Wrong. If that trend continues in March, April, and beyond, each project is now contributing only $10,000 to the cost of keeping your doors open, and the year is slipping away. At that rate, you’ll have to sell a total of 10 jobs (the two at full price plus eight more at the lower contribution margin), and instead of one job every two months, now you need to sell, start, and finish one job a month.
Do you even have the subs and administrative resources to pull that off? Most contractors don’t, and would wind up doing the usual rob-Peter-to-pay-Paul shuffle, starting projects before plans were ready, scrambling for bank draws before the work was done, and leaving jobs unstaffed for days or weeks while disappointed customers sat by wondering what was going on. Quality control would go out the window because your lead carpenters weren’t prepared for that many job sites, and you’d be forced to bring unfamiliar subs into your operation to take up the slack.
And if you’re like most small contractors, you’d also probably stop paying yourself the salary you had budgeted, so you’d be back in the field working for wages. This is the slippery slope many contractors often find themselves on — working harder and earning less. But if you learn to work by the numbers, you can avoid this scenario. Which brings me to the third important metric, your personal financial goals.
Personal financial goals. Covering your overhead “nut” is necessary, but the real reason you’re in business is to earn a living (your salary, wages, and sales commissions) and see some return on your investment (your company’s net profit). At your current planned sales volume of six jobs totaling $480,000, your budgeted compensation for the year might look like this:
• Sales Commissions $19,200 (4% of sales)
• Trade Wages as Lead Carpenter (half-time) $17,500 (3.65% of sales)
• Supervisory Wages as Lead Carpenter (half-time) $17,900 (3.75% of sales)
• Owner’s Salary $19,200 (4% of sales )
• Total Compensation (before net profit) $73,800 (15.4% of sales)
Furthermore, if you stay on track to earn a 10 percent net profit, your company will finish the year with a net profit of $48,000. While in theory this is “your” money, don’t buy the tickets to Tahiti just yet. Net profit is the money you’ll need to grow the company in the coming year, and you still haven’t totally settled up with Uncle Sam, so it’s just a paper number until your accountant tells you otherwise.
What if your personal financial goals were higher — say, $105,000 per year before your net profit? In a by-the-numbers operation, instead of watching the year go by and guessing at how many sales at what profit margin you’ll need, you start by setting your goal, then work backward. I’ll cover this in detail later, but here’s a quick example of the process.
The difference between your current budgeted compensation for the year of $73,800 and your goal of $105,000 is $31,200. Assuming that your average selling price, job costs, and overhead don’t change, you could budget for more sales at the same gross profit margin to earn the additional dollars you need. Two more average projects — eight for the year — would cover the difference with a nice cushion to spare, but only if you can do them without using any extra staff, facilities, or other overhead (see example).
Our owner originally was compensated a total of $73,800 — a combination of sales commission, trade wages, and owner’s salary — on six sales (Example 1). To achieve a compensation goal of $105,000 — an increase of $31,200 for the year, or a GP of $151,200 — he or she can either build more projects at the same markup/margin (Example 2), continue planning for six projects but raise the average selling price to $85,200 (Example 3), or do a combination of the two approaches (not shown).
Another option would be to rebudget the original six sales at a higher price to cover the additional income. But if you’re seeing a lot of price pressure from the competition — or if, perhaps, you aren’t highly skilled as a salesperson — the price increase could represent a barrier you might not be able to overcome. And if you miss your sales targets early in the year, the rest of the year will be that much more difficult.
Yet a third option would be to find the money you need on each project without raising prices. You might be able to lower your direct costs by negotiating with your subs and suppliers. You might also be able to lower fixed overhead such as utilities or rent so that your break-even for the year is lower.
Finally, you could use a combination of all of these ideas: Budget seven sales at a slightly higher price while squeezing a few percent out of your costs and overhead. The point is that you’re being proactive and planning before the year begins — not reacting in the heat of battle when it’s probably too late.
Where Not to Trim
While gross profit should be your primary focus, there is nothing wrong with also keeping as tight a lid on your overhead as you can, with a few important exceptions.
Supervision. This is one expense category you never want to shortchange, whether you’re paying yourself or hiring an employee. Spending more to hire the absolute best supervisory talent you can find will benefit your company in a number of ways, from increasing customer satisfaction to reducing job completion times to lowering your warranty liability. And when you’re ready to hang up the toolbelt, you won’t be able to afford to replace yourself with an employee unless you’ve budgeted adequately.
Marketing. Many of you proudly say that 100 percent of your work is “by referral,” but there is still a cost involved in recruiting and maintaining all that good will. Moreover, when there is a sudden downturn in the economy, as there is now, those builders and remodelers who have been actively marketing all along have an advantage. With management accounting, you can track which types of marketing performed best, right down to how profitable jobs from a particular lead source (the Internet) are compared with others (word of mouth).
Technology. When you’ve trimmed all you can trim, sensible technology is the final frontier for squeezing out those last dollars of profit. The Internet has made it possible to connect everyone on your project in real time, letting you see inefficiencies that used to go unnoticed. But unless you’ve budgeted enough money for the software and services you need, you won’t be able to afford them when the time comes.
With each column, I’ll have something you can download or a reading recommendation. For next time, pick up a copy of Jack Stack’s “The Great Game of Business.” This case study of how a business can be transformed when everyone is operating by the numbers is one of the best and most concise I’ve read. It’s available at greatgame.com. And while you’re online, go to jlconline .com, click on the JLC Extra tab, and listen to Alan Hanbury’s explanation of why active marketing — not relying on word of mouth — is so important for remodelers.
Joe Stoddard is a contributing editor at JLC and moderator of the business technology forum at jlconline.com.