Financials can get complicated. Balance sheets, profit and loss statements, amortization schedules, percentage of completion, and building fees earned are just a few of the culprits. But what you really need to know is simple: Are you bringing in more money than you are spending?
Total Monthly Overhead
All expenses that are not specifically related to a project (rent, insurance, marketing, salaried office employees, etc.) are overhead expenses. Estimate annual overhead expenses, then divide by 12 to get your monthly overhead expense. (Include owner’s compensation at a modest level — you can use bonuses to distribute “excess” profits.) If some expenses hit a particular month harder than the rest, adjust the figure for that month, but don’t worry about nickel-and-dime fluctuations.
Gross Profit Dollars
To break even, you’ll need to produce (not just sell) the same number of gross profit dollars as your expenses; and to earn a profit, you’ll need to produce more gross profit dollars than your expenses.
Start by estimating monthly sales, allowing for seasonal variation, then convert sales into gross profit dollars, in two steps. First, determine what portion of new sales you will actually produce (called “percentage of completion”). Gross profit from sales in the last quarter of the fiscal year typically isn’t produced until the next year, but it’s usually balanced by sales from last year that will be produced this year.
Second, multiply sales by your target gross profit percentage. Start with your actual gross profit percentage over the last 12 months, then adjust it depending on changes in job type, job size, and other variables that will affect job costing.
Evaluate and Monitor
Now the fun begins. Compare total monthly overhead expenses to total monthly gross profit dollars. First look to see if you can live with the level of profit or loss in any given month and over the entire year. This includes considering how it affects those on your team who participate in profit sharing.
Also make sure that the plan gives you an adequate cushion for months (such as December, January, and February) when overhead expenses are likely to outpace gross profit dollars.
If you aren’t satisfied — not enough profit, not enough cushion for slow periods, etc. — look for ways to increase gross profit (via more sales, higher gross profit percentage, or a better percentage of completion) or to cut expenses. If you need to make cuts, try to balance the need for increased short-term returns against the need to invest for long-term health.
Finally, track your plan each month. Assuming you’ve accurately estimated overhead expenses, you should know exactly how much you need to sell and how much you need to produce each month to maintain a healthy business.
—Bruce Case is president of Case Design/Remodeling. email@example.com.