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Your Origami Monthly Report - How We Calculate Your Targets

Your Origami Monthly Report is a simple and succinct summary of the most important numbers in your monthly financial statements. These posts help you understand and use the information in this report to manage and steer your business.

One thing we emphasized in designing the Origami Monthly Report is distilling all the financial statement information down to what matters most for managing your business. As a result, we put 3 Key Numbers front and center for you each month: Real Profit, Real Sales, and Salary Cap. We explain what these numbers are and why they are important in the Your Origami Monthly Report - The Key Numbers post.

Another thing we were after is a simple way to set meaningful targets for these numbers. Targets have a way of focusing attention and motivation, as well as giving you a measuring stick to evaluate the actual results.

Our experience with small business owners has shown us, however, that setting realistic financial targets (and sticking to them) is not easy. It's not easy to stare at spreadsheets, it's not easy to crunch the numbers, it's not easy to forecast the numbers. So, rather than requiring you to go through a long and uncertain planning process, we wanted to nudge you in the right direction by using a few simple rules to create targets that are both realistic and meaningful. Here's how we went about it.

Real Profit

Real Profit is the percentage of your Real Sales that you retain after covering expenses. This is the number that we keyed on. Because profit is what makes a business viable and profit is what gives a business a future. An unprofitable small business is eventually going to fail, and a business that isn't profitable enough is going to struggle to grow and thrive.

So, every small business owner has to solve the "How do I make a profit in my business?" question. Without taking shortcuts! In our Key Numbers post, we go over how profit calculation has to include all costs and expenses, including a fair market salary for yourself.

For setting a target, we decided to use a simple rule of thumb: 10% is the minimum Real Profit you should aim for. Why 10%? Because anything lower jeopardizes both your and your employees' livelihoods. And anything lower than 10% is going to make it hard to grow (or want to grow) your business.

If you're already at 10% or higher, we'll set your target at 1% above your current Real Profit. This is to encourage you to keep growing your profit margin, even if you're already doing well. If you want a different target, just let your Origami CPA know and they'll set it for you.

Real Sales

As we covered in the Key Numbers post, Real Sales is the amount of sales you retain after deducting direct expenses for subcontractors, materials, and merchandise. We use the term "Real Sales" to underscore that sales should be evaluated after accounting for your direct costs.

Once we have your Real Profit target, we can calculate your Real Sales target by taking your operating expenses (including your Salary Cap) as a given and then solving for the amount of Real Sales you need to achieve your Real Profit target. Let's go through an example.

Let's say we have a business that has $100,000 in Real Sales and $95,000 in operating expenses, resulting in $5,000 in Real Profit. This works out to less than the 10% Real Profit target, so we want to increase Real Sales to hit that mark. By how much though? Let's look at the starting numbers:

  • Real Sales: $100,000
  • Op. Expenses: $95,000
  • Real Profit: $5,000 (5%)

If we want to set a target of 10% Real Profit while holding the operating expenses at $95,000, we're aiming for results that look like this:

  • Real Sales: $105,555
  • Op. Expenses: $95,000
  • Real Profit: $10,555 (10%)

So, we need to increase Real Sales by $5,555 to hit our Real Profit target. That $5,555 increase becomes our Real Sales target. And that's the number you'll see in your Origami Monthly Report.

Salary Cap

As we covered in the Key Numbers post, your Salary Cap is the total amount you can afford to pay yourself and your staff at your current level of Real Sales while still hitting your Real Profit target.

In situations where you're not hitting your Real Profit target, you have two options:

  • Increase your Real Sales while holding your Salary Cap constant (as we've done in the example above)
  • Or, decrease your Salary Cap to a level that will produce your target Real Profit at your current level of Real Sales

Let's work through another example, similar to the one above, but this time we'll say that Operating Expenses include $70,000 in salaries. So the starting numbers from that first example look like this:

  • Real Sales: $100,000
  • Salary Cap: $70,000
  • Op. Expenses: $25,000
  • Real Profit: $5,000 (5%)

If we want to hold Real Sales and Operating Expenses constant and still hit our Real Profit target, we need to decrease our Salary Cap. Here's what our target results would look like:

  • Real Sales: $100,000
  • Salary Cap: $65,000
  • Op. Expenses: $25,000
  • Real Profit: $10,000 (10%)

So, we need to decrease our Salary Cap by $5,000 to hit our Real Profit target. That $5,000 decrease becomes our Salary Cap target.

In the examples above, we present two options for hitting your Real Profit target: increase Real Sales or decrease Salary Cap. But the amount of Real Sales increase and the amount of Salary Cap decrease are not the same. Why is that?

Great question. The intuition behind it is that, for a profitable business, $1 in additional cost is going to need more than $1 in additional sales to cover that extra $1 cost and produce the target profit. So, when trying to hit a Real Profit target, it's either keep your Real Sales constant and cut your costs (Salary Cap) by a $1 or keep your costs (Salary Cap) constant and increase your Real Sales by more than $1.

Can't I do both, that is, increase Real Sales and decrease Salary Cap at the same time?

You can, but the two approaches often require different strategies and tactics. Cutting costs and salary means focusing on efficiency and productivity, operating leaner, and doing more with less. Increasing sales means focusing on growth, investing in marketing and sales, and planning for the capacity to handle the increased demand. It's hard to track those different initiatives when they're in the air at the same time. If you decide to go that route, then target setting becomes more involved than the simple system we've outlined here. The benefit of a simple system, however, is that it's easy to understand and easy to execute.

Is it better to increase Real Sales or decrease Salary Cap?

In the examples above, two different paths lead to the same Real Profit %. The first path involves generating more revenue with the same staff, perhaps via a price increase. The second path involves generating the same revenue with less staff, perhaps via layoffs. Which path is better?

Generating more Real Sales is the better option. If you noticed in our examples above showing the two ways of hitting the Real Profit target of 10%, you end up with more $ in profit by increasing Real Sales than by decreasing Salary Cap. More money is better than less money. And, in our experience, the mindset of growth (while maintaining profitability) is generally better than the mindset of cost cutting and layoffs — though admittedly those options always have to be carefully weighed.

Moving forward, instead of inundating you with traditional financial statements that make your eyes glaze over, we will distill everything down to what matters most for managing your business. 3 Key Numbers, tied to meaningful targets, sent out to you monthly. We would very much like to hear what you think of it. We will be iterating on it for the foreseeable future and would love to incorporate your feedback.

And if you have any questions about our approach or specific questions about your business, please don't hesitate to reach out to your Origami CPA.