Know Your Numbers: The Importance of Creating Cash Management Systems Before Growth

We often see companies pulling in millions of dollars but achieving little to no profit. In most cases, this boils down to one simple problem. These companies aren't calculating their expenses properly when they price their products and services, leaving them in an endless cycle of seeking out new clients just to make ends meet. This can lead to some serious problems if the issue is allowed to persist. Fortunately, this problem can be resolved relatively quickly once you understand what's happening.

The Accidental Ponzi Scheme

You may think that a Ponzi scheme is too insidious and intentional to occur by accident. Still, well-meaning business owners could face charges of fraud if they're not managing their finances properly. If you haven't properly calculated your expenses for a construction project, you may find yourself without the funds to finish the job. In this situation, we've seen contractors dip into the funding for their next project to complete the current one, creating an endless cycle.

This self-perpetuating issue may leave you in a hole that's too difficult to climb out of as you continue to use new jobs to pay off old ones. Even the most well-meaning entrepreneur can be charged with fraud if their budget doesn't leave them with adequate funds to complete the job, run payroll, and pay the company's bills.

Growth Is Not the Answer

We've seen contractors attempt to solve the problem of a miscalculated quote by taking on new clients to access additional funds quickly. It's easy to believe that continual growth will eventually solve the shortfall, but this isn't the case. Unless you change how you value projects and calculate quotes, your new clients will only continue to feed the monster. You must adjust your numbers to get to the root of the problem, and then you can achieve the meaningful growth you're after.

Know Your Numbers

To quote projects accurately, you must understand all the numbers involved in your business. Too often, we find that business owners have simply built their quotes off each project's costs. This may account for the materials and labor involved in that job, but it doesn't consider the business's fixed expenses. The income from each project must also cover your fixed expenses, such as rent, utilities, taxes, and administrative costs. Business owners should also allot themselves a salary rather than simply pull money from the business.

Understanding your business expenses as a whole will give you the numbers you need to calculate your quotes accurately. When you're working from the right information, you'll find it much easier to produce a quote that lets you operate comfortably and profitably.

The Difference Between Margin and Markup

Now that you have your numbers in hand, you need to move forward with a keen eye for both your margin and markup. Confusing the two can cause you to undervalue your services, walking away from each project with less profit than anticipated. The profit margin is the revenue earned after deducting costs, while the markup is the retail price minus expenses.

Though you use the same numbers to calculate both of these percentages, the equation is different. The profit margin is calculated as a percentage of income. To get this number, you would divide gross profit by the revenue. The markup represents the retail price minus the cost. To calculate this, you subtract the cost from the sales price and divide that number by the cost. Finally, multiply the number by 100.

For example, consider a job that costs $100 in goods and labor. If you charge $120, you may assume that you're enjoying a 20% profit. However, when you divide your $20 profit by the total $120 revenue, you only get a 16.7% profit margin. When you subtract the $100 cost from the $120 price, you get $20. Divided by 100 and multiplied again by 100, you get a 20% markup. Every person on your team should understand these two equations so they can use them accurately when calculating quotes.

Evaluate Your Overall Profits and Job Capacity

To properly quote your jobs, you must incorporate your fixed monthly expenses into the cost of every job. You should know how many jobs you need to complete each month and at what profit in order to cover your administrative costs, rent, utilities, salaries, and other expenses. If your current profit margin isn't covering all your costs, you must either raise your prices or increase the number of jobs you complete each month.

Understanding how many jobs you must complete and at what profit will empower you to make wise decisions about the work you take. You'll know when you need to say no to small jobs and when you need to push for more business so you can operate successfully and enjoy profitable, sustainable growth.

Work With a Professional

It would be best to work with an experienced CPA to achieve real, sustainable profits. A CPA can help you get started with profit and loss (P&L) statements that begin to offer a detailed overview of how you're operating and at what cost. We work alongside each client's CPA to make sure we have an accurate view of the big picture. We know that not all P&L statements are created equal, so we can help you track down overlooked expenses, like taxes, that may not be included. From there, we can guide you toward the right path for your business goals.

If your jobs just aren't delivering the profits that you expect to see, you're probably working with the wrong numbers. We can help you review your business's financial plan and identify areas of concern. Our team members can get you back on the path to healthy, steady growth. Give us a call to schedule your consultation.