Renaldo had a terrible secret.
As the owner of a small service business, he was known by everyone around him as a success. He was always busy with jobs. His vehicles could be seen all around town. He had happy customers and a top-notch reputation in the community.
There was just one problem: there was never enough money left at the end of the month to pay himself a salary! Renaldo was like so many service businesses who run their business month to month or job to job. Simply said, they are working on today’s job, not looking back at completed jobs to understand what went wrong (or right) or even looking into the future. By focusing only on today’s task, owners are putting their business at financial risk.
Why a risk?
Because they go on to other jobs without knowing the financial contribution (or hit) each type of job has on the business. Ronaldo had no clue if his large jobs or his service calls were more profitable for his company. Many of these businesses limp along financially month to month. They’re never really sure if there will be money in the bank at the end of the month or if they will be short of funds.
More often than not, they end up like Renaldo – his own lowest-paid employee, taking care of everyone else in the business and putting himself last.
How do you move your business from life support to perfect health?
• How much are you spending on people? Labor is one of the largest expenses for a business. When calculating labor costs, it is important to include both wages and benefits. Once that cost is identified, it needs to be measured. Compare the cost this month to last month and the same month last year. Is it better or worse?
Another measurement to consider is an industry standard. A labor cost benchmark for some service industries is 20%. This means that for every $100 in sales, $20 or less should be spent on labor. Is your business better or worse than the industry average?
“Everybody’s making more than me, and I’m the owner!” That’s what my clients tell me. Some of them are working for free. That’s a problem!
• What are your material costs? Now that you know the cost of labor, the next step is to calculate what you are spending on materials. Material costs are the costs of items used during the production of a product or in performing a service.
For instance, if you own a roofing company, your material costs would include plywood, shingles and nails. If you own a retail store, your material costs would be the cost of the items in your store. Depending on your business, this could be clothing, dishes or greeting cards.
Just like with your labor costs, once you have the numbers, you need to measure them against both your business and the industry standard. Standards vary from industry to industry so it is important to understand your standard and how you are performing so that you can buy and price correctly.
• Can you afford to buy new equipment? Equipment purchases are a big-ticket item for a business. Before deciding to make that purchase, look at the cash flow. Is there enough money to pay for it? It is also important to look at how the equipment expenses will impact the business. Will it be used on all jobs or just some of them? Will it make the work more efficient by using less labor or taking less time?
Calculate these numbers. If the projected cash coming into the business from the use of the new equipment is greater than the cost of the payment for the equipment, then you can afford the purchase.
It is a good idea to finance the equipment over a period of time based on the projected life of the equipment. So if the life of the equipment is 2 years, finance for less than 24 months. By doing so, you are using someone else’s money to build your business.
• Is there money in the bank for payroll? Payday can put fear into a business owner like no other day. Is there enough money in the bank to cover the checks? If not, then what? Like many Americans, many business owners are living paycheck to paycheck. It doesn’t have to be that way for your business, but it does take some planning.
Look at the money coming into the business. Where is it coming from? Is it enough? Are there any areas of the business that could be bringing in cash, but aren’t? Are your prices too low? Changes to the business, even small ones can put more money in the bank and end those payday fears once and for all.
• Was that job profitable? This is one of the most important questions to ask and one of the most ignored ones. Once a job has been completed, most business owners are looking forward to the next job, not looking in the rear view mirror at what has been accomplished. This view can keep a business in a never-ending race to keep getting the next job just to pay the bills.
Instead, take a look at the job you just completed. Did you make money or lose money? Let’s say that you own a construction company and you built an outdoor patio for a homeowner. Were your costs more or less than what you charged? If the costs are higher than the price charged, you need to understand why. Can you reduce costs? Should you increase your price? By understanding profitability job by job, an owner can make adjustments to costs and seek out jobs that are more profitable.
As an expert in your field, you know that expertise and experience are valuable. You don’t want a homeowner messing around with his plumbing or his chimney, so don’t try to handle the expenses and financial side of the business on your own. By doing so, you’re putting your business and employees at financial risk. Instead, why not get off the money roller-coaster once and for all?
I’m Patty Lawrence, a Certified Management Accountant, and I specialize in providing the financial tools and systems you need to make the right decisions to grow your business with complete confidence. Or, as I like to say, I torture numbers until they tell me what’s going on and allow me to put my clients back in control!
Let’s put you back in charge of your business and money. Call me at 717.925.3270 to schedule a free financial health check-up today.