The profitability of a company is like its scorecard. Each month's income statement shows everything that was done in the business and what the results of those efforts were. At the end of the day, a company is either winning or losing based on its profitability. When looking at your “scorecard,” margins, profitability, and total labor are the three items to focus on. Revenue in and of itself means nothing. It's all about how much you get to keep as a business.
Managing Profit Margins
The first component in that equation is managing your margins. As one of the keys to unlocking profits, keep your margins in line by managing your direct cost. Generally, direct costs are as follows; field labor, materials, equipment, subcontractors, equipment rental, and job permits. In other words, any expense that can be directly tied to an address without getting too granular. From that margin percentage, we’re then going to look at profitability.
If you’ve sold enough to cover your fixed expenses, your margins are right, and you’re priced correctly, you should be able to enjoy double-digit profitability. Other positions in the business may get a profit share. So, as an owner, you want to make sure that the way that you pay, incentivizes good behavior to drive top-line sales, better margins, and overall profit of the organization.
A broken compensation plan negatively impacts sales if there’s no incentive to go above and beyond. The flip side of that coin is if your entire team is incentivized for the correct behavior, revenue is impacted positively. Think of it as your organization collectively rowing the boat in the right direction with no one fighting against the tide.
To put this into perspective, here’s an actual example from a member who worked with us on their compensation plan:
Last year, one of our members had challenges with their material percentage being too high. They tried everything to reduce it, but nothing worked. Then I showed them how to look at the problem differently.
When looking at their compensation structure, it was clear that their warehouse manager was not compensated for his performance; it was strictly a salaried position. Though the team member performed all the basics of the job, he was not incentivized to go the extra mile when it came to managing costs. The new compensation plan that we created allocated a portion of the savings to be shared with the warehouse manager. Having a stake in the savings, the warehouse manager became the gatekeeper, implementing a system that sourced better prices and a more stringent approval process on inventory purchases that other team members made. When money was saved, he received a share beyond his base salary. As a result, their company was able to save over $40,000 in one month on materials based on the new compensation plan we built for their warehouse manager.
Does this example apply to everyone? Maybe not, but the concept is universal. And incentivizing your employees to think like an owner always results in additional savings or revenue for your company depending on how it’s applied.
At the end of Q1 2023, that same company closed out the month at a 25% net profit. As you can see, the benefits are twofold; they not only scaled back on material costs, solving that problem, but they created an incentivized employee through a better pay structure. Their customized plan was structured so that a percentage of the money saved was shared with the team member. Over the next several months, their material percentage not only lowered but maintained a very healthy number to ensure a high level of profitability. Why? Because they had a compensation plan in place that incentivized behavior and changed their team’s mindset.
Is Your Compensation Plan in Balance?
Some company owners may need to evaluate their own compensation. For instance, the owner of a company also acts as its General Manager and decides to pay themselves a $300K salary. The organization does 3 million in revenue, so the owner’s salary comprised 10% by itself. Sure, you can do that as the owner, but would your organization pay that much for a general manager that wasn’t you? If not, figure out what that number is. Typically, your overhead labor should run between 8% - 9%.
Here's a good metric: Your total labor cost should never exceed 30%, not including benefits or payroll taxes. That includes field staff and office staff, depending on your business. If the owner is taking an inflated salary, that number may be higher.
Example: An owner of a company also acts as its General Manager. The organization does 3 million in revenue, but the owner decides to pay themselves a $300K salary. That's 10% by itself. Sure, you can do that as the owner, but would your organization pay that much for a general manager that wasn’t you? If not, figure out what that number is. Typically, your overhead labor should run between 8% - 9%.
Keep in mind that all labor that’s calculated together is the highest category on an income statement. Therefore, if labor is out of whack, it makes it more difficult to generate profitability. Your total labor cost should never exceed 30%, not including benefits or payroll taxes. That includes field staff and office staff, depending on your business. If the owner is taking an inflated salary, that number may be higher.
In some cases, if your compensation plan is out of balance, you may actually be overpaying for skill and talent. Many businesses pay their people out of their profits. That is a broken compensation plan. A business shouldn’t be looking to give away additional profit, but to increase overall performance. Simply trying to pay more than other organizations may impact profitability. So, you have to make sure that you have a very well-thought-out process in how each position's paid.
So that goes back to approximately 20% to 22% for your field labor, and 8%-9% on your overhead labor without benefits and payroll tax. Start by identifying your current labor percentage overall. If it’s over the metric that we shared at 30%, you may already have a broken compensation plan.
It's also worth mentioning that a broken compensation plan not only affects margins and profitability, but it’s also a major headache to administrate. Start with identifying what is it you have today and what percentage you want to get to. If you find that your total labor is at 20%, there's a really good chance that you're struggling to perform at a very high level because you're not paying people well enough.
After a journey in the HVAC industry that began when he was sixteen, Chris Crew went on to coach a large electrical company helping franchisees achieve success. Later, he shifted to owning an electrical business, growing it in a four-year span to 60 trucks, five locations, and generating $18 million. Ultimately, he sold his shares to join The Blue Collar Success Group® where he now serves as President. Chris Crew offers extensive knowledge about every facet of in-home services.