Contractor U: Bottom line thinking

By Mike Draper

Contractors who are overly focused on increasing their sales without regard to their costs are like hockey coaches who put five forwards on the ice at all times. Their team might score 10 goals on the night and lose 12-10. In this month’s Contractor U, let’s look at the difference between being successful on the Top Line (your offence, as it were) and the Bottom Line (which is generated by defence, or cost control).

First of all, let’s define Top Line and Bottom Line. Your Top Line is the total revenue of your company and refers to the number at the “top” of your income statement.  It represents the amount of work that you have invoiced your clients for work performed in a given period.  It is not profit; it is revenue.

The Bottom Line number is at the “bottom” of your income statement and represents the amount of Net Profit or Loss your company has for the given period.  It is what remains of your income after your expenses, including overhead, have been accounted for.

While the primary concern of most small businesses is their bottom lines, some companies do indeed strive to increase their top line revenues without too much concern about the bottom line.  Companies that think this way are typically on a rapid growth path and growing revenue is their top priority.  You may be wondering why a company would focus so much on revenue instead of profit, but there are many possible reasons.  They might be trying to take market share away from their competitors and will do so at almost any cost.  They may be reinvesting in the company to generate even larger profits later on.

On the flip side is the company that is focused primarily on profit without too much concern for revenue.  This type of company is looking to make as much money as they can.

Lastly, there is the company that wants to do a balanced combination of growth and profit.  They want to grow, butthey want to do it profitably.  Which type of company are you? From my perspective, the only reason to be in business is to make a profit.

Not making the money you should

In our industry, I constantly meet owners of contracting firms who are so focused on increasing revenues that they believe that their revenue growth will take care of all of their costs.  It rarely works out that way. The net result is that too many of these owner-operators don’t make the money that they want or should make.  They do lots of work and have good revenue numbers, but they don’t have enough profit.  At end of the year they say, “I didn’t make enough money.” And they tend to say this year after year!

The reality is that contractors need to make sufficient profit on each job so that they can cover not only their direct job costs but all of the overheads that are associated with running a construction business. In order to do so, each job has to be profitable.  The practice of taking jobs just to stay busy is a mistake.  Taking unprofitable work so you can keep your staff working is also a mistake. Without profit on each job, it is not worth doing the work.  Doing work for the sake of working and not making money is crazy.

Having said that, why does this happen so often?  There is so much pricing pressure in the industry and so much pressure to keep employees working that contractors take the work even if it is not going to add anything to the bottom line.

I am sure that you are thinking, “I can’t charge more than I do because I won’t win any work.”  While it may be true that you won’t win as much work, it isn’t true that you lose more money from raising your prices.

Let’s look at some examples.

Increasing your prices by 10 per cent

If you currently have a 20 per cent Gross Profit and you increase your price by 10 per cent, you will make 50 per cent more Gross Profit.  That’s right! A 50 per cent increase in Gross Profit from a 10 per cent increase in price.  It’s not complicated: your costs are going to stay the same. That’s why discounting kills businesses – and it can kill yours – it it gets out of control. By the way, remember that Gross Profit is Revenue less Job Costs, before subtracting overhead expenses.

Now if you feel that you can’t charge any more, there are two things to keep in mind.  If you increase your price you might not win as much work. Since the work is at a higher profit margin, when you do win work, you will need less of it to make the same profit.  Less work for the same money is a good thing.  In the example above, you will make the same Gross Profit while doing 50 per cent less work. That’s a no brainer. We at Renovantage have been encouraging our clients to raise their prices by 10 per cent for over 10 years and not one has lost even close to half of their work!  In fact, most of them improved their sales processes at the same time and ended up with increased sales.

Decreasing your prices by 10 per cent

The other option, instead of increasing your price by 10 per cent, is to reduce your costs by 10 per cent.  You need to do a better job in buying product, run your projects more effectively to reduce the labour portion of your work. Reducing the labour portion doesn’t mean going back and demanding a lower price, it means working with better trades who have developed an efficient model to do quality work at very competitive rates.  They have figured out how to run their own business better and as a result can do the work for less money.

Ultimately, combining a price increase with reduced costs will help to create the largest improvement in your Gross Margin.

Often, I hear contractors saying that they have increased their sales, but their profits don’t climb at the same pace.  They take on more work, but the increased volume creates inefficiencies in the business.   More mistakes are made now that the business owner is not on site as much, trades and employees take too long to do their work, not enough time is spent on planning, etc.  All of this translates into increased costs and less profit.

As we said at the top of this article, focusing on just increasing sales is like building a hockey team based on goal scorers.  The team scores lots of goals but has no defense and is guaranteed to lose.  Lose enough, and you are going to be out of the league (out of business, that is) for good.

Running more efficiently

For contractors, the best way to grow is by focusing on running the business more efficiently.  Take out all of the unnecessary expenses and time wasting activities.  A big time waster is running to the local building supply store many times a day.  Plan the needs of the job well in advance and get more material on site at one time.  Do your best to think ahead for what you will need and order it in advance so that you can order it from lower cost suppliers.  Buying materials at the last minute from the closest lumber yard costs more. You will spend less time running around picking up material and you will be buying at better pricing.

Both of these outcomes will help increase your profit on the job.  This one change in the way you operate can have a very significant effect on your overall profit.  It all comes back to the carpenter’s saying, “Measure twice, cut once.”  Spend more time planning the job and the materials needed and you will spend less time running back and forth to the store.  Sometimes you just have to slow down to speed up.

Cash flow

Another area of inefficiency has to do with cash flow.  When cash flow is tight, contractors are always juggling who they are going to pay, which phone call they will answer, who are they going to call back and which is the next urgent item that needs to be ordered.  The amount of time some contractors spend dealing with cash flow shortages is enormous.  Trying to keep all of this in one’s head is next to impossible.  Trying to remember who you owe, when, what, how much and from whom you have money coming in takes an enormous amount of thought and energy. This is time and energy that could be better spent focused on winning profitable renovation work.

If you were to spend five hours a week juggling cash flow (that’s low for many contractors!), then you have five hours less selling time.  In a year that corresponds to over 260 hours – or six weeks of extra selling time – that is lost.  With six weeks more time to secure better work, your business will look totally different.

Since so much time is lost managing cash flow, it is important to get it under control.  This may take some time and some hard work.  Don’t make it worse by taking on non-profitable work! You are not in the finance business and shouldn’t be financing your client’s project.   There is really no reason for contractors to have cash flow problems.  Make sure that you set up your milestone payments so that you get paid before you have to pay out. It’s that simple!

Other options are to borrow some money if you can or go to your suppliers and trades and negotiate better terms.  If you are upfront about what they can expect from you, you just might find that many are ok with it.  The worse thing is to just ignore them, as they won’t go away and the burden will still rest on your shoulders.  Even offer a post-dated cheque if that helps.

Focusing on profitable business can be implemented immediately but it should also be treated as a long term change in your business model.  Small, incremental changes, aggregated over time will produce the best results.  Think of these changes as a marathon and not a sprint.  It takes time for change like this to show results, but if you don’t start now you are just pushing the results further into the future.  So make the time to review the strategies in this article and then force yourself to implement them in your company.  In the end, it is all about the Bottom Line!

Mike Draper is a business coach for Renovantage (www.renovantage.com) and a frequent contributor to Canadian Contractor.