As You Begin To Budget For Next Year, Check What You Are Measuring!
Make sure you are focused on the right direction, for your company’s health now and in the future.
While I never aspired to drive a lightning-fast car, I’ve worked with a few people who have. I remember being invited to take quick drive with a co-worker in a Viper. My co-worker, by the way, loved fast cars so much that she bought the boss’ BMW M5 even though it couldn’t be driven in winter! The office was in the suburbs with country roads close by. As we approached 100 mph, she explained that she had to concentrate and keep her eyes focused on the road because the slightest shift of her eyes caused the steering wheel to move. It was thrilling but I don’t need a repeat!
I think about how a small lack of focus on a key factor made such a difference when I think about how dangerous it can be for a company to focus its decisions on measurements that may not be correct.
For example, are your sales increasing? You may think so if revenues are up because of your recent price increases passed on to customers. Check carefully, though. If you haven’t increased the number of customers or the amount of work, your revenue may have increased but your sales probably haven’t. Are you budgeting as if you are doing more work?
Are you calculating your markup on costs correctly? I don’t see this as much as I did a few years ago, but there are companies that are calculating their markup based on costs + their markup percentage. So, they are using:
$200 for Cost of Goods Sale plus 45% markup ($90) for total of $290. Profit 90. But that leaves a gross margin percentage of only 90/290 = 31.03% This was not the desired intent.
$200 cost plus markup calculated to achieve a gross profit margin of 45%. That formula is 200/1-.45 or a total of 200/55 = 364. Profit of 164. Gross Profit Margin percentage of 164/364 = 45%
The difference of 15% on every dollar of cost is a game changer. Imagine the difference for all jobs. And keep in mind, the owner still has indirect costs to cover.
How about cash flow versus profit? If you are “prepaying” for materials (and possibly deposits for subs) and you are not collecting cash for work you’ve performed, you could be very profitable on paper and in a hole cash flow wise. If sales are increasing and there is a timing difference between payments to vendors and receipts from customers, this problem will continue.
It is a good thing for an owner to have a focus on key performance indicators (KPIs), but important that she/he is focused on the correct measures, now more than ever. From the perspective of your exit from your business, cash flow, gross margin, and sales trends are three critically important measures that a buyer (or lender if you have an internal buyer) will review for the past 5 years and project into the future.
If you’d like to discuss your company’s goals for a graceful exit, including the financial health and salability of your feel free to give us a call or email. It’s never too early to begin! You can reach me via email: [email protected] or on my cell phone a: 224-688-8838.
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