We had an excellent turnout for our most recent webinar on profitability. However, we had a number of questions that we did not have time to address during the program. We will take the time to answer them now on our blog.
Q: Help me understand the issue of cash flow and how it relates to growing a business?
A: First, it should be obvious, more sales means larger payrolls for those installing or servicing the products. If salespeople are in the mix, they are frequently given advances.
Now the simple arithmetic (apply it to your own actual amounts)
If you were doing $500,000 per month that equals $6 million dollars per year. To make this as simple as possible, let’s say you earn 10% pre-tax net, that’s what’s left after all bills, operating expenses, etc. are paid. At this point, with very rough math, from $6 million dollars, you’re going to earn $600,000. (Not accounting for depreciation, amortization or special one time charges)
Next, estimate your turn time; if you’re selling/installing windows, roofing, siding, cabinet refacing, etc. from the time you get the order with approvals for credit, etc. the average for most of these products is 5-6 weeks from the day you get the order, the job should be complete.
At this point, you have 6 million dollars, less your net profit of $600,000 leaving you $5,400,000 in expenditures.
Next, remember your turn time is 6 weeks. We divide that into what we call a networking year (52 weeks – holidays, sick or lost days, etc. = 48 networking weeks). Now divide that 6, which is your turn time, into the working weeks and you come up with 8 turns per year. You are turning your operating capital over 8 times.
Remember, you ended up with expenses of $5,400,000 and you come up with a figure of $675,000 capital needed (scary isn’t it). Remember this is rough mathematics. What helps makes it workable is getting deposits (25-40%) on every job, which is sometimes more difficult on jobs which are financed, but you may get progressive payments on those as well. Now do your arithmetic. If it takes you more than 6 weeks for the turn, you will need more than that. If your turn is less than 6 weeks, you’ll need less. In our recorded series, “How to Run a Profitable (or More Profitable) Business, we explain this in greater detail and examine dozens of ways to increase operating capital.
Q: How do we combat the internal resistance to needed price increases?
A: The word combat implies that there are those in your company who fight price increases. This usually comes about for reasons no different than price resistance when you are selling in the home. The “value” hasn’t been established. The issues of your marketing costs (leads), equipment, depreciation, training, hospitalization, rent, light, heat, all of the factors, which go into maintaining your company are only available through profitable revenue.
Balance the latter against the fact that most salespeople believe that your company needs “better quality leads” and “lower prices”.
To be blunt, your people need better training to sell the value of the products you market. Price increases when created by vendors, should allow you ample time to advise your sales staff and have them close out anything, which is “pending”. Improve the training you give your salespeople on selling value. Handle all price increases the same way. Have training meetings on price vs. value. And don’t forget to present the Total Offer Concept.
Above all, don’t let price issues dominate your sales meetings.
Q: Where do pricing formulas come from in most companies?
A: Unfortunately, these often come from someone else’s pricing method. Such as a previous employer’s, competitors, or an oversimplified formula (which is very archaic), which relates to multiplying your cost of goods and services to establish a price. As an aftermath, salespeople are permitted discounts and other latitudes, which enable them to give incentives or “drops”. The unintended consequence of these pricing methods is usually less or no profit.
A price list should originate from known and current prices for both material and labor. Example: if you take the cost of one square of roofing and add to it, the cost to install the one square of roofing, you now have the base cost to supply and install the one square of roofing. Obviously, issues such as tear off, underlayment, special flashings, linings, etc., also contribute to that one square cost. These can be priced independently or grouped in the per square price.
Next, (from your operating statement) examine what are the actual costs, annually, monthly, etc. for your general and administrative costs (often called overhead), plus your selling costs and your marketing costs. These are all percentages and let’s assume for the sake of argument, that all three of these latter items total 50%.
Next, assume that you want to make a 10% pre-tax profit. 50% plus 10%, now equals 60%. These represent all of the extraneous costs relative to producing a profitable sale.
Next, think of your selling price for one square of roofing as being the difference between the 60% example above and the cost of the labor and material at no more than 40%. The combination adds up to 100%, which equals your selling price.
Now here’s the final step.
Remember, you have to be covering all of the expenses named above, plus that 10% net-profit you want to earn. If the actual cost to provide and install one square of roofing material is $150, divide that number by (.40). Equals $375, which is the per square price for that roof, covering operating costs plus selling and marketing and that 10% pre-tax net profit.
However, note that there is no allowance in this price for incentives/discounts and if you were to give a 10% discount on your selling price when it is quoted you have wiped out your profit. If the discount/incentive represents something you offer regularly, it also has to be factored into your price.
I know this sounds complicated; however, it really isn’t. In fact, once you prepare your prices in this format, salespeople are required to sell at these prices in order to receive the 10% commission they can earn if the job is sold at the right price.
Q: As part of your methodology to retain 10% to 20% pre-tax net, how do you handle a salesperson selling a short (less than the price listed) contract?
A: We have seen and heard all the formulas and most of them “schtink”, which is a lot worse than “stink”.
The minute a salesperson elects to (authorized or not) break a price below any authorized incentive you offer, he/she is giving away a portion of your profitability. So, think of this formula.
Example: A job, which should sell for $5000 and the salesperson brings it in at $4500. Your 10% pre-tax net is $500. His 10% commission (if sold with the proper pricing) is $500. In essence, he has just given your (or his) $500 away. If you unwisely split the difference, you are probably encouraging the practice if you want to do the job (only after re-measure). When the job is completed, you might give the salesperson 1 or 2%.
This may seem a rather cold, callous method to adjust in contracts sold short. We don’t perceive it that way. Its presence as a standard adjustment will often reduce the number of short jobs sold.
Often the salesperson claims that his jobs are often sold with generous (calculations) measurements. (Go back to the formula for pricing). The salesperson cannot be held accountable for faulty material, unwanted adjustments made for installation, but all things considered, the creation and control of selling practices together with a standard adjustment method enables management to protect their net pre-tax profit projections.
You can further evaluate a salesperson’s “price efficiency” by checking job costs and measuring the outcomes – do they exceed the 40% allocation for labor and materials? If 40% was exceeded, did the salesperson’s pricing create the problem?
This is only part one of of the questions we received and our next blog posting will address further questions, so be on the lookout for that.