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In my last article (see the June/July issue, page 107), I commented that you must make a profit if you wish to remain in business—if you don't, your business won't be around for very long. There are other basics you must learn in this business to survive, as well. However, even after learning these fundamentals, some of us feel we need to test them. Often, we end up testing not only good business principles,but also our own patience and that of our staff.
Here is a scenario that incorporates several day to-day type problems you might encounter in your business career:
Let's assume the last 12 months have been a disaster for your company. You are the premier hardwood flooring installer in your city. Early last year you decided to expand and began installing aluminum patio covers. You installed one or two of these covers for friends on weekends, and they were a piece of cake. No problem. Even though you had been advised to stick with what you do best, you caved in to temptation and took on two new patio-covering jobs for your existing customers.
You promptly lost money and time on those two jobs. In addition, you purchased new equipment not in your 2002 budget. You got into two or three dumb arguments with customers. You ended up not collecting final payments on a couple of jobs. You lost your focus and you lost money to the tune of about $9,759. The year 2002 was a bad year for you and your business.
Now, as any smart businessperson would do, you have decided to refocus on your business, correct these problems and make some money. You made the following predictions for the next 12 months, based on your company and personal experience:
• You will take on 122 new jobs that will be sold,installed and collected at an average sale price of$4,530.
• Your overhead for the next 12 months is 23.4percent.
• Your profit goal is 10 percent.
After a careful review and re-evaluation of the last12 months in business, you decided:
• You must recover the $9,759 you lost last year.
• You want to find a good opportunity to make up for your loss last year, so you have been looking at a set of plans that calls for 1,280 square yards of commercial grade carpeting that will cost $18.00 a yard for material and $2.50 a yard for installation. This work is in addition to the hardwood flooring on the job. A friend who installs carpeting has told you he makes38 percent on all his work. You have determined that this might be a way to make up for some of the loss last year.
• You would like to hire an office manager at a salary of $2,750 a month ($3,712 a month with benefits).
• You would like a new van for the business. A friend in the car business just called. He found a three-year-old one-ton van for the unbelievable price of only $4,000. The financing and the other charges will bring your total cost to about $5,950.
Now, you need a money guy for a short-term loan to help you get caught up and profitable. Hopefully you already have a money guy and a line of credit as part of your basic financial planning. If you can do it here, you probably can solve similar problems you will run into almost every day in your business. Until then, your money guy insists you make business decisions based on cold, hard facts. Here is what you need to know:
1. Keeping in mind that you want to recover the $9,759 you lost last year, you can either sell an increased volume of business or increase your markup. If you decide to increase your markup, what is the correct markup to use for the next 12 months?
2. What markup should you use on the carpeting sale?
3. If you hire the office manager, how will it affect your markup? Should youhire the office manager?
4. How would buying the van affect your markup?
Do this exercise the same as you would in a real life situation. You will gain little if anything from this article if you look at the answers before you have worked through all the problems.
Determining markup to recover your losses
Markup is computed by dividing your total projected sales (jobs sold, installed and collected) by your job costs.
For our example: 122 jobs @ $4,350 =$530,700. Your new overhead number is the old number plus your loss of $9,759, so your overhead is 23.4 percent of $530,700, or: $124,184 + $9,759 = $133,943. Your profit goal is 10 percent, or $53,070.
Next, you need to compute your projected job costs using this formula:
Total sales - gross profit (overhead +profit) = job costs. For our example: $530,700 - ($133,943 + $53,070) = $343,687. So, $343,687 is the number for your new projected job costs.
Now you can compute markup: sales Ă·job costs = markup, so $530,700 Ă· $343,687 = 1.5441. Your markup for the next 12 months is 1.55 (never round down on markup).
If you decide to increase your sales volume instead of raising markup to recover the $9,759 loss, you would use the same math for increasing sales as shown under "Hiring an office manager" below.
Determining markup for the carpeting sale
What markup should you use on the carpeting sale? None. You are not going to pursue selling carpeting, patio covers, hula-hoops or anything other than what you know and do best. Period. End of conversation. Hopefully, you learned a lesson last year, and you do not need to spend money to re-learn it all over again.
Hiring an office manager
You can use one of three approaches for this problem:
1. Leave your projected sales "as is" and raise your markup. Normally, raising markup (unless you are consistently losing money on jobs as you did last year) is not a good thing to do. Raising company markup can have an adverse mental affect on the salespeople. Then, you not only lose sales but also have the additional job of getting the salespeople mentally back on their feet and selling again. That can be tough.
2. Leave your markup as is and increase your sales to compensate for the new office manager. If you go with this option, you need to figure out—to the dollar—how much of an increase in sales you will need.
3. Make no changes to either the markup or the volume, hire the new office manager anyway and lose your shorts. That is the approach most people in this business will use, and that is one of the reasons so many contractors go right out of business. This is not an option your money guy wishes to pursue.
The smart thing to do here is to raise your total sales over the next 12 months. In raising your total sales for the year, you first must find out how much in additional sales you need, again to the dollar:
Your overhead is $124,184 plus the $9,579 loss from last year. The office manager will cost the company an additional $3,712 per month, or $44,544 for the year. So, your overhead for the next 12 months is $124,184 + $9,579 + $44,544 = $178,487.
Your new sales volume then can be calculated by simply dividing the new overhead number by the old overhead percent of 23.4 percent: $178,487 Ă· 23.4% (.234) = $762,765.
To calculate your new markup, use this formula: total sales - overhead - net profit = job costs. For our example, $762,765 - $178,487 (overhead) - $76,277(net profit) = $508,001. So, $508,001 is then umber for your projected job costs. Sales Ă· job costs = markup and $762,765 Ă·$508,001 = 1.5015. Your markup for the next 12 months is 1.51.
Our previous sales figure without hiring an office manager was $530,700. You need $232,065 ($762,765 - $530,700 =$232,065) in additional sales in the next 12 months to cover the cost of your new office manager. That translates into 54 ($231,065 Ă· $4,350 = 53.35 or 54) more jobs sold than you based your original overhead and profit numbers on.
The normal work year has 52 weeks,or about 210 working days. You have predicted 122 sales or 2.35 sales per week. If you add 54 more jobs to that amount, that means you must sell 176 or 3.4 jobs per week, or just over one additional sale a week.
If you sold the same number of jobs last year, 122, how much of an increase is 176? The answer is 44 percent (54 Ă·122 = 44 percent). Regardless of what the office manager can do, and even with your markup going down 4 points from 1.55 to 1.51, unless the manager can free up enough of your time so that you can go out and sell the additional 54 jobs, i.e. increase your sales by 44 percent, this would not be a smart hire.
You need to have an average of 3.4sales a week, at an average sale price of $4,350, for a minimum of three months (preferably four to six months) to prove you can sustain the sales necessary to support hiring the new office manager.
Buying the new van
This isn't something you'd want to pursue at this point for two very good reasons. First, you must show you can sustain the increased sales needed to cover your new overhead expenses as explained in the math exercise above. This will take at least three months and preferably four to six months of steady sales that meet your goals.
Second, even if the van only cost$1,000, it is not a good business decision to buy the van unless it is included in your budget for the coming year. This kind of undisciplined, emotional buying is what gets contractors into financial problems every day.
For fun, you also can do the math as in the office manager scenario above to see what the actual increase of sales needs to be and the change in the markup that is needed. However, you must be realistic.
You must make a profit if you wish to remain in business. If you do not make a profit, your business will disappear. The contractors who have the discipline to conduct business as we have shown above and to resist impulse buying are the ones who recover from bad years and avoid more problems in the future.