Inside a $4M Painting Business Doing ALMOST Everything Right... Except This

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In this video, I'm tearing down the real financial statements of a penny business doing$4 million a year.
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The owner has a full team.
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He has project managers, salespeople, a sales manager, admin help, and an integrator.
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Now he wants to grow to$10 million in the next 12 months.
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But a big team and high sales do not always create a valuable business.
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I'll show you what the numbers say about his cash, profit, taxes, and plan for growth.
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If you clicked on this video, you may want the answer to these three questions.
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Is this business reaching its 55% profit goal?
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Does it make enough profit in cash to grow from 4 million to 10 million?
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How can the owner lower his tax burden and build more wealth outside of business?
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We'll use the company's real numbers to answer these questions.
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By the end, you can compare this business to your own.
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If we haven't met, I'm Daniel Honan.
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I'm a CPA and former painting business owner.
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I've helped over 500 painting businesses from startup to 20 million in sales, know their numbers, and save big in tax.
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This is the fourth video in my painting business financial teardown series.
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I break down painting businesses into four financial stages.
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Startup, build, the swamp, and sellable asset.
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In each video, I open the books of a real painting business from one stage.
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For this teardown, we're looking at the sellable asset stage.
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That means the business makes more than$3 million a year.
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At this stage, the owner should not need to run each job or make every choice in the business.
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The company should have a team that can run the day-to-day work.
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It should make a strong profit and it should produce cash.
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And it should keep growing without depending on the owner.
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The goal is no longer just to build a bigger company, the goal is to build a valuable asset.
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Let's call this owner Rich.
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Rich runs a painting business in Florida.
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I removed his real name and any details that could show who he actually is.
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Rich's business did about$4 million a year in sales over the last 12 months.
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He wants to grow to 10 million in the next 12 months.
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Rich aims for a 55% gross profit margin.
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At 55% gross profit, the business should keep 55 cents from each sales dollar after paying the direct cost for each job.
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That money must pay for the full team and all the other overhead.
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It must also leave a strong profit.
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Rich already has a full team.
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He has project manager, he has salespeople, he has sales manager, he has admin help.
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He also has an integrator.
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The integrator helps run the company and keeps the team moving towards Rich's plan.
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This team should help the business grow without putting all the work back on rich.
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But growing from 4 million to 10 million will take more than a good team.
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The company will need strong profit, cash, and systems.
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Taxes have also become a larger burden for rich.
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He owns real estate outside of his painting business.
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Now he wants to grow that part of his wealth.
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At this stage, Rich's business plan, tax plan, and wealth plan must work together.
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These facts give us the right questions to ask.
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Is Rich reaching his 55% gross profit goal?
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Does the business make enough profit to support the full team?
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Does it have enough cash to grow from 4 million to 10 million?
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Can the company grow without depending on rich?
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And can rich use the wealth from this business to grow his real estate and reduce his tax burden?
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Let's open the financial statements and find out.
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Alright, so the first thing I like to do before getting into profitability, liquidity, and solvency is actually understand what is the constraint of this business.
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So let's dive into the financials to see if we can figure this out.
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So first thing I like to look at is the balance sheet and understand okay, does this business have enough cash to grow to the next level?
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So right now this business has$802,000 in cash, which is outstanding.
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So when we compare their cash in the bank with their overhead costs, let's see,$1.3 million in overhead costs over the last eight months.
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And so they have a$164,000 on average is what their overhead is.
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If we multiply that by two, their minimum cash balance should be$329,000.
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And they're at over$800,000.
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So they have more than enough cash on hand.
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Almost to the point where they actually probably have too much cash in the business, and they probably should take some of this out as distributions so that the owner can then diversify his wealth.
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Because the big thing at this stage is that once you get beyond$3 million in revenue, you're really building a sellable asset.
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And you have oftentimes most of your wealth is tied up in your business.
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So this is a great stage to actually start pulling some cash out of the business and diversifying your wealth.
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Because as Warren Buffett says, the way to grow wealth is to put all your eggs in one basket and watch that basket very closely.
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And this owner, Rich, has done this.
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He has grown an outstanding business and he has all his eggs in one basket.
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Most most of his wealth is in his business.
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Now, to keep his wealth, you want to start diversifying it.
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Because right now, his business is in one geographic region.
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It's doing one industry, right?
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There's a lot of risk there.
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So we want to take some money off the table and diversify it.
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So from a constraint perspective, he's not constrained by cash in any kind of way.
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So now we'll take a look at the other factors, supply and demand.
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Does he have enough of a team?
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Does he need more customers?
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So when we ask him some questions about his team, right now he's booked out for a few weeks.
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So about three to four weeks.
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So no issue there.
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Also, he has a sales team and he's able to get out to the estimates within three business days.
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So no constraint with the sales team.
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And then on top of that, he does have a strong admin team that's able to do speed to lead to new leads coming in and get back to them within three minutes.
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So he meets that rule of three.
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He's able to produce the work within three weeks.
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He's able to get out to estimates within three business days, and he's able to get to new leads within three minutes.
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So no supply constraint that I can see.
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That leaves a marketing constraint or a generating more customers constraint, basically a demand constraint.
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And so he wants to go from four million, which is what he's doing over the last 12 months.
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He wants to go from that to 10 million over the next 12 months.
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So this is really, he needs to generate more customers.
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So let's take a look at his financials to see what we can learn.
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So right off the bat, we see 3 million over the first eight months, which is a really strong revenue, especially when we compare it to last year at the same time.
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He was just under 2 million.
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So that's 52% growth, which at this level, that's huge.
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That's a huge amount of growth.
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Then we'll take a look at his gross profit.
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And his gross profit is just under 55% gross profit.
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He is targeting 55%, and he is just a hair under it.
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So he is obviously has a very tight chip, tight operations to be so close to actually hitting that 55% gross profit target.
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So that looks really great.
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Now we can tell that his gross profit rose about the same as his revenue compared to last year.
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So he's basically maintained that efficiency year over year.
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The next thing we look at after gross profit is customer acquisition costs.
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And as a reminder, customer acquisition cost is how much we're spending to close the deal.
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So that's your marketing spend plus what you're painting your salespeople.
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So if we take a look down below at the expenses, his marketing costs are about 8.75%.
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So 8.75.
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And then we have our salespeople here.
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So salespeople wages at 1.73, and we also have commissions for salespeople here at 6.97.
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So when we add those two together, 1.73 plus 6.97.
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So we're at about 17.45% for customer acquisition.
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All right.
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So if we take that and take our gross profit and divide our gross profit by 17.45, which is our customer acquisition cost, this gives us our gross profit to customer acquisition cost ratio, which is 3.1 to 1%.
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So this is a little low.
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It's not bad.
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We want to have at least a minimum of three to one.
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And he's hitting the minimum.
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But if we're trying to double, over double in the next 12 months, we really want to have a stronger GP to CAC ratio.
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Because as this painting business tries to reach colder and colder audiences, his customer acquisition costs will reliably go up.
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And so what we probably want to look at doing is start to work the gross profit upwards and actually start targeting maybe 60% gross profit or maybe even 65% gross profit, which some of you might be like, wow, that's way too high of a gross profit.
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But I push back on that.
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We work with a lot of painting businesses that actually do 60 to 65% gross profit.
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And there's one that publicly actually shares this with everyone.
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His name is Jason Phillips out of Dallas, Texas.
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He has a$15 million residential repaint business and he reliably hits 65% gross profit every single year.
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And the way he does that is that he has a really strong sales process and really strong offer.
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And that allows him to have a higher pricing and still maintain a 35% close rate.
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And so for this owner, for Rich, I'm recommending to him to actually start to work to improve his offer.
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He already has a really strong sales team and sales manager, but looking at his offer, his offer is basic for a painting business.
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They offer a warranty that's about five years, they're fully insured, they also background check the workers, all the standard things that you typically hear that a professional painting business does.
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What he doesn't have is any kind of risk reversal guarantee.
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So I recommend it to him to implement a risk reversal guarantee to allow him to increase prices while maintaining still a strong close rate of somewhere between 30 and 40% close rate.
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And so if we can do that and get his gross profit closer to 60%, that's going to open up some more room to spend on customer acquisition costs.
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And that will allow him to potentially double in the next 12 months.
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All right, let's take a look at the rest of the profit and loss here.
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Scanning through, auto expenses are below 3%, which is typically what we see two between two and three percent.
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Insurance is at 1.5%.
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Typically, we see that around 1%.
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So that's a little higher, but nothing too crazy.
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And his uh total overhead positions, let's take a look at that.
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He has a sales people, which we already talked about, and then his production manager is about 8.1%.
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We typically want to see uh production somewhere between four and seven percent.
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So it's not anything too crazy, but it is just a tad higher.
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The office team here, office managers under one percent, which looks pretty good.
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So typically, when we add the admin team, the office team, and the production management team, we want that to be no more than 7%.
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And this is right around 9%.
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So there might be some room to dial in the production management compensation plan.
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Scanning back through the other overhead costs, everything else is pretty low.
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And so overall, we have a net margin of 11.2%.
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So 11.2%, and then on top of that, he has his officer salary, which is 1.44.
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So total compensation to the owner or discretionary earnings cash flow to owner is 12.64.
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So based off of his roles in the company, I would want him closer to about 18%.
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So how did I get that?
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Basically, as a completely passive owner, if he was completely passive, which he is not, I'd want him to make at least 15%.
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And then on top of that, he's actually leading the company, right?
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So he has an integrator that helps him implement his plans, but he's still leading the company overall.
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So I want him to get another 3% on top.
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So really, I would like him targeting 18% discretionary earnings.
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And so we're a little bit off that, about six percentage points or so.
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So, where can we make this up?
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I think the main thing is getting gross profit a little bit higher, and we might be able to dial in the production manager compensation plan so that he could better hit that 18% discretionary earnings.
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But when we look at the dollar amounts here, he has$341,000 in net income in the first eight months, and there's still four months to go.
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And then on top of that, he has his officer salary right now is at 43,000, which is a little low, but he's gonna do a catch-up um owner contribution to make sure that his officer salary is reasonable per the IRS requirement.
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So, right now, net on dollar amount, he's just under 400,000 coming to him, and we still have four months left in the year.
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So the big concern from my perspective is he's gonna have a lot of taxes.
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So let's take a look at his tax situation.
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And what I like to do for the folks that have a lot of different assets going on is do something called a trifecta, which displays their personal situation with graphics so we can get a better idea of what's going on.
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So he has his main escort here.
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And the thing that I want to highlight is he does have some real estate as well.
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And he has right now long-term rentals.
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And the thing with long-term rentals is it's classified as passive income.
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And so passive income is an IRS designation that if you have passive income, or in this case, losses, you can't use passive losses to offset active income.
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In this case, it's painting business income.
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You can't offset the two.
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And the big benefit with real estate is that you can show paper losses because the home or property often has a lot of depreciation, which is basically paper losses, where you could have, you know, all these different fixtures in the home, maybe washing machine, water heater, refrigerator, all these things can be depreciated in a cost aggregation study.
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And then you can show a lot of paper losses, which will show that your rental is actually a loss for the year, even though it might actually cash flow and you're getting rents and making money.
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And so that's a big benefit from a financial perspective for real estate.
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But the problem is that for long-term rentals, you don't get to take those losses from those long-term rentals and offset it against your active painting business income, unless you meet a couple of loopholes.
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So, one, if you're a real estate professional, you're able to do this.
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However, he is not, so we can't take that one.
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The other option would be maybe his spouse is a real estate professional because he is married and he has a couple kids.
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Maybe if his spouse was a real real estate professional, they could also take this loophole and offset the losses against the painting business income to reduce taxable income.
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But his wife doesn't quite have the time to pursue a real estate license.
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So that is also out of the question.
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And then we also have a short-term rental loophole.
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So if we take those long-term rentals and convert them to a short-term rental, and where we're basically renting out the property for less than seven days at a time on average, and then we're actively participating in that property and meeting certain hour requirements listed out by the IRS, we can actually take those passive losses and convert them over to non-passive losses and use those losses to offset our painting business income, which can be a huge tax savings.
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And one of the things that a lot of rich people basically use to reduce their taxes.
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So that's one key strategy that we recommended to rich in this case.
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The other one is setting up a 401k, which he's already had.
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He already has a 401k.
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He set that up a couple of years ago, which is great, and he's able to max that out.
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And the other thing that he's done is he's had his wife participate in the business in the past to actually contribute towards retirement as well.
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And so all of those contributions are about$24,000 a year.
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He can put in tax-free into his retirement and save for retirement, diversify his wealth, right?
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Because we talked about diversification is important at this stage.
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And then also he's saving on taxes on those contributions.
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So that's great.
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Now, one of the other things that we're taking a look at is something called a defined benefit plan.
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So since he's maxing out his retirement plans, he's doing this real estate strategy, and he still has more capital that he wants to put towards retirement and diversify his wealth.
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We're looking at doing a cash balance plan, which is the defined benefit plan.
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So a 401k is a defined contribution plan where you basically take your own money and contribute towards your own retirement.
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A defined benefit plan is where the company basically contributes to your retirement on your behalf so that when you retire, you have a certain benefit or pension that pays you out when you're in retirement.
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And so there's a special one that we often like to recommend is a cash balance plan.
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And this takes a little bit special calculations.
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You have to get an actuary to actually do these calculations for you to see when are you going to retire?
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What is your last three years of compensation?
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How does that compare to the rest of your team?
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And there's a lot of calculations that go into this, but sometimes you can set it up so that you can put six figures away in a single year into retirement and also get a tax deduction on top of that.
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So they can be a huge win for saving for retirement, but also for cutting your tax bill down significantly.
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So we're taking a look at the cash balance plan for him as well.
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And then the third thing we're looking at is setting up a family business services company.
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So he has his main painting business that is taxed as an S-corp, but also we want to set up a family business services company that hires his two kids.
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So he has two kids that are working age, they're over seven years old and they're under 17.
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And so he wants to give them experience doing some marketing tasks in the company and actually pay them so that they can learn about the business.
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And also it's a tax deduction to his business.
00:16:06.629 --> 00:16:11.429
So the way that we set this up is set up a sole proprietorship that provides services back to the S-Corp.
00:16:11.590 --> 00:16:16.870
And then that S-Corp basically 1099 is that that sole proprietorship and pays them for services rendered.
00:16:16.950 --> 00:16:20.629
And the sole proprietorship pays the child's wages, both children.
00:16:20.789 --> 00:16:25.029
And as long as the pay is reasonable, it's documented, you know, this can work.
00:16:25.110 --> 00:16:29.110
It is a little bit higher risk strategy because this is related parties paying each other.
00:16:29.189 --> 00:16:33.350
However, as long as you're documenting, tracking hours, and it is legitimate work, this can work.
00:16:33.429 --> 00:16:38.230
And so we're paying the children up to their standard deductions, which is around$14,000 per year.
00:16:38.309 --> 00:16:43.029
And that is a deduction to the company and it goes to the children basically tax-free.
00:16:43.110 --> 00:16:45.990
They don't have to pay taxes because their standard deductions wipe it out.
00:16:46.070 --> 00:16:56.950
And then on top of that, they can contribute a portion of those earnings, those that earned income, into their own Roth IRA, so that their earnings on that money can grow tax-free.
00:16:57.110 --> 00:16:59.909
So they basically don't pay money on the taxes going to them.
00:16:59.990 --> 00:17:07.750
And then their earnings grow tax-free, which is great because that rarely happens in the tax world where you get tax-free money and then you also get to grow it tax-free.
00:17:07.830 --> 00:17:10.549
So that's a really awesome strategy to set our kids up for success.
00:17:10.710 --> 00:17:10.870
All right.
00:17:10.950 --> 00:17:17.350
So those are the three main strategies that we recommended for rich to implement to significantly cut down his taxes.
00:17:17.509 --> 00:17:24.630
All right, to sum it up, the big thing for scaling from 4 million to 10 million is that we got to consider that the customer acquisition costs are going to go up substantially.
00:17:24.710 --> 00:17:27.190
So we want to continue to improve gross profit.
00:17:27.510 --> 00:17:31.910
We have a solid gross profit at right about 55%, but let's see if we can get it to 60%.
00:17:32.310 --> 00:17:37.910
That will give us more room to spend on customer acquisition, which should help us scale to the$10 million in revenue.
00:17:38.070 --> 00:17:41.750
The other piece is considering taxes and diversifying wealth, right?
00:17:41.830 --> 00:17:45.910
We don't want to keep all of our wealth at this time just locked up in the painting business.
00:17:45.990 --> 00:17:47.670
So let's take some of those funds out.
00:17:47.830 --> 00:17:57.270
Let's put it into real estate, maybe put it into short-term rentals so that we can use those paper losses after we do a cost segregation study and offset our non-passive income from the painting business.
00:17:57.430 --> 00:18:07.830
And then on top of that, let's also continue to max out our 401k, but then also look at establishing a cash balance plan where we can put maybe even more money into retirement and cut our tax bill down significantly.
00:18:07.990 --> 00:18:22.310
And then finally, setting up a family business services company that basically provides services to our painting business S Corp and then pay our kids up to their standard deduction and also set them up for long term success by establishing Roth IRAs for them.
00:18:22.470 --> 00:18:27.990
All right, so hopefully this video was helpful for you to understand what it looks like for a business at the sellable asset stage.
00:18:28.150 --> 00:18:30.790
And with that, I'll see you in our next financial teardown video.