After complaining to Joe, your leadman, that the last job didn’t hold margin and make the profits you’d projected because it took too much time and the cost for materials was too high, you come to the epiphany that your leadman has hands-on know-how but only a rudimentary understanding of how to control costs. For example, his general knowledge on bidding and job costing did not translate into good decisions that led to overall project and company profitability. In essence, you asked Joe to do a job with one eye closed.
Now, go a step further and ask yourself: Do any of your people have more than a rudimentary understanding of how your company, any company, makes money? If the answer is NO, then you have a huge opportunity in front of you.
If you can teach your employees how your company makes money, then it’s easier to teach them how to control costs. While you don’t have to open your books to do this, you may have to address a few of your own fears.
Fear number one: Oh, my gosh, they’ll find out how much I make! Well, let me tell you, they think that you are making more than you are. They see you bidding out at $125 an hour and paying them $25 an hour, and they just know the rest of that money is going in your pocket. Rest easy though — you can teach them how companies make money without sharing any specifics on your overhead costs, as I will demonstrate below.
Fear number two: I’ll train my competition! My experience is that if someone has a fire in their belly to start their own business, they will do so — whether they know how to make money or not. Wouldn’t it be better if they did so knowing how to make money, so they don’t underbid everyone for all the years it takes them to figure it out? Besides, when people see just how hard it is to make a profit, it can intimidate them, which encourages them to stay and help you do it.
Here’s a way to teach your folks how companies make money without opening up your books.
Create a fictional profit and loss statement, say for a one million dollar annual sales volume, to teach your people about sales, direct costs, gross profit and overhead as follows:
- From Sales: the money we take in for the work we do, we subtract
- Direct costs: the long list of expenses we incur to do the job, which leaves
- Gross profits: the money left over before the P&L overhead expenses, from which we subtract
- Overhead costs: the money needed to run the operation whether the company does any work or not, which leaves
- Net profit: the money left over on the P&L but not money in anyone’s pocket yet. Keep reading.
Now, remind them that not included on the P&L, but hanging out on another report called the balance sheet, are items like loan payments you have on vehicles and equipment, and mortgage payments on the office. Remind them that after these additional expenses are paid, the company still has to pay taxes. They will see quickly that the one million in sales is now a measly fifty thousand — most of which should be kept in next year’s winter fund to get the company through the slow months.
Next, explain that overhead costs are also called fixed costs because they are pretty much the same month after month.So, the company is essentially subtracting this same amount from the gross profit each month to get to the bottom line. Therefore, how much money gets to net profit depends on the gross profit figure. Now it gets fun. Ask how the company can increase gross profits. Answer:Two ways: increase sales and/or control direct costs.
Drill in on controlling direct costs by brainstorming how direct costs can be contained: Reducing shop time, not wasting materials, not losing tools, preventing warranty work, effectively monitoring subcontractors, keeping or beating the schedule, etc. Point out to your employees that they are the ones who control the direct costs and consequently, how much money ends up as gross profits/net profits; how they control your ability to give them raises, provide health benefits, buy new trucks, etc.
After they learn how companies make money, show how your jobs are bid and then share how your job costing report includes a focus on holding gross margin. This combination of knowledge and understanding will benefit everyone by giving your people the information they need to make profitable decisions on all your projects.