Your accountant handles the books. But they probably don't tell you what the next customer is worth to you. That's operating leverage. It matters more than you think. What is operating leverage? Simply put, it's the relationship between your variable and fixed costs. The higher the proportion of fixed costs you have, the more operating leverage you have. Let me start with an ideal scenario. I'm building a course that takes 40 hours of work to produce. Once it's built, there's no additional time investment. Hence, no variable costs. - Total fixed cost: $1,000 ($25/hour) - Total variable cost per member: $0 - Selling price: $100 (for this example) How many members to break even? Fixed costs / (Selling price - Variable Costs) = 1,000 / (100 - 0) = 10 members After member #10, every additional member generates $100 of pure profit. That's operating leverage at its best. This can be seen in the graph below. The orange section shows my cumulative profit after the breakeven point. Notice that it is identical to the section for cumulative sales. This example is for illustrative purposes only. But your business is different. You run a service business. You don’t build it once and sell it repeatedly. Every customer requires labor. Let's say you're a plumbing service doing $400K in revenue: - Average job: $200 revenue - Labor cost per job: $120 - Materials: $15 - Contribution margin per job: $65 That's 32.5% of revenue. Not bad. There’s one problem: is your labor truly variable? Your plumber is paid a salary. If you add 5 jobs, labor doesn't scale smoothly. You likely hit overtime or need part-time help. The margin per job drops to $50 or $45. Your operating leverage tightens. Your accountant can tell you that you made $60K profit last year. But they won't tell you whether job #200 next month adds $65 or $40 to your bottom line. That gap? That's your actual operating leverage. Why should YOU care? Once you understand your operating leverage, you can answer the real question: "How many customers do I need to break even, and what does each one actually earn me?"

One simple question: how much profit does a customer generate for you? If you can't answer that, you are guessing and your cashflow will likely suffer as a result. I am working on my Foundations course that will help you determine the profitability of a customer, AKA your unit economics. This will be free to all current and future members.

What is Working Capital? We define working capital as the difference between our current assets and our current liabilities. To keep things simple, think of current assets as cash, inventory, or short-term investments and current liabilities as accounts payable (due to vendors), line of credit, or credit card balances. WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES Why is Working Capital important? Cash is the lifeblood of a business. Without cash, the business cannot survive. This is where the majority of businesses fail. If you cannot make payroll, you will lose your employees and the business dies. If you cannot pay your supplier, you have no inventory to sell and your business dies. If you cannot pay your credit line, the bank will seize collateral and your business dies. We now understand how important working capital is to all businesses. How do we manage Working Capital? If your goal is to increase cash, which should be everyone’s goal, then you must increase the time before paying vendors, decrease the time inventory stays in your stock, or decrease the time it takes to collect from customers. Each one of these comes with a trade-off. Paying your suppliers slower can worsen or ruin relationships. Instead, I believe the best approach is to take the full 30, 45, 60, or 90 days that are offered with the supplier, but not a day less. I would suggest focusing on the current asset portion of the working capital formula. Our goal is to get customers to pay upfront and to decrease the inventory on hand to a level that offers a reasonable buffer for varying demand levels. We do not want to run out of inventory as this could lead to the loss of a recurring customer. “Rule No. 1 : Never lose money. Rule No. 2 : Never forget Rule No. 1.” - Warren Buffett Stay Under Par, Samuel Reid

If you want to improve your financial decisions, try using the Payback Period. The first of many concepts we will cover is the Payback Period. It is a simple metric that can be calculated reliably. The Payback Period can be used to compare projects that have similar cashflow profiles. One thing to note is that the Payback Period loses accuracy with uneven cash flows, which is common in practice. By knowing the Payback Period, you can gain insights into how long it will take to recover your initial cash outlay. Please leave any questions in the comment section. As is customary, I leave you with a quote from Mr. Buffet. “You can't produce a baby in one month by getting nine women pregnant.” - Warren Buffet Under Par, Samuel Reid