In our Markup and Profit classes, I use the following criteria to tell if a company is making money. This isn’t the only measure, but from a practical standpoint it will give you an idea of how your business is doing.
First, look at your most recent Profit and Loss statement. You should have at least an 8% net profit. That is the absolute minimum necessary for your company’s long-term survival. (It’s also okay to have a larger net profit.)
Second, are you paying yourself a regular salary? Your salary should be enough to not only cover all your personal bills, it should allow you to save 10%, give 10% and pay your personal taxes. This is an overhead expense, and is not paid out of company profits.
Third, if your spouse is working with you in your business they should be paid a salary equivalent to the work they perform. A good rule is to pay them what a competitor would pay for the same job.
Or if your spouse is physically working on jobs, they should be paid by the hour. Again, the pay should be equivalent to what a competitor would pay for the same work.
This is not “double dipping” as some might suggest. If you don’t charge for everything that you are doing, your reported job cost and overhead expense will not be accurate. Because your actual overhead expenses are used to calculate your markup, your markup will be too low and you will not charge enough to cover your job and overhead costs.
Not everyone is willing to work for free. If for any reason you or your spouse are not able or willing to continue to work for free, you will need to hire someone to do that work. Get in the habit now of being paid by your customer for all the work performed.
By definition, breakeven is the point at which your total revenue equals your total costs for the year to date. If your Profit and Loss statement doesn’t show any net profit (and no loss), you are breaking even. This means that all of the money you brought into the company has been spent on job costs or overhead. You obviously won’t start making money until your total sales exceed your total expenses. The smart businessperson gets to that point as early in the year as possible.
To determine the sales you need to breakeven, divide your total overhead expense for the period by your percent of gross margin. (Gross margin is your gross profit (overhead and profit) divided by your total sales.) The formula looks like this: Breakeven Sales = Overhead ÷ Gross Margin. If you sell this volume at your correct markup, you will recover enough after all job costs to pay your overhead expenses. The remaining volume you sell for the period will provide your profit.
(Breakeven is covered in Chapter 2 of Markup & Profit; A Contractor’s Guide Revisited.)
Almost every business owner has the opportunity to lose money at some point in time. I don’t recommend it, but it happens. When you look at your P & L statement and you have a “−” in front of the figure labeled net profit, you have lost money. It is obviously time to make some changes. If you don’t, the next P & L will show you an even larger number behind the “−” sign.
It can be difficult making changes, but if your P & L is showing a negative number and you are resistant to change, review Cardinal Rule # 4, the one about keeping your ego in your pocket. If a change is needed, make it. One of the most exasperating things I see is a contractor on the verge of going broke, about to lose their home, car and everything else they own, and still refusing to make necessary changes to the way they run their business and conduct day to day activities.
There are other early warning signs of losing money, even if they don’t show up on your Profit & Loss.
- Cutting your sales price to get a job
- Inability to pay credit cards at the end of the month
- Partial or no payments on bills due
- Paying old bills with money from new jobs. Not only is this a warning sign, but many states now have laws against this practice. Be careful!
- Not paying employees on time
- Checks bouncing
- Owner or spouse working on jobs for no pay, and/or owner or spouse not taking a regular salary. We covered these earlier. If you can’t pay yourself because of a lack of cash flow, it’s a sure sign you are headed for trouble
Next week we’ll discuss how you should proceed depending on whether your business is making money, breaking even or losing money.