Editor’s note: This is part one of a series on cash flow.
If you are in the home improvement business, you are a part of a great industry that is estimated to produce more than $300 billion in revenue in 2014. This total includes everything from big-box stores, large and small remodeling companies, many large specialty companies that sell one or two products, and those that replace HVAC and plumbing equipment. You are in a diverse business in an industry destined to get larger.
Running a profitable home improvement business is complex. The average home improvement company usually is owned by someone who in the past worked for another home improvement company prior to starting their own business. Many small contractors were once installers. Some of the large specialty companies are run by those who were in the sales and marketing role before they started their own business. Those who own home improvement companies are entrepreneurs. Moreover, they make things happen and create business utilizing their creativity and intuitive judgment.
Most of these owners lack experience in structuring and managing the “back end” of the business. A large percentage of those operating home improvement companies struggle with working capital issues. It is common for this to develop in the beginning when the business was started and continues as the business grows.
What follows is based on opinions dictated by prevailing business conditions. Certain circumstances may vary based on the state(s) in which your business is operated. All major changes in your bookkeeping, administrative or accounting procedures should be discussed with your accounting and legal advisers.
You’re profitable, but are you growing?
Many start-up companies began with little capital and plenty of sweat equity. Even if sales were good in the beginning, cash flow creates a problem early on. Much depends on the owner/manager quickly becoming a cash management expert. For example, suppose the business immediately starts to produce sales, and at the end of the first year produces $1 million in revenue with a 7 percent pretax net profit. This means they spent in one way or another $930,000 to run the business. That’s $77,500 per month (average) or slightly less than $20,000 a week being spent. Seldom does the average entrepreneur research this need early on and create a plan to make it workable.
Another example is someone who came out of sales with some marketing experience and starts a business with a few salespeople. Let’s say they do $2.5 million in their first year. A 7 percent pretax net (that’s $175,000) means that company will spend $2.3 million to run the business. That’s almost $194,000 a month or slightly less than $49,000 per week. Many companies have accomplished this with less than $10,000 as an original investment, yet the majority of companies that attempted this don’t make it.
In these two examples we estimated a net profitability of 7 percent, which would be subject to federal tax and in most cases state taxes as well. All the while these companies are attempting to grow without sufficient cash to make it happen. Many of these companies utilize a rapid “turn” (the amount of time it takes from the origination of a contract to its completion and payment) on the job once sold, and this is helpful. However, many of these companies operate without the benefit of being a corporation, or the entity is structured in a way they don’t completely understand. Ideally an S Corporation or an LLC (preferably the former) with their accounting method based on an accrual basis works best. This enables the company to take deposits and treat them as liabilities. This plus progressive payments further supplements operating capital to run the business.
Note: When a deposit is received, it is important to remember that this money belongs to the customer and is issued to the contractor as an “in faith” deposit and (technically) does not belong to the contractor until the job is completed.
Dave Yoho is the president of the oldest, largest and most successful small business consulting company specializing in the home improvement industry (since 1962). His company employs a staff of consulting experts who specialize in advising companies on how to become more profitable in their business. His company sponsors a series of educational programs in the form of webinars and seminars, which are explained at hipsummit.com. His recorded materials are sold throughout the United States and several foreign countries. For more information visit daveyoho.com.