What Do You REALLY Need To Know To Run A Profitable Business?
Last month we set the stage. We talked about how companies get started, the pitfalls they run into and how those early seeds of failure eventually put most companies out of business. Hopefully last month's article got your attention and you are now ready to learn what you really do need to know to become profitable.
The number one problem with most contractors is improper labor pricing. Most simply set their hourly rates based on what others are charging--which is a big mistake. Most owners don't fully understand what they MUST charge per hour to cover their real costs of doing business while, at the same time, generating a reasonable profit. You may have a great marketing program, the best techs in town and be growing at 20 percent a year but if you aren't priced
right it is all for naught.
The process of proper pricing begins with knowing what your real costs of doing business are--from a cash flow standpoint--not accounting. Setting rates based on accounting information can literally put you out of business. Most of us understand the basic costs of doing business like rent, utilities, insurance and telephone. In addition to the "normal" costs of doing business, however, we need to consider a couple of additional expenses that are often overlooked: the cost of non-billable time and equipment replacement costs. By the way, these two costs are not only often overlooked, they just happen to be the companies two single highest costs of doing business.
Non-billable time is the time we pay the techs for that we can't charge the customer for, or at least not directly. Non-billable time includes shop time, travel time, vacation, holidays, sick days, callbacks, warranty work, company meetings and customer no-show time. If you add all those up the normal service tech will have roughly 50 percent non-billable time and the average installer will be in the 20-30 percent non-billable range. If your service tech makes $18.00 per hour, and half of his or her time is non-billable, you are looking at a cost of non-billable time of nearly $20,000 per year per tech when you add in the company matching taxes. Two service techs will generate $40,000 in non-billable time while five would add up to a cost of $100,000 or more per year. Not only is that a lot of money, it's normally a company's single highest cost of doing business. And guess what? The cost of non-billable time is also largely overlooked by most contractors when it comes to determining their real cost of doing business to determine profitable hourly rates.
The second highest cost of doing business is the cost of equipment replacement. Equipment replacement costs take the place of depreciation. Equipment replacement costs will always be higher than depreciation since depreciation deals with what the company paid for a vehicle several years ago while equipment replacement costs deal with what the equipment will cost the company several years in the future. The equipment replacement cost, then, needs to be built into today's pricing. To be profitable, the company owner must fully understand exactly what it cost them to do business, from a cash flow perspective, and then they must set their rates based on what they have to charge, not what everyone else in town is charging.
When the owner begins to look at their real cost of doing business in the service department, they often find themselves being forced into flat rate pricing. When you look at the real cost of running a service department, the hourly rate often ends up being in excess of $75
per hour. When service rates begin to exceed $75 an hour, or more, it's a tough sell to the customer, if you are on a time and material pricing basis.
The only vehicle we have to charge what we really need to charge is flat rate pricing.
If you want to be truly profitable the first step is to determine what your real costs of doing business are from a cash flow perspective. Once you know your true costs of doing business you will need to determine what you need to charge to cover those costs while generating the profit you desire. When the point comes that your real hourly rate for service needs to be in excess of $75 per hour it will be time to seriously consider moving into flat rate pricing.
The next business principle deals with budgeting. To be truly profitable the business owner needs to develop a month-by-month, department-by-department, cash flow budget to project both overall profitability and to project potential cash flow problems. Budgeting is essential as the company grows since the costs are constantly changing. Tracking costs
against the budget each month will tell the owner if the company is on track, and if not, why not. Most companies that go out of business go out of business for one of two reasons. First, improper labor pricing and secondly cash flow problems. The reality is that you can be priced
perfectly and still go out of business because of cash flow problems.
Developing a budget, and tracking the results on a monthly basis, are essential in order to maintain profitability as the company grows. There's a direct relationship between your hourly rates and budgeting. The budget will be the vehicle for determining what it costs you to run the company, by department. Once the costs are determined, through budgeting, your hourly rates can easily be set. When a cost changes (adding a tech, increased marketing costs, a new vehicle purchase, etc.) your budget will need to change as well. When the budget changes your hourly rate needs to change as well. Keep one thing in mind. Your customer must pay for all of your costs of doing business. If they don't, you will begin the 1-to four-year process of going out of business we discussed last month--and never know it until it's too late.
Now we have talked about how companies got started, and some of the reasons companies go out of business in Part 1 of this three part series. This month we began talking about what the normal company owner really needs to know to be profitable. We talked about proper labor pricing, by department, and we touched on the need, or at least the eventual need, of switching to flat rate pricing as your true service rates increase. We also talked about creating a month-by-month, department-by-department cash flow budget to project profitability and possible cash flow problems. We also discussed the need to track budget figures with actual numbers in order to be sure we are on target with our projected profit goals.
Next month I'll complete this series by discussing the final two topics which are service agreements and marketing. Guess what? All the areas we talk about in these articles are covered, in detail, during our three-day "Basic Business Boot Camp." Check out the ad below for coming dates and/or locations. If you prefer, you can call our office for details and/or take a look at our brand new Web site for lots of boot camp information. You can even register online.
Now you may want to re-read the first two parts of this series in preparation for the final article next month. If you have any questions please contact us.