Financial Needs Hierarchy of a Company
From 'Can I cover payroll and pay myself?' to 'consistently generate a reliable income stream over time.' Explore the 5 stages of the financial needs
Disclaimer: This blog post is based on a YouTube live session hosted by Mason Poe on the channel of Edgar Allan, featuring speaker Ryan Watson. The purpose of this blog is to summarize the main insights and advice given during that session. All credit for the original content goes to Mason Poe, Edgar Allan's channel, and Ryan Watson.
Please note that the views and opinions expressed in this blog post are on Menta and do not necessarily reflect those of Mason Poe, Edgar Allan, or Ryan Watson. We have made efforts to accurately represent the information and ideas discussed in the YouTube live session, but any errors or omissions are unintentional.
We encourage readers to watch the original YouTube live session to gain a comprehensive understanding of the topics discussed. The link to the original video can be found here.
The Hierarchy of Financial Needs is a framework used by Ryan Watson and his team, based on Maslow's hierarchy of needs. It illustrates the prioritization of financial needs for companies, particularly service providers.
The image below summarizes the needs:
1. Solvency: This addresses the question, "Can I meet payroll and pay my employees and myself?" on a weekly or monthly basis (depending on the company). The fundamental need is to ensure that you, as the founder, and your employees receive their paychecks reliably.
2. Gross Margin or Project Profit: Gross margin refers to the percentage of revenue remaining after deducting direct costs associated with producing services. It is advisable for the gross margin to be equal to or exceed 50%. For instance, if you receive $100,000 for a project, the production cost should be less than $50,000. You can improve this by having a more efficient team, with good SOPs and clear scope of the projects.
3. Cash Reserves: Cash reserves represent funds that a business sets aside in highly liquid and easily accessible forms, like cash or cash equivalents. These reserves serve to meet short-term financial obligations and unforeseen expenses. It is recommended to have reserves covering at least three months of operations.
4. Net Margin: Net margin, also known as net profit margin or net income margin, measures a company's overall profitability after accounting for all expenses, including operating expenses, interest, taxes, and other non-operating items. It indicates the percentage of revenue remaining as net profit or income. The net margin is calculated using the formula:
Net Margin = (Net Income / Revenue) * 100
A net margin greater than 0% signifies profitability, with the ideal range typically around 20%, although it commonly falls around 11%.
5. Predictable Revenue Generation: This refers to a business's ability to consistently generate a predictable stream of income over a specific period. It involves implementing strategies, processes, and systems that enable the business to forecast and anticipate revenue with reasonable accuracy.
The key idea is to analyze and position your company within this hierarchy, focusing efforts on improving each step before advancing to the next.