On Target Contractor’s Blueprint Chart Your Course to Business Success

On Target Contractor’s BlueprintChart Your Course to Business Success

On Target Business Intensive: Session 2

Oct

ober

3, 2

013

Advi

sors

On

Targ

et

1

• Session 1• Create a working draft of your Mission Statement• Create a working draft of your 1 and 5 year Vision• Answer the questions on the handout

• Additional activities• Values Exercise• Business Diagnostic Assessment

Implementation Steps

• 3 Financial Indicators• Profits, Cash Flow, ROI

• Cost Behavior• Profit Improvement Planning• More Key Performance Indicators

• Liquidity, Solvency, Collections, Breakeven• Creating a Budget/Profit Plan

Effective Financial Management

• Accounting system is fully & accurately functioning• Controls are in place to ensure accuracy• A Realistic Workable Profit Plan (aka Budget) is in place• Financial Monitoring is being used effectively as a business tool• Key Metrics are being used to keep your finger on the financial

pulse of your business• Owner reviews Financial Data and Metrics at least monthly• An adequate credit line is in place • Company is profitable, solvent and able to finance its growth and

reward stakeholders

Best Practices: Finance

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• Put together a solid business plan• Be in the best position to obtain financing• Grow a sustainable business• Create a valuable company that you can later sell or otherwise

provide for your exit from the business

Sound Financial Management is critical if you wish to:

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Effective Financial Management

Key Financial Data For Business Survival

Business is about making moneyTo do this, it must simultaneously increase three things:• Net profit margin – Operating profit margin• Cash flow• Return on investment (ROI)

3 Key Financial Indicators Of Your Business’ State Of Health

Indicator 1: Profit Margins

• Net Profit = What’s left over after you deduct ALL expenses from the revenue your business generates

Net Profit = Total Income minus Total Expenses

• THE bottom line in your business

• Indicator of the overall management of the business

Gross Profit = What’s left over after you deduct direct job costs from the revenue your business generates

Gross Profit = Total Income minus Direct Expenses to Produce jobs

Indicator of the productivity of your field crews

Indicator of the accuracy of your estimator (and pricing)

• Gross Profit Margin (GP%) is profit derived from work produced divided by Gross Revenue

Gross Profit Margin = (Gross Profit/Revenue)%

• Net Profit Margin (NP%) is after-tax net profit divided by Gross Revenue

Net Profit Margin = (Net Profit/Revenue)%

How To Calculate Profit Margins

• Production / service delivery processes• Material Costs• Labor Costs• Customer relations• Team Skills and Development • Pricing & Estimating• Selling Skills

Improve The Gross Profit Margin by working on the drivers:

• Administrative operating processes• Variable Costs • Overhead Costs• Customer relations• Administrative Team Skills and Development • Marketing Activities and Costs

Improve the Net Profit Margin by managing:

Gross Profit Margin = (Gross Profit/Revenue)%

• Higher is better• 50% is goal • 45% is industry average** Residential and Commercial Contractors under

$10MM, depends on mix of work, and use of subcontractors

BEST PRACTICE GUIDE : Gross Profit %

Net Operating Profit Margin = (Net Operating Profit/Revenue)%

• Higher is better• 15% is goal (25% BEFORE Owner’s Compensation) • 5% is industry average**Residential and Commercial Contractors under $10MM** There is a distinction between Net Profit and Net Operating

Profit, which is Profit before taxes, and “other” income & expenses not related to operations of the business including financing costs (interest expense)

BEST PRACTICE GUIDE : Net Operating Profit %**

The three questions of measurement

• Is it Accurate?• Is it Acceptable• Is it Sustainable?

Indicator 2: Cash Flow

Obtain Cash

Purchase Materials

Bid & Sell ContractComplete

Project

• There will be occasions when money is flowing out faster than it is flowing in

• Virtually every business experiences times when there is a cash flow gap

• Managing cash flow so as to avoid any critical situation due to lack of cash when it is needed is a major responsibility of a business owner

What Does The Cash Flow Cycle Mean To Your Business Operations?

• Businesses can make a profit but have negative cash flow • Failing businesses can have positive cash flow, possibly due to

large asset sales • Business start-ups require large cash outlays to build the asset

base = cash flow risk

Cash Flow – More Than Just Profit

• Over the longer term, you have to manage your cash flow to fund your business growth

• You can grow your business in the short term by ‘borrowing’ credit through late payment of suppliers

• Eventually, however, everything evens out and such strategies are not sustainable

• With that in mind, projected growth should be managed within known cash flow constraints…and if external funds are required, this needs planning in advance

Cash flow Over The Longer Term

• Shorten the Cash Flow Cycle • Understand the difference between Cash Flow and Profit• Plan in advance for business growth and/or downturns

Improve Cash Flow

• Prepare a Cash Flow Projection• Manage Your Spending on a monthly, if not

weekly basis• Invoice Promptly• Develop a systematized approach to receivables

and collections • Obtain a line of credit

BEST PRACTICE GUIDE : Cash Flow

• Return On Investment is net profit expressed as a percentage of the value of the total assets you have tied up in the business

ROI = (Net Profit/Total Assets)%• ROI is a profitability ratio – it is the true measure of the

financial productivity of a business

Indicator 3: Return On Investment

Return on Investment = (Net Profit/Total Assets)%

• Higher is better• Should be at least 10%• 25% or higher is a goal

BEST PRACTICE GUIDE : ROI

ROI: An Example YEAR 1 YEAR 2 YEAR3

NET PROFITS 10,000

11,000 12,100

TOTAL ASSETS 100,000

112,000 125,400

ROI 10%

9.8% 9.6%

ADDITIONAL ASSETS

12,000 13,440

NET PROFIT RETAINED

11,000 12,100

ADDITIONAL CAPITAL

1,000 1,340

• Increase sales revenue by increasing price and/or volume• Keep variable costs down (equal or below the rate of increase

in revenue)• Achieve greater productivity from resources which are

financed through overhead• Ensure that tight control is exercised over assetsSO THAT• Cash flow increases simultaneously with the increase in net

profit

The Function of Management:

• High tangible net worth (equity)• Consistent profitability• High cash flow from operations• Cash balances representing 30-45 days of operating

expenses• AR representing less than 30 days sales• A ratio of current assets to current liabilities (“current

ratio”) in excess of 3:1• A high level of working capital• A ratio of liabilities to assets of 1.0 or less (debt ratio)

Characteristics of Financial Health

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• Starts with Financial Statements: • Profit & Loss Statement (Income Statement)• Balance Sheet

How do we find out where we stand?

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• Accuracy is Essential• GIGO

• Accrual vs. Cash Basis• Accrual Basis – Day to Day operations

• Enter Invoices and Bills as they are incurred – not as they are paid• Cash Basis – Paying Tax• Enter data on Accrual Basis/Click of a button will show reports in

either format (in QuickBooks)

Regarding Your Financial Statements…

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• Good Structure• Sufficient detail to analyze data

• Use sub accounts where more detail is needed• Consider using classes if appropriate

• Group Expense accounts appropriately • All direct costs in COGS• Non Operational Income and Expenses in “Other Income & Expense”

section• Group Balance Sheet Liabilities appropriately

• Loans that will not be repaid this year in Long Term Liability section

Chart of Accounts Tips

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Profit and Loss Statement

IncomeDirect Costs (Cost of Goods Sold)Gross ProfitVariable ExpensesOverhead ExpensesNet Operating Profit

Other Income & ExpensesNet Profit

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Definition: Profit Margins

• Net Profit = What’s left over after you deduct ALL expenses from the revenue your business generates

Net Profit = Total Income – Total Expenses

• THE bottom line in your business

• Indicator of the overall management of the business

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Gross Profit = What’s left over after you deduct direct job costs from the revenue your business generates

Gross Profit = Total Income – Direct Expenses to Produce jobs

Indicator of the productivity of your field crews

Indicator of the accuracy of your estimator (and pricing)

Profit and Loss Statement

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Balance SheetDescription

Cash Checking, Savings, Petty Cash

Accounts Receivable Amounts Due from Customers

Other Current Assets Prepaid Expenses, Amounts due from others

Total Current Assets

Fixed Assets Equipment, Vehicles, Property, Depreciation

Other Assets Startup expenses, Goodwill from purchase, Company deposits, Long term loans made to others

Total Assets

Accounts Payable Amounts owed to Vendors

Credit Cards

Other Current Liabilities Payroll Taxes Payable, Customer Deposits, Short Term Lines of Credit

Total Current Liabilities

Long Term Liabilities Loans, Lines of Credit that will not be paid off in one year

Equity Contributions, withdrawals, Retained Earnings, Net Income

Total Liabilities & Equity Must equal Total Assets to Balance32

Balance Sheet

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Key Performance IndicatorsFactors that indicate the current and future performance of a business in areas that are critical to the company's success.

• Revenue to Budget• Gross Profit• Net Profit• Break Even Sales• Liquidity - Current Ratio• Solvency - Debt Ratio• Collections (Days Sales Outstanding)

Financial KPIs

Gross Profit Margin = (Gross Profit/Revenue)%

• Higher is better• 50% is goal • 45% is industry average** Residential and Commercial Contractors under

$10MM, depends on mix of work, and use of subcontractors

BEST PRACTICE GUIDE : Gross Profit %

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Net Operating Profit Margin = (Net Operating Profit/Revenue)%

• Higher is better• 15% is goal (25% BEFORE Owner’s

Compensation) • 5% is industry average**Residential and Commercial Contractors under $10MM** There is a distinction between Net Profit and Net Operating Profit,

which is Profit before taxes, and “other” income & expenses not related to operations of the business

BEST PRACTICE GUIDE : Net Operating Profit %**

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Current Ratio = Current AssetsCurrent Liabilities

Should be a minimum of 1.5 or higher (3.0 or greater is better)

Quick Ratio = Cash + Equivalents Current Liabilities

Should be at least 1.0Higher is better for both

BEST PRACTICE GUIDE : Liquidity Ratios

Debt Ratio = Total Liabilities Total Assets

Should be less than 1.0

Debt to Equity Ratio = Long Term Debt Stockholder’s Equity

Should be less than 1.5 or 150%

BEST PRACTICE GUIDE : Debt Ratios

Days Sales Outstanding =Accounts Receivable x 365

Annual Revenue (previous 12 months rolling revenue)

• Should be 30 days or less

BEST PRACTICE GUIDE : Days Sales Outstanding (Collections)

Cash in Bank = Overhead Expenses* (next month)

Gross Profit MarginPlus: Fixed expenses for months 2 & 3Or – just think 3 months fixed expenses for a quicker

calculation*Include Variable Costs and Overhead Costs

BEST PRACTICE GUIDE : Cash in Bank – Ideal

Cash in Bank = Overhead Expenses* (next month)/Gross Profit %Plus: Fixed expenses for months 2 & 3

Or – just think 3 months fixed expenses for a quicker calculation

*Include Variable Costs and Overhead Costs

BEST PRACTICE GUIDE : Cash in Bank – Ideal

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Return on Investment = (Net Profit/Total Assets)%

• Higher is better• Should be at least 10%• 25% or higher is a goal

BEST PRACTICE GUIDE : ROI

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• Session 1• Create a working draft of your Mission Statement• Create a working draft of your 1 and 5 year Vision• Answer the 10 questions on the handout

• Session 2• Review your own Profit and Loss and Balance Sheet and compare

to what you learned in Session 2

• Additional activities• Values Exercise• Business Diagnostic Assessment (link forthcoming)

Implementation Steps

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