Owners of contracting firms earn on average 8 percent Net to Owner; but above average entrepreneurs earn 16 percent Net to Owner and the top 10% of our industry earn considerably more. How much is in your wallet?
Many owners focus on building their revenues as a way to build their wealth. While there can be a correlation, it is not a direct one. In order to make a good return on your investment and earn an above-average income (16+ percent), it is critical to focus on the bottom line as your goal and work backwards.
This article was first published in Landscape Management magazine. Its concepts are key to your success. Read on for specific how-tos:
One Contractor’s Profitable Journey
For five years, I worked with a company where the owner initially thought he wanted to build a large company with four division managers and all the trappings. You read many stories of owners building large successful companies, and this was also his goal when he first hired me to consult with him. After a few pointed discussions and many months of failing to make his managers earn their keep, he was forced to clarify his objective from revenue growth, to personal income growth. He stopped dreaming of building a big company and shifted his goal to increasing his earnings (net-to-owner) to $350,000 and reducing the amount of his time at work to less than four days so he could focus on other business opportunities.
He restructured his company:
- Fewer Services: He streamlined his service offering by removing types of work that were “one off” or difficult for him to make a consistent profit on. For him, this meant eliminating hardscape projects and jobs over $10,000, and shifting focus to recurring maintenance packages. Many readers may think about doing the opposite, removing jobs under $10,000; you need to decide what is right for you. (What would you remove from your service line?)
- Sweet Spot: He fine-tuned his client type. Initially, he was trying to be a high-end company but realized his bread and butter was in the middle market. (How focused is your firm on its sweet spot?)
- Right-Sized Overhead: He slashed overhead by going from four division managers to a single manager who oversaw production. (Is your overhead optimized for your revenue?)
- Pay rewards: He put incentives in place. He promoted self-management and high profit following Jack Stack’s concept called “The Great Game of Business.” (Does your firm give employees bonuses for the right results?)
This contractor met his goals, earning the income he wanted while dropping his time at work to under four days a week. What are your goals for personal income and time spent at work?
Are you earning 8 percent or 16 percent?
Two years ago, I undertook a study with all my clients and found that within this group the average company earned 8 percent net-to-owner. The top 25 percent of the companies sampled earned 16 percent net-to-owner (with some niches earning 18 percent), and the top 10 percent earned much more.
Net-to-owner is defined as Owner’s salary + Net profit (calculated on an accrual basis!) after straight-line depreciation but not including the costs of owners’ perks, which vary from company to company and are sometimes quite large.
Keep in mind these are averages. Some contractors are earning less, and some are earning much more. My question for you is where are you now, and where do you want to be?
The fallacy of 10 percent. Growing up in the industry, I would hear presumed experts claim that you should earn 10 percent. I find this target to be dull and misleading. Where did this number come from, and was it meant to be a standard or a minimum goal? Why not earn more than 10 percent? The problem with setting low goals is that you may hit them, and then lose focus!
Set a dollars-based goal. In order to raise the personal income, set yourself a dollars-based goal and work backwards. This can be accomplished by making some basic tweaks in service lines, pricing model, personal time management, and determining how the owner and the management team view the financial success of each profit center. Are you including your team in your financial planning? Are their goals high enough?
Putting earnings “into” your wallet
Have you ever wondered why your profit and loss (P&L) statement indicates that you are earning good profits, but by the end of the year, you are not able to take that money out of your business and put it into your wallet? This is a common problem, and following are six missteps that can cause this:
- You are running your budget on a cash basis, and you are not budgeting enough for equipment depreciation, and thus, profit.
- Your receivables are too high; too many clients owe you too much money.
- Your contracts are written in such a way that you are financing your clients’ purchase of your products and services. You have become their bank.
- Your accounts payable is not up to date, so your net profit is not accurate.
- You are not taking out enough personal income each month and you are waiting for the end of the year, hoping you have enough left.
- Your equipment has too many breakdowns and related management costs, and it is sucking the profits from your business.
Year-end investments can hurt your wallet
When I build a new relationship with a contractor, a common theme I hear is the (bad) advice they are getting from their accountants. Accountants often call up their clients at year-end and tell them “You are going to make too much money: you may want to buy some equipment.” This approach is flawed for four reasons:
- Your accountant is inadvertently promoting the over investment in equipment, which takes additional time and money to maintain, pay for and manage. This reduces future profit and also reduces the value of your business by reducing your “return on assets.”
- This shifts your focus from making investments throughout the year, when they might be needed, to the end of the year when you may have missed a window of opportunity.
- It shifts your focus from investing in people or training, to buying equipment. You need a balanced approach.
- It reduces your personal income, resulting in less in your wallet.
Raise your company value. The higher your net-to-owner income, the higher the valuation of your business will be when it is time to sell. If you want to put more in your wallet and/or the wallets of your employees, then do the following:
- Start by setting an earnings goal.
- Look for both “time” and “cost” savings.
- Benchmark yourself, division by division, against your own results and against the top 25 percent (high-profit) companies.
Focus on raising your net-to-owner income, and you, your employees and company will win.