Play the "What If" Game: How to keep your trade company from going out of business
Running 'What if?' scenarios isn't a waste of time
The “what if” game can be very revealing and profitable! Before considering playing the game it would be very helpful to fully understand the three main reasons most trades companies go out of business:
Improper labor pricing— The number one killer of small businesses involves not understanding how much the company needs to charge, in each department, to cover costs while generating a reasonable profit.
Cash flow— Cash flow is the number two killer of small businesses. Even if a company is priced properly, in each department, it can still go out of business because of cash flow issues. Most trade companies are highly seasonable with the end result being the company losing money between two and four months of the year. The company may be profitable for the entire year but if it can’t cover short-term cash flow needs, it can easily go out of business before those profitable months kick in.
One department subsidizing another— This is often a major issue with older companies offering several products or services. Few companies, actually less than five percent, break their costs out, by department, all the way through the profit and loss statement, including fixed and variable overhead. Again, the end result is predictable. One department ends up subsidizing another one and no one knows it until it’s too late.
The first step in avoiding all three of the above potential pitfalls is to model your company by department. Have you ever tried playing checkers without a checkerboard? It can be done, but it’s a lot easier of you have the game tucked away in your family room closet. Well guess what, you can model your company, by department, manually but it’s a lot easier to play the “what if” game if you have a copy of Grandy & Associates modeling software program called “Labor Pricing for a Profit with Cash Flow Projections.” Now to save time let’s assume you have created a month-by-month, department-by-department cash flow budget either manually, or using our modeling software.
You have entered the equipment replacement costs, direct and indirect labor, fixed and variable overhead and materials, all by department. When completed you will instantly know which departments are making money and which are not. You also will know if the overall company is making money and what your projected month-by-month cash flow looks like. This is not a simple process to complete but it can be very revealing.
When the initial model has been completed the real fun begins. Now it’s time to begin the “what if” process of changing things (add a tech, change an overhead cost, buy another piece of equipment, increase your material mark ups, etc.) to see how the proposed changes will affect your hourly rate, cash flow and overall profitability.
This process can pinpoint problems while clearly showing the company owner what changes need to be made to ensure future profitability. I want to share the summary results of three companies I have worked with over the past several months to illustrate how it works.
This company did about $1.5 million in gross sales. Roughly a million dollars was generated by the commercial division with the remaining being generated by residential service, which was, by the way, on time and material pricing. The commercial division had a projected net profit of about $20,000 while the service division was generating about $35,000 in net profit. The final “what if” involved totally eliminating the commercial division, shifting fixed overhead to service and then adopting flat rate pricing within the service departments. In order for service to absorb the extra overhead, and generate a reasonable profit, the hourly rate needed to be raised by $30 an hour. That increase will not even be noticed by the customer if you are on flat rate pricing. By increasing the service hourly rate by about $30 an hour, and eliminating the commercial division, the company nearly doubled its overall net profit. Bingo, doing a few “what ifs” clarified the needed changes to increase profitability while eliminating the normal headaches of commercial work along with its resulting cash flow issues.
This $24 million company had a $12 million mechanical division and a $12 million service division at two physical locations. When the initial model was completed it revealed a loss of about $188,000 in the mechanical division. The first “what if” reduced the mechanical division, and responding overhead, by about $4 million in gross sales. The loss in the mechanical division increased to about a half million dollars. That was not the answer. The second “what if” eliminated all mechanical work, and accompanying overhead, at the second location. That model revealed a loss of roughly $750,000. That was not a good option either. The finial model eliminated the entire mechanical division including support staff, techs and relevant fixed and variable overhead. That was a winner. Company gross sales were cut in half down to $12 million but the resulting overall net profit was $2.5 million. Again, the “what ifs” clearly defined the direction the company needed to go.
This company grossed a little less than $2 million and had two locations about 200 miles apart with nearly all support staff, in terms of paperwork, in one location. The company had four divisions with the initial model yielding roughly a break-even situation, overall. However, since the company was modeled by department it became obvious which departments were losing money and which were extremely profitable. The overall game plan involved keeping all departments, including the ones losing money.
However, two things became apparent during the “what if” process in terms of the departments that were losing money. First, closing those departments altogether would only make things worse since much of the fixed overhead would remain and would have to be moved to profitable departments, which could not support the increased overhead. Secondly, if small changes could be made in terms of increasing gross sales and improving productivity while making slight increases in pricing, the losing departments could become profitable within the next six to 12 months.
One department, at the second location, proved to be much more profitable once the company was split into departments. The game plan at that location became obvious. Grow the profitable department as fast as possible. The game plan to create growth was put into place. Assuming the overall objectives are accomplished, the company should become very profitable within the next year. Bingo — modeling the company, and doing the “what ifs”, again revealed a clear path toward profitability.
Keep in mind the most profitable companies within the trades industry are run by owners who understand the numbers. Modeling your company, either manually or using software, can be a tremendous aid in terms of setting the stage for profitable growth in the future.
Is your company growing, but making less and less money? If so, it might be time to have a two-day, on-site, Company Overview performed. Over the two days we will model your company, by department, on our labor pricing software. By the end of the two days your Financial Business Plan will tell you what you need to charge per hour and you will have created month-by-month, department-by-department cash flow budgets to track your progress. Proper maintenance agreement and job pricing will also be determined.
For more details, contact Tom Grandy. We are also offering Reeves Journal readers a $500 discount so be sure to mention you read this article.