The Case of the Boisterous Bar Braggart
Liars always figure, and figures always lie. Heard that one before?
Liars always figure, and figures always lie. Heard that one before? I know that most of you know how to use percentages to make your results look better. For instance, a small remodeler might say he had a 40% sales increase rather than admit it was from $100,000 to $140,000. A large company would say its volume increased $100,000 instead of 1% on a $10 million volume. We use the terminology that we know will cast the best light.
When a remodeler says he marks up 100% (2.0 multiplier), you might wonder what floodlight he has been shining on those numbers, or about his blood alcohol level. Another just-as-successful remodeler is doing the same volume with a 50% markup (1.5 multiplier). The truth is that when it comes to net profit, they could be twins!
Look at the examples in Table 1. Let's assume each company has four employees, including the owner. If the first remodeler includes only material, subcontractors, labor with payroll taxes, permits, fees and professional design costs in hard costs, that $500,000 cost of goods sold (CGS) would be sold for $1 million. On the other hand, the second remodeler correctly (to my thinking) collects as many costs as possible directly associated with an employee (including labor burden) to place in CGS.
Standard overhead items such as office expenses, sales, marketing, staff, owners' compensation, labor burden for office employees, accounting, etc., would be the same for both companies and could be 30% of sales for a professionally run remodeling business. Company 1 has $500,000 of gross profit, $300,000 of overhead, plus that unaccounted-for $167,944 for labor burden, which leaves $32,056 for net profit. That is the same for Company 2 (See Table 2).
Companies 1 and 2 charge the same sales price and have the same net profit. Company 1 needs $500,000 of gross profit to support the overhead and labor burden items that Company 2 placed in cost of goods sold. When each new employee is hired by Company 1, a new overhead budget must be assembled, new break-even and new gross profit targets determined, and thus new markup calculated to cover the increase in overhead and maintain net profit. Employee-produced sales growth hurts this company, even bankrupts it.
With properly calculated labor burden, hiring and firing does not affect overhead except marginally: With communication devices, some administrative function time and some auto expenses (insurance, possibly depreciation or lease expenses), this comes to maybe $5,000 per employee. That's small potatoes compared with the $167,944 "hidden" cost of employment possibly "ignored" by Company 1.
The beauty of Company 2 is that it is having every client help pay for education, training, bonuses, vacation and other days we pay to have people not work. With this model, you can charge intelligently for labor-only jobs or for extras, and compare in-house versus subcontractor costs, with no year-end surprises.
Figures do not lie, but we often lie to ourselves and to peers. When people brag about their markup, ask what is in their cost of goods sold, what their target sales are (not a range or an approximation), what planned overhead is and what their target net profit is. If they cannot answer those questions, you are experiencing "liars always figure." Now you can out-figure them.
Alan Hanbury, CGR, CAPS, is the treasurer of House of Hanbury Builders Inc., a full-service remodeling company in Newington, Conn. He is a frequent speaker at trade shows and home builders associations on profitability and accountability. E-mail him at firstname.lastname@example.org.