How Much Net Profit?
Expressed as a percentage of your volume how much Net Profit is enough? What are your pre-tax Net Profit targets?
- 1 to 5%
- 5 to 10%
- 10 to 15%
- 15 to 20%
- 20% and beyond
How did you come up with the number and what did you base it on?
Edited 1/5/2006 5:36 pm ET by JerraldHayes
Replies
At the moment Jerrald, I'd say 20% plus. That's based on my anticipated billing for the year and what I need to net to lead a "comfortable" life. I'd be willing to shoot for somewhat less as my volume goes up but right now I have to try to be fairly picky about the jobs I take...
Well I think that's a really great target for a Net Profit especially for a relatively new business operation. Most new businesses typically work with 0-5% as they mistakenly think they have to sacrifice profits to the get work and build a client base. Are you paying yourself exclusively out of the Net Profit or are you paying yourself a salary/wage too?
We target a on average a15% net profit but always look for projects and opportunities where we can boost that.
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Just ending my first year full time Jerrald, so it's been a tad variable ;) But generally I pay myself what I need as I need it out of the net. Kept some aside for rainy days (Jan, Feb ;) )
I try to stay away from jobs that will just churn money, and sticking to jobs that will pay me a premium to solve problems... we'll see how it goes.
Jerrald,
I've got a question along those lines. Mind if I E-Mail you?
Robert.
Not a problem at all, go ahead and email me and I'll see if I can help you.
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That's a fun question.. I suppose it depends heavily on what kind of volume you do.
When we first started out, we were shooting for 5-10%. We quickly found that wasn't adequate at all, once we did build up our volume and realized we still were dead broke.
As a growing buisiness at our current volume, we need more than 20%. Less, and important improvements to our business become impossible, and it becomes way too easy to get stuck during a slow period just waiting for that next check to fall into the mailbox... not a fun place to be. My clients need me to work on their systems, not spend all my time nickel and diming my expenses and worrying about paying my bills! With better cash flow come better capabilities as well... better tools for us to work better, smarter, faster, more flexibly. Better ability to help our clients on the jobs that don't go quite as planned without having to grinch over every dime. Frankly I just think it makes everything much smoother.
And whenever I get tired and tempted to scoot through that next job, I look at the profit numbers and am reminded I need to *earn* that money. That means something when you're actually getting something instead of just trying to rush that volume through the door.
It's possible to make the margins without gouging or compromising quality. All you have to do is be *worth* it. I do think when first starting out, price is one of the only weapons you have. But it's a tough one to weild without stabbing yourself in the foot! I still don't know what else a beginning company can do to differentiate except price, without a track record. Of course, you also have time... lots of it... to dedicate to each project to do it way over expectations. Perhaps that is the other way to differentiate early on?
How did others get over that starting hump?
-=Northeast Radiant Technology=-
Radiant Design, Consultation, Parts Supply
http://www.NRTradiant.com
NRTRob - "That's a fun question.. I suppose it depends heavily on what kind of volume you do."
That's actually just what I was thinking about (what does it depend on) and why I brought it up.
I've talked with a bunch of contractors over the last few years who when talking about Net Profit cite either that the Remodelers Cost of Doing Business Study shows remodelers typically reported Net Income earnings (net profits) falls in the range of 6.2% to 8.4% so that's what they target. Interestingly the study I have at hand (1997) says "The average net profit reported by all of the remodelers responding to the survey was 6.8% of sales" but then goes on to say that "The net profit of the most profitable firms in the study (the top 25 percent of respondents ranked by profitability) was 15.6 percent...". I then ask myself why are so many contractors targeting the average rather than the most profitable performance level?
Michael Stone on pg. 186 of his book Markup & Profit: A Contractor's Guide says "You should be making a minimum of 8 percent net profit" but there's no reasoning or discussion on it beyond that sentence. Ellen Rohr in her book How Much Should I Charge?: Pricing Basics for Making Money Doing What You Love doesn't really make any recommendations but does use a pretax net profit target of 20% in one of the contractor examples she profiles. In the PROOF manual on page 66 Irv Chassen writes "It is not PROOF's purpose to recommend or suggest the rate of profit markup..." although in the contractor examples he profiles he often uses 8%.
Still it seems no one offers any reasoning or arguments as to what's a good number to use.
However just the other day I re-read an article I downloaded a while back entitled How Much Profit Is Enough? by George Hedley of Hard Hat Presentations. That got me thinking. In the article he presents some real reasoning as to how to think about Net Profit. First off he writes about a really good point when with "The goal in business is NOT to stay in business. The goal of business is to ALWAYS MAKE A PROFIT" that I don't think a lot of contractors get. How many contractors do we all know who's businesses really aren't businesses at all but just their vehicle to give themselves a job.
But then he goes on to say:
Return on equity, that's a different way of looking at it that I haven't heard anyone else say or write about that I can recall. Equity defined as the net worth of a company or what kind of money the owner has invested in getting the business up and rolling makes it makes a lot of sense to me to figure Net Profit as a return on that investment.
Using his model and lets say you were a start up and had invested $ 100,000 in getting things rolling by buying trucks equipment and setting up a payroll reserve you would then want a $20,000 return on that investment (in addition to paying yourself a salary or wage). Using a Capacity Based Markup strategy you would then take that $20,000 goal and divide it by the number of billable hours you expected to generate in a year and add that to any markup you had already figured for covering your overhead.
If you been in business for a while and your company's net worth is $300,000 like in his example you would want to get a $60,000 return on that investment.
Those dollar figures you could then reverse engineer into a percentage of sales and that 20% on Equity might then appear anywhere within ####range of the range of 6% to 20% of sales. Does that make sense? Hows that sound? I do think that's a better way of looking at Net Profit than just plugging in some arbitrary percentage just because someone says that's what you should use.
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Edited 1/9/2006 8:13 pm ET by JerraldHayes
I think you can spend a lot of time reading and figuring and come to any end you desire. Every point of view and angle is supported my someone. I can give a few hints at how I survived for near 30 years and only hit a few minor bumps along the way. Ended up wits a few nice homes and kids through college with no student loans to pay off. First rule is you have to turn a profit. Making money is not gouging the customer. The contractor who goes broke before the job is finished gouges the customer much worse then the one who earned and extra 5%. Second rule is have a good accountant from day one. Someone who is keeping a close eye on the financial side of the project with an unbiased eye. For someone just starting out SCORE is a great source of experienced, willing and very able help at little or no cost. As the contractor it is very hard to keep the proper perspective while doing the work for two reasons, first you bid the job and are reluctant to admit a goof and second you keep thinking 'I can make up the mistake by saving on the next purchase'. Third rule is when starting out do only one job at a time and FINISH it completely before beginning the next. The is always a temptation to look for a new job as the present one is winding down and it's tempting to take that first check to make the cash flow look better but it is rarely a good idea as you end up with two upset customers as you can't get one finished while trying to get the other started. Forth NEVER get a job because you were the low bidder. 99.9% of the time you are low bidder you screwed up and missed something. If a job is worth doing it's worth doing right. To do a job right you AND your business both need to be paid well. Anyone seeking just the low bidder is not someone you want as a client. That said, if someone can do the job you are doing better for less then they should be doing the job. You charge more than the minimum because you provide more than the minimum. As for an exact number, I always shot for a 20% NET. Net meaning after all expenses including me were paid. The net profit was what the business got as a salary so to speak. The business had a worth and it could have earned 5-6% in savings bonds or near 10% in a S&P index fund. If it was going to work it deserved to earn more for the risks and labor involved. It would be interesting to have that survey you mentioned above go back and see how many of those business earning under 10% were still in business and healthy after 10 years.
PeteVa - "It would be interesting to have that survey you mentioned above go back and see how many of those business earning under 10% were still in business and healthy after 10 years."
There are more recent surveys than that one but I haven't bought them since the data doesn't vary too much from the older ones when you look at them in terms of percentages as opposed to dollars.
However there are other papers and studies I've read from perhaps either Harvard University's Joint Center for Housing Studies or The Associated Schools of Construction website that showed they generally didn't survive.
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Great post!
So, presumably the idea of having a net profit target is in order to know what to bid on specific jobs? One works out all the costs of doing the job, then takes into account the desired net profit target and that's the figure you bid?
What about what the market says?
John
If my baby don't love me no more, I know her sister will.
Edited 1/10/2006 8:34 am by john
Edited 1/10/2006 8:34 am by john
john-
"So, presumably the idea of having a net profit target is in order to know what to bid on specific jobs? One works out all the costs of doing the job, then takes into account the desired net profit target and that's the figure you bid?"
Well not quite Net Profit is only a component part of the Gross Profit and the Gross Profit which includes a representative portion of your Fixed Overhead Costs is what you add to the Direct Job Costs to come up with your bid price.
"What about what the market says?"
Well if the market says it wont pay enough for you to have your company earn a Net Profit then you probably go into another line of work. What's the point of being in business if you don't earn a profit. If your company doesn't earn a Net Profit then at best all you have done is create a meager borderline job for yourself.
Besides that how do you know just what the market says? How does the market speak to us? Many contractors only will charge X for a job because they "think" that's what the market will bear when they really have no idea of just what the market will pay. And it often turns out their problem isn't really in "what the market will bear", it's in their salesmanship skills.
If you can't generate and earn a Net Profit with a business of your own you are actually far better off spending the money it would take set up and run a business on a Certificate of Deposit and then taking a job with a company that can.
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If you can't generate and earn a Net Profit with a business of your own you are actually far better off spending the money it would take set up and run a business on a Certificate of Deposit and then taking a job with a company that can.
It's OK, Jerrald, I believe I've already grasped the importance of making a net profit. I thought this thread was discussing how much the net profit should be.
JohnIf my baby don't love me no more, I know her sister will.
John- "It's OK, Jerrald, I believe I've already grasped the importance of making a net profit. I thought this thread was discussing how much the net profit should be."
It is. But without having a markup in place to cover your overhead costs any discussion about "how much Net Profit" becomes moot and pointless. I certainly can't tell from what you wrote in your post if you already understood what a markup for Gross Profit represents or not. Your earlier post made no mention of it and talked about taking the all the costs of doing the job and then adds to that the the desired net profit and that's then the bid. You didn't make any mention of how you were going to cover your fixed costs of doing business and that's the tragic error that many neophyte contractors make.
While I recognize a lot of the contractors here by their screenames I don't know who "john" is so I have no way of knowing whether you already understood what Gross Profit means and that omission was just a slip of the tongue/keyboard or if you really don't know. And like I said I don't think there's any point in discussing how much Net Profit is enough if a contractor doesn't have margin/markup strategy in place to cover overhead costs.
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I don't know who "john" is so I have no way of knowing whether you already understood what Gross Profit means and that omission was just a slip of the tongue/keyboard or if you really don't know.
Perhaps you should let me worry about what I know or don't know, and proceed to answer the point without concerning yourself as to whether or not I'm qualified to discuss it
JohnIf my baby don't love me no more, I know her sister will.
John - "Perhaps you should let me worry about what I know or don't know, and proceed to answer the point without concerning yourself as to whether or not I'm qualified to discuss it"
John in addition to my contracting business operation I also do management consulting where one of the things I do is help contractors get their pricing and pricing mechanics right. Your statement "One works out all the costs of doing the job, then takes into account the desired net profit target and that's the figure you bid?" is just plain old bad advice. It's outright wrong. This past summer I worked with a roofing contractor client who just took his costs and added 15% "for profit" because he thought that was what he was supposed to do and he couldn't understand why he was always broke and busted. I don't really care so much about you, and what you do and do not know, as I do about all the other contractors that might read a statement like that and think that that's the way it's done. It's not. It's incomplete so it is wrong. I'm sorry that you are so sensitive to the criticism but that but that's what you wrote. And like I've said, I don't think there's any point in discussing how much Net Profit is enough if a contractor doesn't understand and have margin/markup strategy in place that accounts for overhead costs.
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Like I said, leave what I don't understand to me. Don't worry, I'm not sensitive to your criticism. simply amused at your attempts to avoid my point.
This discussion is obviously not going anywhere so I will drop out
JohnIf my baby don't love me no more, I know her sister will.
Jerrald, as usual your thread resonates with me - but for a different reason.
I've just had 2 weeks off, overseas, marrying off a daughter. It was a great time to read David Gerstels' book and think about my small construction business because before we left, I realized that as hard as I work, I had no real money.
Oh, I'm paying off the mortgage and the business expenses, but my wife just lost her job and things are going to get tight.
So, I began to think about systems and profits.
I think Gerstels is right in that having documentation is the basic way to estimate a job's cost. I never did that before, but the first thing I did getting back, was returning to a paper based system rather than a PDA.
I also fired up my computer and looked at my job costing for materials. I realized I made a good profit margin. I also realized I was not accounting for labor profit unless I called in a sub. I have a rough idea for fixed overhead, but during this quiet time (for me) I need to hone my numbers much better.
How much profit is enough? Certainly, because I do smaller jobs, I charge my materials at a higher markup. I do this because I cannot economically order and have a delivery of a $50.00 item. I need to pick the unit up myself.
As far as my net profit goes, I am making an appointment with my accountant so we can discuss business models and cash requirements. I am also doing a LOT of reading and note taking.
In fact, I was going to ask if anyone have David Gerstel's email address so I can address some questions I had about his book.Quality repairs for your home.
AaronR ConstructionVancouver, Canada
AaronRosenthal- "I think Gerstels is right in that having documentation is the basic way to estimate a job's cost. I never did that before, but the first thing I did getting back, was returning to a paper based system rather than a PDA."
Huh? I'm not sure what you mean by that? Were you running your whole business operation off of a PDA? I'm not a big fan of paper based systems (or as I refer to them "Legal Pad" systems) because I think they lead to a lot of unnecessary repetition of data where a computer based system doesn't (or shouldn't) and it makes referring to and/or reusing old data a breeze. However I can't imagine running much of anything of a PDA and I use a PDA all the time.
"I also fired up my computer and looked at my job costing for materials. I realized I made a good profit margin. I also realized I was not accounting for labor profit unless I called in a sub...."
Again I'm not sure exactly what you are saying here too. You're saying you weren't making any Profit on your own labor and only made a profit on the labor you subcontracted for?
"...I have a rough idea for fixed overhead, but during this quiet time (for me) I need to hone my numbers much better."
Are you by any chance using my PILAO Billing Rate Worksheet by any chance or are you using some other planning tools and methods?
"How much profit is enough? Certainly, because I do smaller jobs, I charge my materials at a higher markup. I do this because I cannot economically order and have a delivery of a $50.00 item. I need to pick the unit up myself."
It sounds like your talking about recovering the respective costs of actually acquiring the materials though the markup you put on materials. That may or may not be okay. Personally I don't really like the idea of recovering acquisition costs through a markup because it's not specific enough and we prefer to did it by estimating those costs as Direct jobs Costs. In fact we have sort of an unwritten rule for any job under 10K you have to have a line item in the estimate for the time and money it will take to put the materials on the job in addition to the costs of those materials. That's because sometimes it may be no cost at all if we arrange to have everything delivered but there are other times where like you said you can't get delivery on a $50.00 item. In those cases we budget and plan for the time it will take to get that $50.00 item. So in reality if it takes an hour to get that $50.00 item the real cost to our client for that item if we had a billing rate of $85 per hour would be $135. If it takes an hour to get $500 in materials the real cost of those materials would be $585. That's a huge variation that a standard markup on materials isn't going to cover. The $50 item would need to be marked up 2.7 (270%) and the $500 in materials needs to be marked up 1.17.
The only case I can think of right now where I would use a markup to recover acquisition costs is if let say I had something like an employee who would go out and spend 3 hours every Friday picking up all the materials for all the small jobs we had lined up the following week. That way all the projects would share in that cost of those 3 hours/$255. You would then figure out the average cost of materials that you used in a week and divide that number by $255 to come up with the markup.
Still I think I would still prefer to estimate the acquisition costs as a Direct Job Cost and leave my markup on Materials to account purely for Net Profit. It's more specific and accurate.
"As far as my net profit goes, I am making an appointment with my accountant so we can discuss business models and cash requirements. I am also doing a LOT of reading and note taking."
Make a photocopy of what Gerstel had to say regarding Capacity Based Markups and print out my paper regarding The Problem with Using a Total Volume Based Markup and send it to him ahead of time because believe it or not a lot of Accountants are still unfamiliar with that line of thinking and think only in terms of a Total Volume Based Markup or as Gerstel calls it a Uniform Percentage Markup
"In fact, I was going to ask if anyone have David Gerstel's email address so I can address some questions I had about his book."
I've already looked. I think if you really want to contact him you will have to do it through his publisher who not so coincidently happens to be ....
And hey it certainly wouldn't hurt to ask the question here too to see how people here interpret what's in his book.
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"I'm not a big fan of paper based systems (or as I refer to them "Legal Pad" systems) because I think they lead to a lot of unnecessary repetition of data where a computer based system doesn't (or shouldn't) and it makes referring to and/or reusing old data a breeze."One big mistake was never documenting on paper (or any other way) the time and conditions in doing a job. I would end up being optimistic about the time to do a job rather than factual measurements.
On labor costs I charge an hourly rate - but never accounted for sales and estimating costs for myself. I originally thought that because I'm a "small operator", measurements were unnecessary, even though in my previous life (management) I would never have let my department run that way.Jerrald, I was planning to fail because I failed to plan. I flunked the carryover test. Tunnel vision. In fact, I have your worksheet on my computer, but never used it. Myopic. I'm learning my lesson before I loose everything.I agree with you about the acquisition costs. My jobs are more-often -than-not in the under $500.00 category, so I see the job, give a price, get the materials & return to do the job. Normally, I add what I feel the time costs will be to the estimate, but that leads to a non-competitive bid against my peers. That's why I'm trying to move up from smaller repairs to bigger ones.BTW, my cousin is an MBA who operates a landscaping/design company in LA When we talk, I can often see the same problems in his operation I see in mine. I WILL be bringing info to my accountant. Thanks for the reply.Quality repairs for your home.
AaronR ConstructionVancouver, Canada
AaronRosenthal - "One big mistake was never documenting on paper (or any other way) the time and conditions in doing a job. I would end up being optimistic about the time to do a job rather than factual measurements."
One thing that I guess I've been fortunate (or cursed) to be blessed with is an obsession for taking notes. Back in my college days i used to carry around a little loose leaf notebook that I was always jotting down notes in. A lot of those notes were the times it took for me to complete tasks I was working on. I was working towards a career in design and technical theatre so I would record how long did it take me to draft a light plot, how long did it take to hang it, and how long did it take to cue the show. I can remember early on in my career saying one day as we were dry teaching (cueing) a show if we didn't speed things up we would teching when it came time to start a real rehearsal the next morning and everyone scoffed at me until the sun came up and blared through any open doors in that theatre.
I took a job at one point working in a large shop that produced trade show exhibits and theatrical scenery and one day the shop foreman stopped by my work table asking me what I was writing in my notebook and I showed him how I was not only recording the time it took me to perform certain tasks I was also timing the other people around me too because I knew one day I could use that data.
I sound pretty weird huh?
But it worked out to my advantage.
Yeah just writing it down is certainly better than not keeping any records at all . In fact what I primarily use my PDA for today is it's my timecard.
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"On labor costs I charge an hourly rate - but never accounted for sales and estimating costs for myself. I originally thought that because I'm a "small operator", measurements were unnecessary, even though in my previous life (management) I would never have let my department run that way."
You can either charge for estimates directly or if you still want to "do estimates for free" you can work in the time you spend estimating into your billable rate within my PILAO Billing Rate Worksheet on the Overhead Cost Worksheet on Line 46.
"I agree with you about the acquisition costs. My jobs are more-often -than-not in the under $500.00 category, so I see the job, give a price, get the materials & return to do the job. Normally, I add what I feel the time costs will be to the estimate, but that leads to a non-competitive bid against my peers. That's why I'm trying to move up from smaller repairs to bigger ones."
Nah, it seems you are locked into thinking you need to sell on price and rather than value! (But that's a whole other discussion!) Moving up to bigger jobs isn't going to solve that problem at all. There is gobs of money to be made in the small job market and some people are certainly raking it in.
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john - "
Like I said, leave what I don't understand to me. Don't worry, I'm not sensitive to your criticism. simply amused at your attempts to avoid my point."
I am leaving that to you john. I was only commenting in reaction to what I thought was the incomplete bad business advice you wrote about how to come up with a bid. Don't write something I disagree with strongly and I wont comment.
And if your point was "What about what the market says?" I didn't avoid it at all. Read what I wrote:
Was that it? Was that your point? "What about what the market says?".
I don't think most contractors have any real idea what the market is actually saying at all. They lose a bid and they automatically think it was because of price when it was really due to some other factor that has more to do with their salesmanship skills than their price or just what their Net Profit Margin is. So thinking (mistakenly) that the market is demanding lower prices they cut their Net Profit margin and still lose bids! In one of his lectures one of the things I heard George Hedley say that I thought was really vital and important was:
"....simply amused at your attempts to avoid my point.
This discussion is obviously not going anywhere so I will drop out"
And who's avoiding the point? As I alluded to in my post #67959.8 and my reason for bringing up this topic, there's another whole perspective you can take to looking at how much Net Profit is enough where Net Profit is looked at more directly as a return on your investment (George Hedley's article-How Much Profit Is Enough?) and you certainly didn't address or comment on anything he or I wrote regarding looking at Net Profit as Return On Equity.
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Hiya Jerrald...
Hope you'll excuse a hijack but the recurrent theme of selling on price and "what the market will bear" always gets me revved up ;)
Let me start by saying that I am painfully aware that I am a neophyte compared to most here insofar as contracting for a livlihood goes. But, I've owned two successful businesses, including one that ran for over 20 years in a very price sensitive industry (a large commercial photolab) and until the industry I was in essentially evaporated, we were very successful in avoiding the price bullet. Matter of fact, "the" industry magazine ran a cover story about me titled "Will he be the last man standing?" or something to that effect.
I'm telling this not (merely) to blow my own horn, but to commiserate with the temptation to sell your clients based on price. There is in fact a place for that (witness WalMart) but IMHO there's essentially no future in being a small contracting firm that aims to be the low cost provider. What we sell is not a commodity, there are almost infinite variables and virtually every job has unforseeable pitfalls and complications. The issue involved (as I'm sure you are aware) is called "price elasticity" if those interested want to research it, and while I imagine most folks have a gut understanding of it, doing a little reading on the subject is important I think in an business such as ours.
You can sell yourself on many things: price ("Mr. Fixit - Affordable Home Repairs") speed (Mr. Speedy's - Home Repairs Done Fast") or a high value added... based on selling quality and or intangibles such as superb design sense or problem solving (the last is the market I'm personally trying to address). I think one of the top three "errors" small contractors make (again, with all humility for my newbie status) is failing to identify the market niche that works for them. You simply can't survive nowadays without identifying and marketing yourself to a specific client base. It's like the old saying about being all things to all people. It just doesn't work in a society as fragmented as ours.
I've only been doing this full time for a year, but I had an interesting experience a few months ago. I had a first meeting with a prospect who was apologetic when I came over, saying "I think what I'm looking for is kind of low end for you, but maybe you could give me your opinions, etc". In fact, she was right...it just wasn't the kind of work I enjoy, and consequently I'm no good at it. But most importantly, it told me that I'm creating the image I was hoping for, someone who does "high end", unusual work for clients that don't want a Home Depot kitchen. Nothing wrong with that market segment, and I don't think I'm too good for it, simply not something I enjoy.
Anyway, I've mentioned this before here but if I had to recommend one book as essential for the survival of a small business it would be "Positioning" by Trout and Ries. In my previous business it was the catalyst for me totally redefining what we did and how we did it, and undoubtedly was responsible for us outlasting many of our competitors.
All best wishes,
PaulB
Jerrald,
I have a problem with any financial discussion in residential construction that involves the term "Gross Profit" because Gross Profit is customarily calculated as Revenue (-) COGS, where COGS includes the cost of labor.
Net profit is defined as Gross Profit (-) Overhead, but there is no place in the customary way of doing things to assign field labor to Overhead, nor can we assign the cost of non-billable hours of our field crews to COGS?!?!?!?
Unlike every other business model, residential building contractors have labor costs that cannot be attributed to COGS if we are to understand our true cost of making a Unit of Sale. There is also the consideration that every one of our Units of Sale are unique, not just across the industry, but within each company.
The problem, as I see it in a graphic manner, is that, using periodical P&Ls we will never see a true statement of what is happening overall. We will either see a great report while at the end of a job or a terrible report at the beginning when we are still waiting for the owners payments to catch up with what we have spent to date. And how about the times between jobs.
A monthly chart of Gross Profit as a percentage of sales would look like:
-% -% 80% 70% 60% 70% 60% 50% 60% 50% 40% 50% 40% 30% etc.
to eventually if we had managed to start one job on the first of the year and had just completed the last job of the year, arrive at a true and usable figure for that year.
SamT
SamT - "Jerrald,
I have a problem with any financial discussion in residential construction that involves the term "Gross Profit" because Gross Profit is customarily calculated as Revenue (-) COGS, where COGS includes the cost of labor."
Well,.... this discussion isn't really about Gross Profit at all or at when I started it that wasn't the direction I was headed in which is why I called it How Much Net Profit? and I linked to a definiton of Net Profit so that hopefully people wouldn't mix up and confuse the two.
"Net profit is defined as Gross Profit (-) Overhead, but there is no place in the customary way of doing things to assign field labor to Overhead, nor can we assign the cost of non-billable hours of our field crews to COGS?!?!?!?"
Well I can't speak for Total Volume Based Markup advocates but I can say in the Capacity Based/PROOF methodology the non-billable hours worked by production labor are distributed accross all the projects Direct Job Costs by making them part of the Labor Burden calculation. They therefore become part of the Cost of Goods Sold. Why is that a problem? You are saying that you think that's a problem aren't you?
"The problem, as I see it in a graphic manner, is that, using periodical P&Ls we will never see a true statement of what is happening overall. We will either see a great report while at the end of a job or a terrible report at the beginning when we are still waiting for the owners payments to catch up with what we have spent to date. And how about the times between jobs.
A monthly chart of Gross Profit as a percentage of sales would look like:
-% -% 80% 70% 60% 70% 60% 50% 60% 50% 40% 50% 40% 30% etc."
Well you wouldn't see quite the array of numbers you gave there. Gross Profits of 80% Wow! They would typically fall more in a range of 10% to 40% but yes they would fluctuate. The whole point of my beating the Capacity Based Markup drum over and over again is that in a Capacity Based Markup system that the range of fluctuation is dramatically reduced when compared to what you get in a Total Volume Based Markup system. Looking at two contractors doing the same kind of work with the same overhead costs the Capacity Based Markup Contractors Gross Profit might range month to month from 34% to 37% where the Total Volume Based Markup Contractors Gross Profits would range from 25% to 45%. The both average out to 35% but one fluctuates month to month more than the other. The Total Volume Based Markup Contractor would have months where the cash flow looks like it really coming up short.
Then again how a contractor looks at, manages, and reports their earning also effects that range too. Percentage of Completion billing and accounting is generally a better way of looking at and managing a company from a cash flow perspective. (see Steve Maltzman Better Cash Flow with Percent of Completion Accounting about a third of the way down on that page).
And it can be argured that a more refined approach of Earned Value Management is even better than simple Percentage of Completion.
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I found another penny in my pocket to pitch into the pot. Net profit being the topic. Net profit is earned by the business, wether 1 man or a thousand it is what is left over every everything has been paid for, all wages paid and overhead expenses paid. Net profit is only shared with the tax man. A one man business should be both paying the individual a wage as well as earning a net profit. If there is a week of no work that wage should be paid out of overhead/operating expenses NOT dipped out of any net profits that there may be.
As for non-billable hours I don't see how you can have any. I can see bad planning or estimating when first starting out but one line on any bid computation is Overhead (insurance, vehicles, gas, tools, light bill, phone, office rent and a figure that is best learned thru experience for those hours you know will be spent in traffic etc). Another important line is Labor. This also has to be billed at the cost to the business not the rate paid to employees. I've never had a man that was paid $10/hr cost less than $15 and more likely $20 and for a moment to mention gross profit, this labor has to be billed around $25. I may sound high but when looked at carefully comes close. The business has to make a profit on all labor. A final parting note I never marked up materials at all. I always figured I was selling a service and not materials. Any customer who asked was welcome to any bills for warranty purposes or any other reason they may have had. I also had a target market and for many I was over priced but there were always enough to keep me busy that were willing to pay my price for the services I provided. A few slack moments there would be time to give some little old lady a roof or new furnace at cost but bottom line at the end of every job every nickle was accounted for and any planning errors adjust both up and down as needed.
Pete,
You said, "As for non-billable hours I don't see how you can have any."
I think we're having a communications problem here, 'cuz I don't see how any construction company can not have non-billable hours of labor costs.
You bill the client for the time someone actually spends at the clients jobsite, but who do you bill for the time when you are sitting in the office. Or for when you have the laborers washing the truck? Or whatever?
SAmT
SamI guess I've just never spent enough time in the books explaining how I should be listing things but I know how those hours are seem by myself.These days all my work is time and materials. When I submit a bill one line is 'Overhead' as of right now that item is 20%. That is when my time spent in traffic, hours spent planning for the next days/weeks work and probably a few minutes spent on my laptop in the truck in BT :-) gets added into the equation. I guess some argument could be made as that not being totally fair to the client because some of his money pays for time spent in the office he's paying the light bill for, working up numbers for the next job. His job numbers were put together on overhead time paid by the last client so in my mind all is well. My accountant sees is as a proper way to account for time.Doing one project at a time these days makes it simple but in the days when I was doing several I still made sure the overhead line had the time you would call 'non-billable as well as a day a month for the gang to spend as 'shoptime' getting tools all collected and checked , trash to the dump, place cleaned out so it could be walked thru and those little lost pasts found and put back in the proper tool box.
PeteVa - "...A one man business should be both paying the individual a wage as well as earning a net profit."
That's a really great point but unfortunatly a lot of solo or small time operators just don't seem to get that.
"As for non-billable hours I don't see how you can have any."
Unfortunately they do occur and they are a fact of life. Whether they are training, tool maintenance, or time spent drinking coffee waiting for the lumber truck to arrive. Also paid holidays and vacation time is non-productive time that still needs to be accounted for and paid for in some way Given that you just need a methodology to account and pay for them in some way. I think Shawn McAddens February 2002 JLC Calculating Labor Costs article does a good job of explaining how we account for that time and it's the same thinking I used in the PILAO Billing Rate Worksheet.
"A final parting note I never marked up materials at all. I always figured I was selling a service and not materials...." Well I do understand and appreciate that sentiment and thinking, that's how we see ourselves too but I still think since the service we perform provides a new finished product that didn't exist before any contractor should be entitled to a Net Profit on the materials (and subs) that were part of the project so we mark up our material (and subcontracting) costs to earn a Net Profit on them.
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Jerrald,
Didn't get a chance to E-Mail you but I will shortly.
In the mean time you just hit on something I've been wondering about.
PeteVa - "...A one man business should be both paying the individual a wage as well as earning a net profit."
That's a really great point but unfortunatly a lot of solo or small time operators just don't seem to get that.
I was for some time a one man show. I've had the last four years to look back on that time and see my successes and failures for what they were as oppsoed to what they appeared to be at the time.
During those years, I never made a "Profit" net or otherwise. My rate was based on what I needed to make, what it cost me to make that amount, and whatever else I thought I could get out of a job. Not a very effective way of doing things.
One thing I've noticed is that it is hard to have a relevant discussion about things like profit without some knowledge of a persons business model and expectations.
I have a friend who runs a very legitimate business, keeps perfect books, tracks every job and knows where every penny goes. He covers his overhead and expenses, pays himself, and his business makes a profit. If you ask him I bet he'll say 20%.
I have another friend who has no idea how his business runs. All his funds are co-mingled with his personal banking. His prices are worked out on a legal pad and given on a generic form from staples. He works, works, works, pays his bills, takes whats left and starts all over again next job.
Both work solo or with one helper most of the time.
This year around the Holidays we all went out for a few drinks and the subject came around to money and business. The friend who runs the squared away business told us he had paid himself exactly $37,800 to date for the year. He was gonna have enough left for a $5K bonus and maybe a few tools he wanted. The friend who has no idea how his business runs took a guess and came up with maybe $105K that he had paid himself for the year. ( We've been friends for some time and partnered on some jobs. Based on lifestyle and past experience, if anything that guess is probably $10K low.)
So all this brings me around to what should the Solo-small operator realistically expect to make? How much is he making before he adds profit and overhead on?
My wife has a had enough of Uncle Sam's reindeer games but Uncle Sam can't exactly decide if he needs my services any longer. In the mean time I've had some time to look at my past business and see where I'll go once I'm on my own again.
One thing I've noticed is that a lot of my friends who are trying to do it right, Pay taxes, carry all the insurance they should have, plan for retirement and plan for an emergency/disability type situation almost all bring home less than what mt E-7 paycheck is. And, to be honest, I find that a little disheartening. If as group we don't expect to attain a certian comfort level or lifestyle 10% net could be another mans 50% net.
Jerrald,
You said, "Well I can't speak for Total Volume Based Markup advocates but I can say in the Capacity Based/PROOF methodology the non-billable hours worked by production labor are distributed across all the projects Direct Job Costs by making them part of the Labor Burden calculation. They therefore become part of the Cost of Goods Sold. Why is that a problem? You are saying that you think that's a problem aren't you?"
In CBM the cost of non-billable hours is recovered across all projects. Where are they reported in a P&L or other managerial financial report?
Yes, I realise that non-billable hours are ultimately a part of COGS, however it is not a Direct Cost of any particular job. It's a part of Overhead. Or is it?
My point is that the customary financial reports don't do a good job of telling us what we need to know.
If I want to know the labor portion of the Direct Cost of a job, I would normally look at the payroll reports. If I can only see the total billable rate charge for a Job I would have to reverse engineer that figure to arrive at the Direct Labor Costs for that job. It gets more confusing under these scenarios if I hired some crew temporarily just for that job. They are Direct Costs, but I am not recovering any Overhead except that assignable to that hire. The balance of the difference between the Billable Rate and their actual cost would be extra Net Profit.
Consider the following scenario:
Total cost of labor per year is 2000 crew hours, disregarding manager supervision.
All units sold are identical w/no markup on material so we can disregard it's effects.
In year 1, I build/bill X units, the next year, I bill/build 2X units, recovering 2000 crew hours each year. When I compare the two years I see that in the second year, the direct cost of labor per unit sold is cut in half and the labor charged to Overhead disappeared. I also see that I made exactly twice as much Net Profit the second year.
How is it possible that I could cut Direct Costs in half and eliminate labor Overhead and only double my Net Profit with twice the units sold?
Poor financial reporting.
I am trying to envision a system of reports that will help me know what is going on in my business. I am thinking that I want to run some sort of a "P&L" on each job in particular, then run a P&L on the business only at the close of a job. I'm not sure how to work this for a time when two or more jobs are running concurrently, perhaps a method of "averaging" those jobs that aren't closed out.
SamT
SamT - "In CBM the cost of non-billable hours is recovered across all projects. Where are they reported in a P&L or other managerial financial report?"
They (non-billable hours) don't appear on a P&L at least not as their own dedicated item. They are however represented there in that they are amortized over the cost of labor as a function of burden you have placed on your own company's direct labor.
Yes, I realise that non-billable hours are ultimately a part of COGS, however it is not a Direct Cost of any particular job. It's a part of Overhead. Or is it?
There are really two kinds of Overhead. Fixed and Variable. The non-billable hours are part of burden which is Variable overhead.
My point is that the customary financial reports don't do a good job of telling us what we need to know.
I disagree with that based on your example below (I'll explain in a second). The standard financial reports are fine for what they are intended to report.
If I want to know the labor portion of the Direct Cost of a job, I would normally look at the payroll reports. If I can only see the total billable rate charge for a Job I would have to reverse engineer that figure to arrive at the Direct Labor Costs for that job.
The total billable cost is the Direct Labor Cost for any particular job! You don't need to reverse engineer anything!
It gets more confusing under these scenarios if I hired some crew temporarily just for that job....
it's not confusing at all. If you hire temporary labor, they are then subcontractors not employees, or at least they should be. If you are hiring and firing people as employees whenever you need them for a particular project you are really making your accounting and planning life difficult and you probably will have other even bigger management problems on your hands too.
They are Direct Costs, but I am not recovering any Overhead except that assignable to that hire.
Yes they are Direct Job Costs but they aren't [your] Labor, they are Subcontractors. What kind of overhead (or whose overhead) are you talking about trying to recover? Your Overhead is recovered as a function of YOUR time that you spend supervising them. The overhead on them is recovered as part of the rate you are being charged for their use by their employer.
The balance of the difference between the Billable Rate and their actual cost would be extra Net Profit.
That's true but I have a good hunch your saying that is coming from different realm of thinking than why I say that's true. We hire temporary labor at times. Either as genuinne authentic subcontractors or from a temp agency. We have no real overhead costs associated with them generated at all. However we do have direct job costs generated associted with their hire. Our own employees need to supervise or schedule them and our employees billable rate recovers our overhead and Net Profit on our time. We also then markup up those subs for Net Profit too so we earn something off of using them. They don't however generate overhead costs for us so we have no markup for recovering overhead cost on their use.
Consider the following scenario:
Total cost of labor per year is 2000 crew hours, disregarding manager supervision.
All units sold are identical w/no markup on material so we can disregard it's effects.
In year 1, I build/bill X units, the next year, I bill/build 2X units, recovering 2000 crew hours each year. When I compare the two years I see that in the second year, the direct cost of labor per unit sold is cut in half and the labor charged to Overhead disappeared. I also see that I made exactly twice as much Net Profit the second year.
Well your scenario while hypothetical it's really an impossible case. Your math is correct, you would of course make twice as much Net Profit because you doubled your crews productivty! You increased productivity 100% which is pretty much a real world impossibility.
How is it possible that I could cut Direct Costs in half and eliminate labor Overhead and only double my Net Profit with twice the units sold?
Poor financial reporting.
Not at all. Your finincial reporting was just fine. The hypothetical scenario you described is for all intents and purposes practically speaking impossible. It has nothing to do with poor financial reporting.
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Jerrald,
Well, you've torn up or declraed every thing I said as imopossible.
I guess you don't know what I trying to say and or ask.
You said "The total billable cost is the Direct Labor Cost for any particular job! You don't need to reverse engineer anything!"
What the heck is Total Billable Cost in Proof? It can't be Billable Rate time Billable hours. That would make revenue equal to costs. Again disregarding material.
You said "They (non-billable hours) don't appear on a P&L at least not as their own dedicated item. They are however represented there in that they are amortized over the cost of labor as a function of burden you have placed on your own company's direct labor."
Well No Duh!
So what was MY COST TO BUILD THAT HOUSE???????
Don't tell me that my cost on that house includes my cost of having my guys stand around because that is a cost I have whether I sell any units or not. The total amount of hours they "stand around" is an inverse function of sales and it is good to get them off their azz.
Overhead costs have been defined as the cost of staying open for business without any sales.
it's not confusing at all. If you hire temporary labor, they are then subcontractors not employees, or at least they should be.
Yeah, tell it to the IRS.
If you are hiring and firing people as employees whenever you need them for a particular project you are really making your accounting and planning life difficult and you probably will have other even bigger management problems on your hands too.
And just what has that got to do with a discussion about where to assign certain costs? I spent many years getting hired the day I showed on site and getting RIFfed the day the job was over.
but they aren't [your] Labor, they are Subcontractors.
Yes they are and not they're not.
Yes they are Direct Job Costs . . . What kind of overhead (or whose overhead) are you talking about trying to recover?
That's my point, there is no OH on them to recover. And if you charge at the same PROOF rate as your regular crew, AND call Total Billable Hours a Direct Cost to the job, you are skewing your Direct Cost all over the place.
However we do have direct job costs generated associted with their hire.
Well, yeah. You get a bill for them, don't you?
Well your scenario while hypothetical it's really an impossible case.
IT IS ILLUSTRATIVE, JERRALD! Do you understand me better when I talk louder? (|:>)
Your math is correct, you would of course make twice as much Net Profit because you doubled your crews productivty! You increased productivity 100% which is pretty much a real world impossibility.
And what has THAT got to do with a discussion about allocating Net Profit?
Not at all. Your finincial reporting was just fine
Nope. Mine sucks.
SamT
Jerrald,
Ok let me make one thing perfectly clear
THESE ARE NOT REAL WORLD NUMBERS. THEY ARE NOT HYPOTHETICAL NUMBERS.THEY ARE JUST SOME FIGURES I CHOSE FOR EASE OF MENTAL CALULATIONS
ok?
I don't know if this is what you are saying, but it is what I keep hearing. That is, that part of the Direct Costs are the billable hours times the PROOF Billable Rate.
You said, "The total billable cost is the Direct Labor Cost for any particular job!"
Assume that I pay my guys enough so that when Uncle Sam and his State cousins get done with me, they cost me @20/hr. Further assume that PROOF tells me to add $20/hr on top of that to recover my OH and Profit. Finally, let's assume that the $80K job had $30K of material which I marked up 33.33% for a material charge of $40K. The labor bill was also $40K. See how nice those numbers I used are to work with?
Using the method I hear you saying, I would have Direct Costs of 30K for material and 40K for labor with a Gross profit of 10K. I already know that is not the case, so don't bother telling me that.
So what are you saying?
SamT
Jerrald,
What I'm saying is that financial reports have to be timely, that is they have to be an accurate reflection of the state of the company at the time the report is made. They also must be consistant, that is, they can't amortise part of a cost one time and not some other time. They must be able to handle all possible circumstances, even those that are not likely to occur or only rarely occur.
When I am reviewing a year I don't want to see any Variable Overhead included in the COGS column.
Assigning non-billable hours to the Cost of Goods Sold means that without spending one less penny out of my pocket, COGS goes down if I just work more hours even if I still right the same number and total amount of checks for each job done.
That would mean that the COGS/Revenue ratio would appear to change merely by changeing the number of units sold that all cost the same.
There are really two kinds of Overhead. Fixed and Variable. The non-billable hours are part of burden which is Variable overhead.
Well I can't speak for Total Volume Based Markup advocates but I can say in the Capacity Based/PROOF methodology the non-billable hours worked by production labor are distributed accross all the projects Direct Job Costs by making them part of the Labor Burden calculation. They therefore become part of the Cost of Goods Sold.
First, you are saying that some Overhead is part of COGS, second, I have to disagree. Merely distributing the recovery of part of your Overhead does not change it to Direct Costs. PROOF also distributes the cost of office staff, office rent, Marketing, Sales, pencils and paperclips across all the Projects Direct Job Costs. Does that make them part of the Cost of Goods Sold too? No.
See what http://www.auditnet.org/misc_frm.htm has to say about Labor Burden: Answer: Labor burden is the contractor's actual costs for worker's compensation and liability insurance, payroll taxes, social security and employees' fringe benefits (including employer paid health insurance) imposed on the basis of payrolls. This burden must reflect the variability of some burdens, i.e. social security.
From: http://www.bized.ac.uk/learn/business/accounting/busaccounts/notes/cogs-ex.htmWhat is Cost of Goods Sold?
Cost of goods sold is also sometimes phrased as COST OF SALES.
The cost of goods sold is the costs actually incurred in producing the product or service. It is the direct costs of production. It does not include the indirect costs, which may be things like administration and marketing costs. These cannot be directly attributed to producing the product and so are not included. [ed; Emphasis added]
The cost of goods sold for a production company will include things like raw materials, energy and labour used to produce the product. For a retail company such as Marks and Spencer it will be the total amount they have paid to their suppliers for the products they sell on the shelves.
And finally, from :http://fast.faa.gov/pricing/98-30-C7.htmTable 0-1. Direct Labor Terms and Definitions
Terms
Definition
Direct Labor
Work performed by individuals which is directly related to a specific cost objective. This work is readily identifiable with a particular product or service.
Indirect Labor
Work performed by individuals which is not identifiable with a single final cost objective but is identified with two or more final cost objectives or an intermediate cost objective. One example of indirect labor is the work expended by the controller of a company. The controller’s work is not directly identifiable in the production of a specific product or service, since his or her work is spread across several projects or tasks.
Labor Hour
The unit of time by which direct labor activity is measured.
Labor Rate
The dollar amount paid to an individual per a given amount of time in consideration of work accomplished.
Labor Cost
The product (i.e., result) of multiplying labor hours by appropriate labor rates.
The problem is that we are not strictly a production business, although we manufacture goods. We are not strictly a retail business, although we buy and sell goods. And we are not strictly a service business, although we do provide a service.
Some of us avoid the retail aspect by not marking up any goods sold and some of us try to stay purely a service business by working T&M.
Any Financial reports that we as a group use must be able to handle any mixture of all three models. Remember, non-billable hours is not the same as non-productive time. Those non-billable hours are used for vehicle maintenance, office building repairs, and other things for which the cost must be assigned in order for us to understand our business. Would you have us double assign that time, once to Direct Job Costs, and once to building maintenance, or should we assign a $0.00 cost the the actual task that used the labor?
SamT
Don't miss this site, Jerrald.
http://www.imanet.org/ima/sec.asp?TRACKID=&CID=1577&DID=3405
"What about what the market says? " The market rules!!!!!! Setting up a Bently dealership next to a homeless shelter probably isn't smart business move, wrong product in the wrong market.
The product you are offering should determine the market you target. If all you are offering is your sweat and muscle then look for a neighborhood that can afford $10/hr. Should you desire to add some mental activity then you should look for a bit higher rate. Kick in some tools and experience and you hopefully are nearing the $40/hr rate. If there is no market for what you have to offer either the product is defective or there is no need. In that case you must either change the product or market.
You will find the range of market planning ranges from NEW COKE to Pet Rocks.
You will find the range of market planning ranges from NEW COKE to Pet Rocks.
Whoo Yah!
I always shot for a 20% NET. Net meaning after all expenses including me were paid.
For a small business your description of "NET" is a little different than most. Most small businesses describe their "NET" as EBITDA/OD - Earnings Before Interest, Taxes, Depreciation, Amortization and Owner's Draw. Typically a small business owner pulls their income out of the business profit.
We're pretty much talking about the same thing, just different ways of slicing it. At the end of the day I don't think it matters much whether you call it net before owner's draw, or net after owner's draw. But the percentage at the bottom line will vary greatly depending on whether the owner's draw is above or below that net line.
As an fyi to the group I work pretty closely with five different service businesses (one of which is construction related). Our average net across the group is about 12%, a "good" business will do about 15-16%, and the very well run businesses will do 18-23%.
- Rob
Great idea for a thread Jerrald.
J. D. Reynolds
Home Improvements
How much net profit is enough?
What ever the market will bear. PUt out estimates with what you need after all your expenses are covered and if you get no jobs, then you may figure you are too high.
I guess it all depends on what you are in business for; part time to keep busy, to buy a house or make the house payment; feed the kids or charity work.
That's the beauty of entrepreneurship; the freedom to chose for yourself what you want to do and what you want to earn, your regulation being the marketplace.
>>How much net profit is enough? What ever the market will bearBingo!
i don't know if I can answer your questions, but I'll take a shot at it. I pay myself a regular monthly salary, and I like to have my salary and overhead covered by the end of November, so I guess I am looking for a net of 8%. Although I actually expect little income around the holidays.
Doesn't always work that way. In 05 32% of gross sales was material and sub costs, 17% was overhead costs, and 51% was salary and net. This did not cover it and I lost ground to the tune of $5,600 to the position I was at the start of the year.
I had a few expences that were 1 time shots last year, (Trailer, lawyer fee for LLC, and bought a bunch more scaffold) But I made those commitments before August, and things had been going well up to that point. I did not get a large job I had anticipated for fall, and things really dropped off after that. (plus I realized I wasn't going to meet my goals and that took the wind out of the sails)
Bowz