 Forces of Cash Flow.

For more on this topic, we encourage all CFOs to read Thomas A. Stewart’s classic book Intellectual Capital: The New Wealth of Organizations. Pay particular attention to the extensive appendix, where he suggests specific accounting rules that better align with an information-based economy than with a manufacturing-type economy, which generated many

So why do we continue to hold on to these losers? “For strategic reasons” is the excuse! Yet what is strategic about losing lots of money over a long period of time?

The net result: Crabtree’s client grew to $25 million in the next five years and hit 10% profit, after paying the owner a competitive salary. Yes, there were significant taxes to pay, but that’s because the company was now generating real after-tax wealth that helped both the business and its owner become debt-free and flush with cash.