By REMODELING Magazine Staff. Back in the June 2000 issue, we set the REMODELING benchmark for net profit at 10%. How do real-world remodeling companies measure up? According to financial data collected twice annually by Business Networks from each of its 100-plus remodeling company clients, the average net profit actually reported is just over half of the benchmark. For the majority of these remodeling companies -- those with sales volume in the range of $500,000 to $2.5 million -- average net profit is 6.15%.
It would be premature, however, to declare on the basis of this evidence that a benchmark of 10% net profit is unrealistically high. Net profit earned and net profit reported are not the same animal. Reported net profit is lower because every company employs any legal means it can to reduce tax liability. The simplest and probably most universal example is the Christmas tool buy. Plenty of companies purchase new equipment -- computers and copiers for the office or bench tools for jobsites -- at the end of the year, just before tax time. It's a legitimate way to upgrade company inventory and reduce taxable income at the same time. Such purchases are discretionary in the sense that, were profits not strong enough, they could be postponed without compromising performance. Depending on how big the company is and how generous Santa Claus is, this kind of year-end buying can take net profit down as much as a point.
Another phenomenon is common in boom times. It's the tendency of company owners to upgrade their company vehicles more often than is necessary to provide reliable transportation. This typically involves splurging on accessory packages and detailing that boost ego and reduce profit. Other types of discretionary spending have the same effect on profits. The cost of the company's health insurance plan, for example, is a discretionary use of money that would otherwise show up as net profit. The trade-off, of course, is that health coverage helps attract and retain a top-notch work force. The same is true of a bonus system that helps boost performance while lowering reportable net profit.
Mind the gaps
What's the point? For one thing, a goal of 10% net profit may not be as unattainable as it first appears. Companies who currently report 6% or better may already be close. To find out how close, take an inventory of expenditures that could be considered discretionary, then back those costs out of overhead. (Of course, this is an exercise for internal accounting purposes. It has no effect on your tax return.)
Second, every company, regardless of size, would do well to re-examine expenses to see where profit is leaking. In direct costs, the most likely candidate is labor costs. In overhead, it could be in rent, cell-phone use, insurance, or any one of hundreds of other costs. You won't know until you look.
Discretionary spending and tax-reduction strategies may cause reported net profit to be lower than what is actually earned. Smaller companies, however, struggle to hold on to profits largely because overhead is too high. Averages are compiled from financial information submitted by 100-plus companies every six months to Business Networks. The data are current as of September 2001.