The 3 million dollar road Part 2: Along the $3 million road
December 16, 2011 by Mike Draper
The following is the second in a four-part series that will examine the road to a $3 million business.
By Mike Draper
Now that you have mastered the $300,000 annual sales level it is time to set your sights on higher revenue and higher profits. Reaching for $1 Million in annual revenue is a very big step and may seem overwhelming at first, so let’s look at one of the key areas needing attention – cash flow.
Inadequate cash flow is one of the biggest reasons why a contractor doesn’t grow. Without positive cash flow, the constant cash shortages will force a contractor to remain small. With proper cash flow management your business can grow and prosper.
Here is the Wikipedia definition of Cash Flow:
Cash flow is the movement of cash into or out of a business, project, or financial product. (Note that “cash” is used here in the broader sense of the term, where it includes bank deposits.) It is usually measured during a specified, finite period of time, such as a month. Measurement of cash flow can be used for calculating other parameters that give information on a company’s value and situation.
So every dollar that you bring into your company is referred to as cash in and every dollar you spend is cash out. Cash out does not necessarily relate to an expense item. An example of cash out that is not an immediate expense is buying a new truck or other asset that depreciates over time. You might pay $30,000 for a new truck and that is cash out. But it is not all expensed in the first year you own the truck. The actual expense on that $30,000 truck is the yearly depreciation allowed by CRA, typically 15 per cent the first year and 30 per cent each year thereafter.
Understanding the cash needs of your business as it expands is critical to your expansion phase. (If you would like me to send you a cash flow forecast sheet, email at: firstname.lastname@example.org.) This forecast sheet will help you plan out what your cash needs will be as your business expands towards the $1 million mark. It will show you how much cash you will need to inject into your business, either through your own investment or some form of a loan. The key is to make this as low as possible, to know how much is needed, when you will need to extra money and when you can repay borrowed money.
In order to need as little as possible, you must manage your cash flow with your suppliers, sub-trades and homeowners. Supplier and sub-trades want to get paid immediately and homeowners want to pay as slowly as possible. You want homeowners to pay as quickly as possible and you want to pay suppliers and sub-trades as slowly as possible. This is where the problem originates. You are in the middle, and, as such, if not managed properly, you will have cash flow problems.
How do you deal with this?
Negotiate with suppliers who will accept credit terms and credit cards instead of dealing with suppliers that are COD. Even if a COD supplier is cheaper than one who takes credit, it might be better for your business to pay a little more and be able to balance your cash flow. Remember, a business without positive cash flow will not survive. One with slightly higher costs and positive cash flow can survive.
Some sub-trades always seem to have their hand out asking for money to continue working on a job. The reason is they usually have a cash flow problem of their own, but, this is not your issue. Work with sub-trades who are willing to work with your payments terms. Set up a policy and a procedure where you will pay all of your trades once per week on the same day and time each week. Outline before you hire them what your payment policy is. Be fair. Live up to your commitment of paying them on the day you promise.
Here’s an example of a good plan that helps everybody: Tell subtrades that all correct invoices you receive by noon on Thursday each week will be paid by 3 pm on Friday the same week. Train your sub-trades to understand that when they get their invoices into you on time and you will pay them on time. If they show up with an invoice on Friday they will have to wait until the following Friday to be paid.
In a scenario like this, the cut off is the deadline you set and they know the deadline before they even accept the work. And doing your sub-trade cheque runs once per week will free up time, enable you to have your bookkeeper come in less and take on more work for you. The bookkeeper can organize the invoices, allocate them to the job that they belong too, write the cheques and have them ready for your signing. Now with predictable invoices dates you can better plan your cash out requirements.
What about cash in? Cash in is cash collected from your clients. There are many different methods to collect money from clients. Proper project planning and cash out requirements need to be done so that you know how much money you need to be collecting on each job and by what date. Carefully plan to make sure that your payment schedule with your clients enables you to be cash flow positive. If your payment schedule is by date, then make sure your payments are more than the amount of work you will have completed at each milestone payment. This is easy to justify because there are costs coming up between payments that need to be covered. If you collect more at each payment than work completed you will be in a positive cash flow position.
Should you accept payments based on amount of work completed, make the payments due on commencement of work, not completion of work. By having payments on commencement, you can control your cash flow better. If the client doesn’t pay you, don’t start the next phase. It also provides money for the materials and the amount you must pay your sub-trades. If the payments are based on completion you will run into the situation where deficiencies or holdups on a phase can give your client justification for not paying.Imagine, for instance, that the electrical payment is held up because your painter has skipped town. Because you can’t install the faceplates before the painting is complete, a picky client could hold payment on the electrical even though it is virtually complete and you’ve already paid the subtrade.
The number one factor that impacts cash flow is profitability. No matter what you do about payment terms with clients, suppliers and sub-trades, you won’t have positive cash flow if your jobs are not profitable. You have to ensure that you apply enough markup to cover your direct costs (labour, material and sub-trades), overhead and profit. It’s common for the owner to wear many hats in a small renovation company. The owner is the general manager, sales rep, bookkeeper, site supervisor and project manager. If you do all of those jobs, you are probably working more than 40 hours per week. Maybe a relative or spouse does the bookkeeping and doesn’t get paid. You must pay yourself for all of the work that you and you relatives do for the company, or you will never have enough money to pay someone else to do it. Following are some guidelines as to how much you should pay for those tasks:
Owner/General Manager 6-8 per cent of revenue
Sales 4-6 per cent of revenue
Bookkeeping/Administration 2-3 per cent of revenue
Site Supervision/Project Management 4-5 per cent of revenue
If you are doing all these jobs, that adds up to a range of 16-22 per cent of revenue. If you can’t pay yourself that much for all of the jobs that you do in your company, you probably aren’t charging enough for your services. You will hit a plateau and stop growing because you don’t have enough money to hire someone else to do the work.
The old rule of thumb on markup is 10 per cent for overhead and 10 per cent for profit. Those factors are totally unrealistic for most renovation companies. Only contractors who do primarily large jobs over $250,000 and custom homebuilders can even begin to think about 10/10. Our experience is that most renovation companies have overhead that is at least 20 per cent of revenue. Most are more. If you aren’t making enough profit, look at your overhead expenses carefully and make sure that you are paying yourself and everyone who is working in your business a proper wage for the work performed. Then set your profit goals. Now you can determine what is the proper markup.
The second big component of reaching $1 million in revenue is obviously sales. Without sales you can’t reach $1 million no matter how good your cash flow is.
The key is to boost your revenues from these four areas:
(1) Increase your number of leads
(2) Increase the rate in which you convert leads into customers
(3) Increase the average dollar amount of each customer’s purchase
(4) Increase the average number of times each customer buys from you
Let’s assume you’re starting with the following situation:
You have 100 leads in a year and you convert 1 in 5 into a client who does on average 1 $20,000 renovation with you.
Here would be the calculation for your revenue:
Number of Leads 100
Conversion Rate 20 per cent
# of Transactions 1
Average $$$ Sale $20,000
Total Revenue $400,000
If you apply a 10 per cent increase to your number of leads, conversion rate, number of times customers make a purchase, and average purchase amount, the numbers look like this:
Original Number 10 per cent Increase
Number of Leads 100 110
Conversion Rate 20 per cent 22 per cent
# of Transactions 1 1.1
Average $$$ Sale $20,000 $22,000
Total Revenue $400,000 $585,640
That is a 46 per cent increase in revenue
Most contractors, when they want more sales, try to generate more leads. But leads are expensive to generate. Why not take the 80 per cent of the leads that you have already generated and do a better job converting them into clients? They are already paid for. You are already in contact with them and more than likely they will buy from someone within two years. According to studies done on sales leads conversion, 80 per cent of leads you consider to be “dead” will buy within two years.
The average dollar sale
Next, focus on increasing your average dollar sale. A client is already going to renovate with you, so try and get them to buy more through you. Are you providing all the material or is the client supplying it? What about repainting the hallway while you are in painting the new bathroom? Look for ways to get them to spend more with you.
Once a project is complete don’t just walk away and say it was nice working at your home. Call them back in six months and find out how they are enjoying the work you did for them. Even drop by to see if everything is okay. You might just get wind of another project that they would like to do but didn’t know you could do that work. This is getting a client to buy more than once from you. Increasing the number of transactions they do with you will increase your sales.
Finally, when you have done a better job of converting existing leads into clients, increased your average project dollar amount and worked to get your clients to buy more often from you, you can then focus on generating more leads. Most contractors do this in reverse.
Lastly, you must be off the tools. If you are working on a regular basis on the tools, you dramatically reduce your odds of making it to $1 million in sales. It is time to invest in a site supervisor and/or lead carpenter to not only be working on site, but to be directing the workflow at the site.
Start with a lead carpenter and a helper. If you use subs, and have a job average of around $30,000, one team with a lead carpenter can take you to around $500,000. You will need to add a second team with a lead carpenter to keep growing. Depending on your average job size, you will need to add a full-time site supervisor/project manager as you approach $1 million. Visit www.renovantage.com/LeadCarpenter for a sample lead carpenter job description.
This combined function will keep your costs in line relative to your revenue. You need to be freed from the minute by minute, hour by hour, work on site so that you can focus on driving the business forward and working with your prospects to bring in new projects. At this level, your ability to sell is paramount to growing the business. If you are stuck on site then you are not out meeting new prospects.
Managing cash flow and fine-tuning your selling process are the two biggest challenges that you have in growing your business to the $1 million dollar mark. As we said in the beginning, with the right focus you can achieve this level of success.