Profit is not the icing it is the meal.
Let’s start with an understanding of what profit is and why it is necessary, as we all know profit is the money left over after all of the bills have been paid, but as a business owner it is NOT the money you have earned it is the money the business has earned, and the business needs this money. Looking at this closer, you work for the company and get paid a salary just like everyone else, that number for a builder should be in the 7-10% range, an expense to the company and should be recorded on your P&L statement this way, just like rent, insurance and marketing an expense to the company. Now what is left is company profit. The first instinct is to say, well that is my money too, I earned it, NO, the company earned it and it needs it. If you treat profit as salary you are robbing the company of the necessary life blood it needs to grow and survive. You get paid a salary to pay your bills, feed your family and take vacations, yes to live on. The company profit is the money it needs to live on to grow, provide raises, pay bonuses and give back to the community. Without growth there are no promotions, your current or future employees have no opportunities, nothing to strive for, it is a dead-end job and they will stagnate or leave for opportunities your company cannot provide.
The business is a living entity onto itself and profit is the fuel for growth, if it is coasting it is going downhill, the only way to coast. To go uphill the business needs fuel and energy, profit in excess of your earnings. In the beginning this will be tough, the bottom line your company may be losing money on the books, but facts are fact and to look at it differently is to lie to yourself about how much you and your company are earning.
For a typical builder the numbers look like this:
Operating expenses will run about 16-18% of sales which includes 7-10% for owner compensation, as the company grows this line will also include salaries of other management roles, CFO, COO etc. But the ability to expand and hire these roles, when needed comes from company profit, you need your money to live on, you should not take a pay cut to bring on new hires and provide the necessary benefits to attract qualified personnel. Increased sales and the resulting profit will provide the on going capital. For the typical builder this is even more critical as outside capital is difficult if not impossible to obtain due to the nature of the business.
So, operating expenses are a fixed number and to obtain a 10% company profit you will NEED 26% of sales to make that happen. This is the minimum to survive. 26% is not some crazy goal to reach someday, some pie in the sky number it is your bare minimum.
Let’s not forget the math, that is 26% of SALES and to obtain that number the cost of the work must be marked up by 35% to obtain the necessary price. Quick math Cost of work = $100 X 1.35 = $135 price and $35 of overhead and profit. OH&P divided by sales is the percentage of earnings based on sales; $35/$135=26%.
Again, the bear minimum necessary, I say minimum because that is the perfect world, your estimate was perfect, no surprises, no unexpected material cost increases, no weather issues, no issues with client pay., Perfect! That is not construction, it is an ESTIMATE the only thing guaranteeing the value of that estimate is you, anything goes wrong and you eat it. We have all heard it, you need a 10% contingency to guarantee a profit, that 10% can be calculated in the cost of the work or added to the markup but it needs to be somewhere. If it is in the markup to cost you are now at 45%, mark up on cost.
At first glance this may look impossible, but these are the facts, not a dream or a goal just the basic facts needed to survive and grow with out calculating the tax bill. The sofa you just bought had at least a 100% mark-up on cost and that caesars salad you had for lunch did not cost $7.00 but that was the price. If we were all aware of the mark-up on the goods we purchased, we would probably think twice but we accept it because that is what things cost including the cost of doing business. These are your costs of doing business and you need to be aware of them and included them in your price or just like most small businesses you will be out of business within 5 years. Without the contingency the cost will come out of profit and with no profit you are coasting, and coasting is going downhill.
A business provides jobs, benefits, opportunities for your employees to expand their potential. The business can give back to the community, provide training, customer service and warranty. Without profit none of these is possible. These are your costs, like it or not but you need to understand it and factor it in.