The Design Builder's Blog

3 Reasons Contractors Don't Share Financial Info With Employees

I recently read an interesting article about how much a business owner should tell their spouse about their company finances.  Two different opinions were shared and explored.   I’m on the side of sharing the info myself, but certainly not everything in detail.

That article got me to thinking about why so few construction and remodeling business owners share financial information with their employees.   First, I’ll offer a few great reasons to do it.  I hope the benefits will motivate more business owners to do so.   Then, I’ll offer my thoughts on why business owners avoid doing so. 

3 reasons to share your business financial information with employees:

Construction business owners who keep all the financial information about their businesses to themselves are definitively missing out on several potential benefits.   Simply put, by sharing financial information you can accomplish at least three things that will help lower your financial anxiety and help you make and or keep more money:

1. You can get the opinions and advice of others so you can be more confident in your numbers and using them to make sound business decisions.  Getting insight from others can also help you avoid costly mistakes.
2. By involving the right employees with the creation and interpretation of business financials you can share the workload required to create them.  This can make getting your financial reports much more timely and therefore improve their accuracy.
3. By mentoring employees on how to use financial reports you can help them learn to think like a business owner so they too can make sound business decisions.   This is an important and required step if you ever want to remove yourself from the day to day management of your business and or offer a profit sharing plan to employees.

So then why do so few owners share their financial information?

Let me also offer three common reasons why many construction business owners can’t or won’t share business related financial information with their employees:

1. The most common reason is because the business doesn’t have a real financial system that properly separates and tracks costs and expenses.  For these business owners their financial system is really no more than a checkbook showing money coming in and going out.  Without the ability to identify and separate your actual job costs from overhead expenses there is no way your business can get a meaningful profit and loss report.   These business owners don’t share the information because there really is nothing of value worth sharing.   Eventually, once a year for most of these business owners, their accountant gives them the good or bad news when their tax returns are ready to be filed.
2. Often financial information is held back because the business owner is embarrassed that he or she doesn't understand the business finances well enough to explain them or answer questions about them.  This is not good.   Imagine what a great employee will think about his boss and or the business if he discovers the owner is guessing at the financial health and well being of the company.  Think about it.  If you were an inspired and career motivated employee would you want to invest in your career at a business that is in the dark about predicting and measuring profits?
3. During my years of experience providing financial consulting for construction business owners I have had many owners share with me their concern that if they educate employees about and share company financial information with them it will only serve to help them get ready to leave and start their own businesses.  This could be true.  On the other hand I found by educating my employees most of them figured out they didn’t want all the stress and financial responsibilities that came with being a business owner.   However, those who did leave and started their own businesses where in a much better position to be financially successful.   As a business owner I found personal satisfaction in helping make that possible.

Some words of advice

If this articles speaks to what is happening at your business it’s up to you to do something about it.   I definitely recommend you do not consider growing your business in any way, or sharing the information with employees, until you and your business can produce and interpret accurate business financial reports.   To help you see if doing so might be worth it try this self quiz to see if a properly setup financial system can help you and your employees improve business profits and reduce financial anxiety.

Guest Blogger: Melanie Hodgdon is a Certified QuickBooks ProAdvisor who has been providing financial analysis and QuickBooks training for contractors since 1994. She’s the co-author of A Simple Guide to Turning a Profit as a Contractor.  Melanie and Shawn often coordinate their efforts when helping remodelers develop financial systems for their businesses so they serve the contractor, not just their accountant.

Understanding and Including General Production Costs in Your Estimates

Estimators are pretty good about including costs for permits, materials, subs, and equipment rental in their estimates. And the really topnotch ones are also adept at estimating the amount of labor time based on knowledge of what their crew(s) can produce. But there is another element that often eludes even the most careful of estimators: the cost of those “necessaries” that will be used on a job but not easily assigned to specific jobs.

These include things like:

• Bits
• Blades
• Rags and other cleaning supplies
• Sanding disks and sand paper
• Trash bags
• Small tools
• Dust masks
• Assorted fasteners
• Caulking and adhesives
• Pencils, markers and chalk

Here are some more candidates:

• Cost to repair and maintain tools and equipment
• Cost to maintain a jobsite trailer
• Propane for the space heater
• HEPA filters
• Bungies, ropes and tie downs
• Trash barrels or bins

These can be considered General Production Costs and you should have a method to allow for them in the job price.

Two ways to price your work

Basically, pricing consists of identifying the actual cost of X and then adding a markup. The purpose of the markup is to allow the selling price to cover not just what X costs, but also it’s fair share of the company overhead, with enough left over to contribute to company profit.

Option A: Include in the estimate

When you include an allowance for General Production Costs in your estimate, you increase the predicted cost of the job. When you apply a markup to the cost, you will also be marking up the predicted General Production Costs. Because you are charging your customer for the cost (income account), the matching cost should be considered Cost of Goods Sold.

For many contractors, including an allowance for these costs in the estimate will increase the likelihood that the costs will be covered.

Option B: Include in the markup

If you consider General Production Costs as being part of the cost of doing business (overhead), then you will account for them by increasing your markup on the job.

Ideally, both methods will result in the same selling price. However, in my experience, far too many contractors decide on a markup based not on the financial requirements of their company, but rather on a figure they found in an article, or what scuttlebutt tells them their competition is using. This WAG (wild ass guess) approach decreases the likelihood of capturing these costs in the markup.

Why I typically recommend Option A

Also, as companies have diversified with changes in the economy, the type of work they do has also changed in many cases. Burying these costs in overhead can make the changes less obvious than placing them in Cost of Goods Sold where significant changes are more likely to be spotted. For example, companies performing lots of RRP work might see a significant increase in these costs due to the requirement for filters, respirators, contractor bags, signage, duct tape, Tyvek suits, etc. The effect on the gross margin (when these costs reside in Cost of Goods Sold) might be noticed more quickly and reliably than remembering to deliberately dig into the overhead accounts to find and monitor them.

Estimating vs. job costing considerations

Once your General Production Costs are part of Cost of Goods Sold, an allowance for the inevitable cost can be included in the estimate. This means that you will charge for them as part of your pricing strategy. However, because of their very nature, you won’t be able to attribute them to individual jobs, so when you look at job cost reports, you will not see an “actual cost” for these items, making the jobs appear slightly more profitable than they probably are. The achieved margins of all the jobs will look higher than the overall achieved margin from the Profit and Loss Statement since the Profit and Loss Statement will contain the dollars spent on General Production Costs and the individual job reports won’t.

How to calculate General Production Costs for estimating purposes

The simplest way is by comparing General Production Costs with Materials costs. Express the relationship as a ratio or percentage. For example, if in the last twelve months you spent $500,000 on materials and $8,000 on General Production Costs, you will need to add 1.6% ($8,000 ÷ $500,000) to your estimate to cover them. When estimating, this figure can be added as a line item as shown in the sample estimate template below.

 Screen shot from Shawn's new estimating Template

Final thoughts

Each job has enough surprises in it. Why not at least plan your sell price to include an allowance for the costs you know you can count on?

Need help with General Production Costs?

Call or  Email Shawn today. 

Do it now so you can be confident you are pricing your spring and summer projects correctly!

Guest Blogger: Melanie Hodgdon is a Certified QuickBooks ProAdvisor who has been providing financial analysis and QuickBooks training for contractors since 1994. She’s the author of A Simple Guide to Turning a Profit as a Contractor.  Melanie and Shawn often coordinate their efforts when helping remodelers develop financial systems for their businesses so they serve the contractor, not just their accountant.

Who's Paying For Your Carpenter's Non Productive Time?

I was discussing the cost of labor the other day with a client, and he told me he really had a handle on what his costs were. “No kidding? That’s great,” I said. I then quizzed him on what factors he’d included, and was impressed that he’d gotten so many: wages; company-paid payroll taxes; Worker’s Comp; liability insurance; vehicles, cell phones, and small tools used by production workers; health insurance; retirement. “And what about non-productive time?” I asked. Puzzled, he asked me what I meant.

The fact is that while it’s relatively simple to calculate what it costs to pay a production worker for an hour of time, you have to remember that he’s not going to be available to perform the work that you estimated for 100% of that time.

Let’s do the math.

Assuming no overtime, a worker is typically paid for 8 hours/day, 5 days/week, 52 weeks/year. This adds up to 2,080 hours. So you’re paying him for 2,080 hours a year.

But for how many hours will he actually be available to you to perform the work you’ve included in your estimate for labor?  Subtracting for some common events, we see the number of hours available for producing the estimated work starts to evaporate.

What else cuts into that productive time? How about those weekly production meetings? OSHA safety meetings? Meetings about the new health insurance or retirement options? What about training and education? How about the requirement that they clean out the vans every Friday afternoon? Do they help clean up the shop? Maintain tools? Are they paid for commuting time?

How might this affect estimating the cost of labor for a job?

Let’s say that you pay Will $20/hr. After adding all the burdens to that hourly rate, you discover that his total annual cost is $63,500.

You can look at this annual total in two ways: how much does Will cost you per paid hour, and how much does Will cost you per productive hour: the hours that he’s actually available to perform those labor tasks you included in the estimate when calculating the job’s sale price?

From the chart, you can see it costs over $5/hour more for Will’s time when you base the cost on his productive time.

So what does this mean in terms of pricing jobs?

Using the wrong labor cost can be devastating, particularly in jobs where there is a high proportion of labor.

Let’s see how it would play out in jobs with varying amount of labor.

For a 100 hour job, based on the burdened cost per paid hour, the estimated cost would be $3,053.

Those same 100 hours, based on the burdened cost per productive hour, costs $3,553. So the cost difference between using the paid vs. productive hr cost figure would be $500. For a 1,000 hour job, the cost difference would be $5,000.

Now let’s look at the selling price of the job, assuming a 50% markup.

For a 100 hour job, the difference in selling price would be $750.

For a 1,000 hour job, you’d be underpricing by $7,500!

So next time you estimate work, be sure you’re working from realistic costs. Labor is tricky to estimate anyway; getting a handle on what it really costs for that hour of nail banging will bring you closer to costing and pricing your jobs accurately.

Need help with figuring out your labor costs?

Call or Email Shawn today. 

Do it now so you can be confident you are pricing your spring and summer projects correctly!

Why Contractors Should Get A Line Of Credit When They Don’t Need One

Guest Blogger: Melanie Hodgdon is a Certified QuickBooks ProAdvisor who has been providing financial analysis and QuickBooks training for contractors since 1994. She’s the co-author of A Simple Guide to Turning a Profit as a Contractor.  Melanie and Shawn often coordinate their efforts when helping remodelers develop financial systems for their businesses so they serve the contractor, not just their accountant.

A line of credit can be your cash flow insurance

I recently had a conversation with a client who, after an incredibly profitable startup a couple of years ago, encountered a perfect storm of difficulties and recently found himself facing a severe cash flow crunch. This is one of those things that happens in any industry, and seems particularly prevalent among construction and remodeling companies

The problem is sort of like health insurance.

When you’re young and in perfect health, it seems stupid to waste money on insurance. There are so many more important (and fun) things to buy: trucks, tools, additional personnel; the list is endless. I remember when I fell off my roof, my life didn’t flash before my eyes, but I did have a very clear sequence of thoughts.

1. I hope the cat isn’t lying where I’m going to land (he wasn’t)
2. This is SO going to hurt (it did)
3. I really, really wish I had insurance (I didn’t)

Back to the cash flow issue.

The point is that when everything is going great and you have oodles of cash, it seems stupid to waste time setting up a line of credit. However, that’s exactly when you should apply: when you don’t need it.

Once you need a line of credit (or, more accurately, once you admit to yourself that you need it), the chances are pretty good that your Balance Sheet will look pretty bad, and it’s your Balance Sheet that creditors want to look at.

Working with your lender

Your bank is actually less interested in your income or even your profit figures; what matters is the extent to which you’re able to pay off debt, and the degree to which your company is running on credit. We’ll look at the critical numbers in a follow-up blog. In the meantime, one of the things that saved my client from being turned down by the bank was that he had an excellent relationship with the bank staff, who went to bat for him. While things were going well, he’d made a point of sharing his successes with key personnel. They knew he was a hard worker with a solid business plan and a track record of success, and this personal knowledge allowed them to see past the current bad-looking financials.

Here is a summary of steps to help contractors secure a line of credit

1. Learn more about your Balance Sheet, the often under-utilized and misunderstood financial report that can spell success or failure
2. Make a point of getting to know your bank personnel, particularly your loan officers; this can up your chances of approval by lifting you from anonymity
3. Apply and get approval for a line of credit when your books look good, when you have plenty of cash, you’ve paid down debt, and you don’t need credit

Five Keys To Getting Contractor Financial Reports That Speak To You

Guest Blogger: Melanie Hodgdon is a Certified QuickBooks ProAdvisor who has been providing financial analysis and QuickBooks training for contractors since 1994. She’s the co-author of A Simple Guide to Turning a Profit as a Contractor.  Melanie and Shawn often coordinate their efforts when helping remodelers develop financial systems for their businesses so they serve the contractor, not just their accountant.

“How can I get meaningful financial reports for my construction business?”

There’s a big difference between a pile of materials and a well-designed building. Yes, everything required to create and use the building is contained within the pile, but until it’s been put together with the intention of producing something useful and well-thought-out, it’s pretty much useless.

The same thing applies to contractor financial reports

I have worked with literally hundreds of contractors’ financial databases, and many of them have got the majority of the information in there, all right. The problem is that, just like the pile of materials, the information isn’t organized in a way to let them easily draw conclusions. Just like the point of having a house is to provide shelter, the point of having financial reports is to make informed management decisions.

My clients, seminar attendees, and reader audience are probably sick of hearing this, but if reports don’t provide useful information at-a-glance­, they aren’t doing you any good. Contractors can’t afford to have their bookkeeper or accountant adjust, explain, and interpret reports. Waiting for this kind of information puts them at the mercy of others. Instead, any contractor should be able to instantly access, review, and draw conclusions from standard reports any time he feels like it!

Begin with the end in mind

The key to getting this right and meaningful is to decide beforehand what questions you want answered. So if you want to know what your gross profit is, for example, then you need to set up your Chart of Accounts to show it to you. If you want to figure out how much your production workers are costing you, then be sure to capture all the burdens along with the wages. If you want to find out which marketing methods are working best, then you’ll need to have two categories of information: (1) you’ll have to have your financials set up so you can see costs by marketing source, and (2) you’ll have to have a lead tracking system that will identify which leads are coming in from which source.

Even software that advertises itself as being set up specifically for contractors doesn’t necessarily classify costs in the most useful way for a particular company; relying on the software to control the content and level of detail of information means you may be giving up answers that are important to you.

Here are five keys to getting the financial reports contractors need:

1. First and foremost, give accounts names that make sense to you. If you want to call your refuse disposal garbage, do it. Don’t be hung up on what your accountant thinks it should be called. Use names that are familiar, descriptive, and have meaning for you.
2. Separate costs related to production from overhead by using different types of accounts; when you run your financial reports, they will be in different regions of the reports and you should be able to get key numbers (such as gross profit) without doing anything more.
3. Use account numbers to control the order of the accounts. Without numbers, your reports may appear in alphabetical order, which may be far less revealing.
4. Organize the accounts in clusters; use sub-accounts to provide detail when required. For example, you can have a main account for marketing, but use sub-accounts for web, home show, print, and other categories.
5. Arrange accounts to show the biggest numbers higher up. For example, if you cluster your production-related accounts together, and 50% of your production costs are for subcontractors, then put the subcontractor account at the top of the production cost list. If you spend only 3% on permits, put that at the bottom.

Take control of your Chart of Accounts so that your financials will speak to you.

You don’t have to have an MBA to derive meaning from reports; the basics are pretty darned easy to understand. However, if your accounts have arcane names, are organized with an inappropriate level of detail, or are in the wrong location, your job will be made more difficult. It’s challenging enough being a contractor without making things harder than they have to be!

10 Sign’s You’re Playing The Game of Contractor Roulette

Most contractors are great craftsman but terrible at accounting and financial management.   Most can build a house from the ground up without any plans but have no clue how to identify and create the financial reports they need to know whether they are making or losing money. 

Building or remodeling a house without any idea of whether you are making money or not, and if you will be able to pay all the bills as they come due, is like spinning a roulette wheel at the casino.   You put money down, spin the wheel and hope to make money.  Problem is that you have no idea or control over where the wheel will stop.   If you run out of money the casino is happy to let someone else step in, lay down some money and do the spinning. 

Like most gamblers, contractors always brag when they win, but never want to talk about it when they lose.

Contractor Roulette Is Not A Good Gamble

If it sounds like I'm describing you and your business you are playing what I call "Contractor Roulette".   Sure, once in a while you may win, and even win big.  But remember the odds are with the casino.   How about you?  Have you been spinning and winning or has the “casino” been winning and encouraging you to keep playing?

My list of 10 signs you’re spinning the “Contractor Roulette Wheel”

1. You lose sleep at night worrying about money.
2. You have no idea what markup to use.
3. You think margin and markup are interchangeable terms.
4. You never know if you will have enough money to pay your bills until they're paid.  Again
5. You guess at project payment schedule amounts and when they're due.  As a result you constantly suffer from cash flow challenges.
6. When a prospect asks you if you will match someone else’s price for the same job you figure if the other guy can do it for that price so can you, so you say yes.
7. You are always putting the whip to your production employees to beat the labor allowance in your estimate because you need to make up for dropping the price of the job just so you could sell it.  Again.
8. Even though you got price quotes for the materials before you sold the job, after you take the job you either bid the materials out to a get a lower price or beat your vendors up to sell them to you for less than they already quoted you.  Again.
9. You do little or no marketing so you have to try to sell to everyone who contacts you, even if you have a feeling they will try to beat you out of any profit.  Again.
10. You need to sell a job this weekend and get a deposit just so you will have enough money to meet last week’s payroll.  Again.

Strive to become a Big 50 Remodeler

If you believe in the idea of relative success, where you convince yourself you are doing pretty well if you compare your results to other contractors who are doing far worse than you, then maybe you can be happy staying where you are regarding financial management at your business.  On the other hand, if you want to measure your success against truly successful contractors, perhaps use Remodeling Magazine’s Big 50 list as your reference.  To qualify for that list you need to be making a decent net profit.

There is hope!

If you have been playing Contractor Roulette here is a simple three-step plan to help you end your gambling habit:

1. Admit you have a gambling problem and commit to do something about it.
2. Get the professional help you need to help you stop gambling and eliminate the causes of your gambling addiction.
3. Find someone you can trust to hold you accountable to doing what it will take to make the switch.

Related articles:

The Five Biggest Financial Related Mistakes Contractors Make

Remodelers: I Bet You Don’t Know Your True Burdened Labor Costs

Five Ways To Think Like A Business For Business Owners

Guest Blogger: Melanie Hodgdon is a Certified QuickBooks ProAdvisor who has been providing financial analysis and QuickBooks training for contractors since 1994. She’s the co-author of A Simple Guide to Turning a Profit as a Contractor.  Melanie and Shawn often coordinate their efforts when helping remodelers develop financial systems for their businesses so they serve the contractor, not just their accountant.

You Can Build A House, But Can You Build Financial Reports Too?

For many contractors, there’s a frustrating gap between what goes into their financial software and what comes out in the form of useful reports. After twenty years of helping contractors obtain and interpret useful reports, I find that the vast majority of my income comes from cleaning up, restructuring, and sometimes discarding and re-starting accounting files that simply aren’t doing their job.

What’s important to know?

The only reason to use financial software is to provide answers to questions. Who’s asking the questions? How about

• your production manager?
• your estimator?
• your sales team?
• your marketing department?
• your tax accountant?
• your CFO/partners/investors
• the bank you’re approaching for a credit line?
• the prospective buyer of your company

If you haven’t thought about these questions before you start, you may be doomed to relying on luck to get your answers.

Starting right

Nobody starts out by saying, “Hey, I’m going to buy software, invest a whole lot of time into entering information, and then hope that I get good results.” Yet, with the best of intentions, most contractors don’t get it right the first time. There are three basic elements that need to be in place before the results will justify the investment of time, energy, and dollars:

If you’re setting out to just “drive around” you don’t need a destination. But if you need to get somewhere, it’s important to know where the destination is relative to where you are. So if I want to drive from New York to California, I should be heading west, not south. It’s the same with your financials. If you don’t have a clear view of the destination (answers to your questions), getting there is left to chance. You must identify what you want to find out.

If you’re planning that trip from New York to California, the path you select will reflect your criteria, such as whether or not you are interested in the fastest route, the most scenic route, the cheapest route, etc. Accounting software varies in its user friendliness and flexibility. QuickBooks is highly flexible and very user friendly, which leads users to take inappropriate routes with a high degree of confidence! There are many ways to accomplish any given task. Making the right choice can be confusing, sort of like making the New York to California trip without the benefit of road signs (or GPS!). You must know the software.

Can you turn right on a red light in Iowa? Is the maximum speed limit in Kansas the same as that in Missouri? Is it mandatory to wear seat belts in Nevada? Do you have to turn on your lights if it’s raining in California? Just as you can get yourself into trouble while driving if you don’t know the law, you can get yourself in trouble in accounting if you don’t know the correct way to classify transactions. You must understand the basics of construction accounting.

The Bad News

The unfortunate truth is that most business owners come from the field. They started a business because they were convinced that they could do a better job (and make more money) than the company for which they worked. Unfortunately, many of the “improvements” they make are in the areas of production and customer relations; few have to do with the numbers side of things. Very, very few construction business owners come to the business with MBA or CPA after their names; most are more of the FEA (Field Experience Acquired) persuasion. And this sets the stage for unfortunate results on the office front. They don’t have the accounting background, they don’t know the software (which is often selected for them by their accountant or bookkeeper), and they haven’t stopped to plan ahead to determine what kinds of answers will help them steer their business towards a desired destination.

The Good News

Help is available! There are good, experienced, qualified resources out there who can either start you out right or help you adjust your course. The key is to look for consultants and trainers with experience in your industry and in your software of choice. Find out how many businesses similar to yours they have worked with. A construction expert who has only worked with development companies with revenue in excess of $20M may not be appropriate for a startup remodeling company with forecast revenue of $600K. Get references. Request a no obligation 15 minute phone call to get a feel for whether they will be a good fit for your business and you.

Final Word

If you aren’t getting the information you need, whether it’s answers about achieved margins, overhead costs, profit centers, or profitability of individual jobs, you owe it to your company and your own peace of mind to turn things around. If you’ve already started driving without a map, without knowing the traffic rules, and without helpful signage, STOP where you are. Don’t make things any worse. Get the help you need so the rest of your journey will be sure to bring you to your destination.

Three Thoughts for Contractors by Cowboy Legend Will Rogers

Will Rogers, who died in a 1935 plane crash, was one of the greatest political sages this country has ever known.  He is well known for his quote:  “Don't squat with your spurs on”.  He also shared many other thought provoking but less popular sayings.   For a little fun I offer these three and what I think they could offer for advice to contractors

“Never miss a good chance to shut up”

Many contractors, me included, have probably had an occasion where we opened our mouths and wished we hadn’t.  Other times we open our mouths, and even though we may not realize it, others we interact with wish we hadn’t! 

Here are a few times when saying nothing might just be the best thing to say:

• If your customer has already decided to buy, shut up.  Don’t risk giving him/her a reason to change their mind.
• If you ask your prospect or customer a question, shut up.   Give them time to think and answer the question.  If due to the silence you keep talking or offer them answers to choose from you might not get the real answer.
• If you have chance to disparage your competition, shut up.  More times than not the person listening to you will begin to think less of you for doing so.  Instead of talking bad about what they do or don’t do, talk about how you do what you do.

“Always drink upstream from the herd”

When starting their businesses too many contractors look to what other contractors are doing and assume they should do the same.   The fact is that 9 of 10 contractors typically go out of business within 10 years of getting started.   The odds of copying the right contractor’s strategy are only 1 in 10. 

Here are a few things drinking downstream of other contractors can do to your construction business:

• Use the wrong labor rates and markup to price your jobs assuming you need to be competitive.
• Assume because another contractor quoted a price to a prospect you must be able to do it for that price as well.
• Getting and using legal advice from online contractor discussion groups without consulting legal counsel before you do so.

“If you find yourself in a hole, stop digging”

A good number of contractors at one time or another find themselves in a financial hole.  Rather than figure out how they got there, they just keep working, often assuming by working harder or longer hours they will eventually get out of the hole.  Unfortunately many of them just dig a deeper hole and eventually the hole is so deep they can’t climb out so they stay in it.  Sometimes the hole can even cave in all around them and bury them and their businesses.  If you want to avoid the most common reasons contractors get into financial trouble check out this previous blog post.

Bonus saying:

Here’s one more from Will Rogers just for fun.  I’ll let you be the one to determine what this means to you!

 “There are three kinds of men:

1. The ones that learn by reading.

2. The few who learn by observation.

3. The rest of them have to pee on the electric fence and find out for themselves.”

The Five Biggest Financial Related Mistakes Contractors Make

Having worked with hundreds of remodelers to help them improve their businesses and achieve their goals has exposed me to the common reasons their businesses run into financial problems.   Here my list of the five biggest mistakes I see contractors make that lead to money problems, and some suggestions on how to avoid or prevent them.

1. Guessing at the markup used to determine selling price

Pricing your work without knowing the true cost of being in business is referred to as using the "WAG" method, or “Wild Ass Guess” method.  Unless a business knows what markup to use to determine the right selling price it puts itself at risk of actually buying jobs instead of selling them.   Unless you know your minimum required markup to cover overhead, how do you know how low you can go when the prospect wants to negotiate?

Don't Put Your Business at Risk by Guessing At What Markup to Use

2. Using different markups on different cost categories without knowing the impact on required gross profit.

This is like a Super-Sized WAG!  Unless you use a single across the board markup on all estimated costs, you will need to be very accurate when anticipating how much you will sell of, and how much you will markup, each category of costs your business includes in estimates throughout the course of the year.  Most contractors who do this have no idea how to do so.  Keep in mind that if you do drop the markup on one item you will need to increase the markup on another to make up for the drop in gross profit dollars on the first one.  One contractor I know said he believed contractors who use this method have what he called “Head Trash” about money.  He went on to say they should “get over it” and should learn how to sell.

3. Not factoring for the cost of non productive time in the labor rate used when estimating.

Most contractors have no idea how to handle this one.   Using the wrong labor rate can have a double negative effect.  Not only will you not charge enough to cover labor costs, you will also lose the markup on the missing labor dollars! To bring in the money you need to pay your employees when they are not producing work you need to include that money in the billable hours they do work. 

How to Cover the Cost of Non-Productive Time in Your Estimates

4. Not estimating and job costing apples to apples.

First, this assumes the contractor even does job costing, most don’t.  As one example I estimate that fewer than 10% of contractors can job cost their labor costs the same way they estimate them.   If you use a burdened labor rate to estimate the dollar cost of task hours, your total labor cost will include things like workers comp insurance, non-productive time and employee benefits.   If you use QuickBooks for job costing, and you enter employee time card information into QuickBooks, typically only the employees wage and employer paid payroll taxes are expensed against the job budget in job cost reports.   This will falsely make the actual labor cost appear much lower than the labor budget from your estimate.   To solve this, use my free labor cost worksheet to calculate your true burdened labor rates for each employee and then work with a QuickBooks expert who knows how to set up the software to include labor burden assumptions in job cost reports without affecting the accuracy of your P&L.

5. Not factoring for actual costs at time of production when estimating

If you sell work that you won’t be starting for some time, in your estimates you will needed to include the actual costs you will incur at the time you produce the work.   If you don’t do so the extra costs will eat away at your planned net profit until it’s gone.  If the extra costs exceed your anticipated net profit you will need to use your own money to finish that customer’s job.  Keep in mind that some reports anticipate many construction materials will increase in cost as much as 25% this year.

Anticipate increases and include them in estimates before jobs are sold

Simple Profit Sharing Plan For Contractors

Recently, several of the contractors I work with have asked for help developing profit sharing plans.   Because they are looking to take advantage of the benefits of profit sharing I thought others may want to consider a profit sharing plan at their  remodeling businesses as well.

Profit is the reward a business and the business owner earns for the risks taken by being in business.  Profit sharing is in effect a type of reward program for company employees.  It is based on sharing a percentage of the total profits earned by the company with the employees who helped earn it.  Profit sharing plans are used to help encourage and foster employee awareness and participation in creating, protecting and maximizing the profit earned by the business. 

Open Book Management:

Open book management is the process of sharing in detail the company’s financial statement with the entire staff on a monthly or quarterly basis. If you want your employees to contribute to protecting and earning profits you'll need to share financial information with them and help them understand how to interpret and use that information.

Why Profit Sharing and Open Book Management?        

• Both can increase collaboration between office and production staff to help improve efficiency and productivity.
• Everyone has a stake in working together to eliminate waste and duplication of effort.
• Because the responsibility as well as the benefits of profit are shared, team members take ownership in the company’s profitability and health.
• Open books and sharing of profit can create a trusting and supportive environment for all involved.

Creating a Profit Sharing Plan for Your Construction Business

Creating a profit sharing plan can be very involved process.   Lots of details, way more than can be included in a short blog post, need to be considered before offering the plan to employees.  If not well thought out before it is introduce, mid stream changes to the plan may cause employees to lose their confidence in the plan and the business.  

Sample Plan

Below is an illustration of how a simple profit sharing plan might work.   This plan is based sharing 10% of a company’s planned net profits with all employees.   With this plan pay-out to employees for profits earned each quarter would be 50% of the profit sharing earned with the balance paid after year end final accounting has been completed.  Also, in the example below if quarterly profit goals are not reached, employees will not receive profit sharing funds during that quarter, but may still get the money earned for that quarter at the end of the year if the overall performance for the year proves successful.

Annual profit goal: $100,000

Quarterly profit goal : $25,000

Based on the example above, assuming you have a total of 10 employees on staff:

• First Quarter – no profit sharing would be paid
• Second Quarter –each employee would be paid $150 in profit sharing (50% of $300)
• Third Quarter – no profit sharing would be paid
• Fourth Quarter – each employee would be paid $200 in profit sharing (50% of $400)
• If Annual Goal is achieved – each employee would be paid an additional $650 in profit sharing

Total bonus paid to each employee for this example ………. $1,000 ($10, 000 ÷ 10 employees)