Contractor Tip of the Month
Are you making money or losing cash?
Whether or not you survive in business is really kind of simple. You must take in more cash than you pay out. Yet, most contractors aren’t even sure if they are making money at all. Often, by the time they figure it out, it is too late to make adjustments, causing failure.
At a coaching session I attended, speaker George Hedley made the statement that he is convinced that 90 percent of construction business owners doing under $10 million in sales don’t know how to read a profit and loss (P&L) statement. Over the years, I have come to believe that George could say that for many business owners who do more than $10 million in sales per year, too.
Many of us grew up in the trade, so we know how to build buildings. However, when it comes to being a businessperson, we get lost. It was not until my company was doing more than $10 million in sales and switched to accrual accounting that I hired a CFO to show me how to read a P&L, and to teach me what effect it had on my operations. Of course, business was much easier back then as the economy was good and the competition wasn’t as educated. Hell, I was running my own company doing more than $10 million in sales a year. I was making money without really knowing how or why I was prospering. That won’t work in today’s business climate.
Here’s a wild card many contractors get surprised by: A company can make money and still go bankrupt. Sounds scary, doesn’t it? You bet, and it happens. This can happen if one does not watch his debt load and other expenses, compared to his profits. Let’s say you owe money for a forklift, truck and scaffolding. Then you have rent, taxes, debt interest, owner distributions and other expenses that cost you $12,000 per month or $144,000 on the year.
At the end of the year, you are feeling alright as your P&L shows you earned $70,000 for the year (before depreciation and interest are subtracted). However, the real picture is that you just had a year during which you made $70,000 in profits the way good ole Uncle Sam looks at it, while losing $74,000 in cash paid out from your bank account. Think about it: There’s $144,000 going out the door in payments/expenses, and $70,000 in profits coming in to cover your costs. A total of $144,000 minus $70,000 equals $74,000 less cash. It doesn’t take many years like this to sink a company.
Several years ago, we started teaching all our managers how the P&L affects our operations and even started paying them based on the monthly P&L outcome. They get their bonuses (or incentive, I like to call it) based on three factors of the monthly P&L: total sales collected, gross profit and net profit.
It is amazing how much a company can benefit by letting everyone in management know how important these three factors are to the success of the company. And, when part of their income is based on the outcome of the P&L, it becomes important to them to start thinking more like business owners.
The good news is, it is not a cardinal sin to not know how to read a P&L statement. However, it is a sin not to have an accountant on board who can explain your P&L to you, whether this person works inside your company or is an outside accountant. The P&L should be done each month, and a meeting should be held to see how your company is doing financially as well as what moves you should make next.
If you wait until the end of the year to find out how your company is performing, it could be too late to change course and take corrective actions. Also, don’t forget to ask your accountant for a cash flow statement to ensure you are taking in more money than you are paying out. Remember, profits don’t equal cash, and, to survive, we must take in more cash than we pay out.