Quick Consultant: Minimum Owner's Salary Required to Establish Business Value

Am I the only person out there who has a secret list shoved somewhere in their wallet that lists every online account, account name, and its password? I’m like that dog on the TV commercial that keeps fretting and worry all night long about someone taking his dog bone, and he keeps looking for a different spot to hide it.

I’m terrified by the thought of losing my list of passwords. I don’t know what I would do if I ever truly lost the list. Of course, I do have a backup stored on my computer’s desktop. The name of the file? Passwords, of course.

Every time I hear one of these security guys on the Today show, Good Morning America, or 60 Minutes, I start worrying about my computer accounts and my passwords. It wouldn’t be so bad if I could just use the same name and password for all these accounts, but “Oh, no,” say the experts. Not only should I be using different passwords for all these accounts, but they say these passwords need to be changed every six months or so.

 

Easy-to-Remember Passwords

Worse, the experts tell us to avoid using passwords that might be easy for us to remember, things like birthdates, middle names, addresses, etc. since those easy-to-remember words are exactly what the hackers will try first.

So, here I am at 67-years-old, trying to maintain more than 20 different online accounts, almost all of which have unique account names, addresses, and passwords. I have three different online banking accounts, a stock account, and accounts with Amazon and Barnes & Noble. I also have accounts required to check on the weather when I fly and another dedicated account for filing flight plans.

One of the worst accounts—and hardest to maintain—is my special, high-security account with U.S. Customs & TSA. This account requires me to use a password that begins with a single 0-9 digit, contains at least eight letters, and then ends using one of eight grammatical symbols like #,%,&,@, etc. Oh, by the way, if I don’t log into the system at least every six months my password becomes invalid.

 

Answering the Security Questions

Even when you enter the correct account name and password, some of the more secure sites ask one or more security questions. I’m convinced these questions are designed to plant seeds of doubt in my mind that I might be coming down with Alzheimer’s.

I hate it when one of these accounts says something like, “Before we can grant you access to your account, you will need to answer the following security questions to verify you are who you claim to be.”

Oftentimes it takes me two or three times attempts before I get it right. Of course, those are on my good days. On bad days, I can’t answer the question correctly in the given number of tries and I am simply cut off and denied access.

One of the original security questions I supplied info for was “Where were you born?” Simple question, right? Well, no it isn’t. I was born in Washington DC. Now, the problem is I never seem to recall exactly how I answered that question since there are at least three or four possible answers, depending upon my mood and sanity at the time. Did I use just “D.C.” (with or without periods), District of Columbia, or Washington D.C? Hell, I never remember for sure exactly how I answered this question.

Same thing with my high school. Did I originally enter it with the suffix “Senior High School” or “Senior H.S.” or did I just shorten it completely and answer “Walter Johnson?”

One of the most amazing security questions I’ve run into was recently asked by my bank. I can’t remember ever having provided them with an answer. The security question was, “What is the name of your first girlfriend?” Yes, I am serious. First, I can’t believe I told them that to begin with, and second I can’t remember exactly what I was thinking when I provided an answer. What did they mean by “girlfriend” or “first.” I start sounding like former President Clinton defining the word “sex.”

I remember failing one of these security questions a year ago and I ultimately was forced to call customer service so I could get back on my account. A young woman was helping me and I remember pleading with her, “Look, just give me some hints, that’s all I ask. I’m 67-years-old and my memory is failing, how about if I toss out a couple of names, like Margaret or Cathy, and you tell me which one I listed or if I am close? I’m sure I loved both of them.” I think she giggled and gave me the name.

 

New Security on the Horizon

I just want to know whether most of these 20- and 30-year-old security experts follow their own advice. Do they really use different passwords for all their accounts and do they change their passwords every six months or so?

Of course, these types of discussions will become academic in the next five years as more and more computers, portable or otherwise, start coming with biometric authentication systems that will automatically check your retina, palm, or fingerprint.

Of course, no system is fail proof, and I am looking forward to reading the first few stories about how users trying to log on to their computers reacted when a bug in the software or hardware claims their retina or handprints cannot be authenticated: “Please verify you are using the correct eye or hand and try again.”

 

Where Does Value Come From?

Last month I talked about the economic value that a firm might represent to owners; as opposed to the value that firm might represent to an outsider looking to buy a company that could generate a good salary and a return on his investment. Are printing companies capable of doing both? Of course they are, but the more critical question is how that applies to your firm.

Fortunately, the quick printing segment of our industry has an abundance of good statistical and financial data. So I thought I would turn once again to some of those reports and share with you some of the answers.

Below is a chart I prepared using data extracted from the NAPL Financial Benchmarking Study, 15th Edition. This study is packed with information so valuable that it has helped turn around companies that were otherwise headed for disaster. How? When you can determine what the very best companies (the top 25%) in the country spend for payroll, cost of goods, and overhead, it is very easy to see what needs to be done to turn a company around. That is, of course, unless you are really good at rationalizing.

 

Clarifying Owner’s Compensation

No matter how many times we have defined it in the past, it is necessary to do so once again. Owner’s Compensation (columns #1 and #2) is defined as “That money which is left over after covering all the expenses of the business, but before paying the owner a salary or giving the owner any fringe benefits.”

The average owner’s compensation figures in the accompanying chart (both percentages and dollars) represent what a single owner in this industry is currently withdrawing from his or her own business. It does not, and should not, include any additional salary or benefits paid to spouses or partners.

So, before you go off and start bragging to yourself and others that, “Hey, Harriet and I make a lot more than those folks,” make sure you re-read the section above. You don’t count both salaries.

Put another way, it isn’t kosher to combine the salaries, benefits, and perks of two or three partners, or a husband and wife team, and call the combined total owner’s compensation. It may be considered economic value to those taking it out, but those salaries and benefits cannot be added together into one lump sum and defined as owner’s compensation.

On the other hand, if there are two partners and each withdraws $100,000 in salary and perks, yet one of those partners could be easily replaced by a $65,000 individual, then there is, in fact, $35,000 in excess compensation being paid to one partner. That would be added back to the salary of the remaining partner. These are the types of calculations that occur all the time when a company’s financial statements are recast for the purposes of a valuation. Your monthly P&L may or may not provide this type of detail.

 

Average Industry Compensation

As you can see from our table, average owner’s compensation, as a percent of sales, actually varies little, regardless of whether one is in the $500,000 range or the $3 million range. Of course, you do not spend or eat percentages; you spend real dollars, so this is one case where size does matter. And larger firms simply produce more in hard cold cash than smaller firms.

If space permitted, I would clearly be appending these remarks to note that while some of the figures in this table may appear quite modest or even low, the very best companies in this industry (the top 25%) report owner’s compensation figures in the 18-24% of annual sales. A few report even better numbers.

However, claims by some folks that they are making 30-34% or more have to be taken with a huge grain of salt. At the other end of the spectrum, at least in terms of owner’s compensation, there are companies in the industry that are struggling just to remain in the “positive” column.

The Fair Market Salary column (column #3) is used in many valuation scenarios as well as in the NAPL Benchmarking Report to convert owner’s compensation into a more accurate representation of true profitability.

Traditionally speaking, the term profits represents all the money that is left over after paying all the expenses of the business. One of those expenses is indeed fair market salaries for owners and officers. So, before we can report on the true profitability of a company, we must first make some allowance for paying the owner a fair salary.

We do that by using a long accepted formula, which calculates a fair market salary for an owner as: Fair Market Salary = (4% of Annual Sales + $14,000) x 1.18

The multiplier of 1.18 is used to account for additional payroll taxes and benefits paid to and on behalf of a single owner. Thus, a fair market salary for the owner of a company doing $1 million in sales would be $40,000 + $14,000. That $54,000 multiplied by 1.18 equals $63,720. (See chart)

 

Excess Earnings Represent Value

Industry benchmarking studies and previous Operating Ratio Reports produced by NAPL have used this fair market salary formula when calculating return on net assets and excess earnings.

While the salary paid to an owner is important, it is excess earnings, or the amount that is left over after allowing for a fair market salary, that is the more reliable indicator of true value in a company. Investors will examine closely these excess earnings, and typically will apply a multiplier, ranging between two and six to arrive at initial valuations. Of course, the value of the assets being sold is typically factored into the valuation, but excess earnings, and not assets, typically represent the bulk of value in most companies.

One last important thing to note: it is quite possible for a company to actually report negative excess earnings because some companies simply do not make enough money to even satisfy or reach our fair market salary threshold, let alone produce excess earnings. In those situations, the value of a company, aside from its assets, can drop to almost $0! Senior contributing columnist John Stewart is president of Q.P. Consulting. He is co-author of the industry best seller “Print Shop For Sale”. Go to www.printshopsforsale.net for a good Q&A on business valuations. Follow John’s blog on his website at thequickconsultant.blogspot.com.Contact him at 2110 S. Dairy Road, West Melbourne, FL 32904, call 321-727-2444, or email qkconsult@aol.com.

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