Focus on Your Bottom Line!
Originally published: 03.01.17 by Ruth King
We were reviewing budgeted vs. actual sales, expenses and profit for one of my contractor clients. She complained that they missed their sales goal by about $40,000.
What she didn’t look at was that the company was $50,000 ahead of their projected gross profit and more than $100,000 ahead of their budgeted net profit.
She totally missed that the company was more productive and more profitable than planned! Instead, she was upset the company missed the projected revenues.
Stop focusing on the revenue line. Focus on the bottom line.
Yes, revenues are impotant. You have to generate sales to earn profits. It’s what you do with that sale once it comes in the door that is more important.
How profitable is that sale? Can you earn a great gross profit on it? Most important, what is the net profit per hour that you earn on that sale?
Do something revolutionary this year. Most contractors estimate revenue and then subtract all of the costs to get a budgeted net profit. If you don’t like the net profit, you change revenues.
Start at the Bottom
Instead of starting with the top line, when you budget, start with the bottom line and work backwards: What is the net profit you want to earn? Then calculate your overhead cost and add it to the net profit.
Finally, what are the direct costs that you have with your historic gross margin? This is the revenue you need to generate to produce the profit you want.
Net profit per hour calculations rely on an accurate labor estimate. How many billable hours do you expect this year? If you go over the estimated number of billable hours, then you earn more profit. Go under, and you earn less profit.
Once you start tracking billable hours and posting the results, your field employees will be more billable and profitable. What gets tracked gets improved.
Calculating overhead cost per hour can be tricky. Determine the yearly overhead for each department and then divide it by the number of revenue producing (billable) hours per year.
People and space expenses are the overhead categories. Departmentalization is based on these expenses.
First the space issues. There are only five things that cause space expenses: rent, utilities, building maintenance, building taxes and building insurance.
Determine the total amount of productive space used by each department. Productive space is the space occupied by either people or things related to revenue producing department. Your bookkeeping space, kitchen, break room, reception and other non-producing space doesn’t count.
Next, people issues. Every other overhead item is really related to people. The more people you have the more office supplies you have. The more people you have the more telephone calls that you have.
In addition, if you know the exact amount of time that somebody spends in a particular department, then take that percentage rather than the overall estimate.
If you have a bookkeeper who is splitting her time between service, new construction and electrical you may need to determine how much time she is spending in each one of the departments on their tasks and then allocate her salary appropriately.
If things are bought only for one department then that department gets 100 percent of that expense.
For overhead items that are split, calculate the total amount of billable, productive payroll, i.e. field personnel payroll.
Then, if the total productive payroll is $100,000 and the service productive payroll is $50,000, new construction’s productive payroll is $20,000 and replacement is $30,000, the service department gets $50,000 divided by $100,000 or 50 percent, new construction gets 20 percent, and replacement gets 30 percent.
Then, calculate the total overhead for each department using either space or people percentages for each overhead item. Spreadsheets can help you make the calculations easily.
Once you have the overhead cost for each department you need to find the productive payroll for each department. This should be the same number of billable hours that you estimate for your bottom line.
Then to determine total overhead cost per hour, divide total overhead for the department by the total revenue producing hours for the department.
If you don’t like the department overhead cost per hour, then one of your 2017 goals should be to decrease it.
Your budget is simply the addition of the total estimated billable hours times the net profit per hour you want to earn plus the estimated overhead. Then, you have your budgeted gross profit. Add direct expenses and you determine the revenues you need to generate to earn the profit you desire.
If you don’t like the revenue number or you think you can’t generate that volume of revenue, then you have to adjust your profit expectations.
Try it. Then, if you don’t make your revenue number in 2017 but you make your profit number, you met your goal.