[EDITOR’S NOTE: VITAL is in its second year of monthly CI Business Mastery Classes where it addresses important CI business topics via webinars. Each class is supported by an industry brand. VITAL has agreed to share some of the information from these classes in a monthly column of highlights from its most recent webinar. The topics are the same as the previous year’s classes, but the content is refreshed. This CI Business Mastery Class was on profit math, and it was supported by Origin Acoustics.]
Making more money is a topic that comes up frequently in our discussions with integrators — it is certainly an outcome that we are all interested in. Today, we’ll look at profit trends across the industry and introduce the levers for profit margin. Then we’ll break down the profit math to show you how it can be measured and impacted effectively.
Most integrators don’t know their true net profits, confusing revenue and selling jobs with profit or being busy, and confusing that with making money. Those who do know their net profit often find that number to be lower than double digits. When asked how much profit they could or should make, you’d find that very few have a target beyond, “I want to do better than last year.”
This is the single biggest area of opportunity for integrators — knowing their profits, having realistic targets, and knowing what to do to get there. Why? Because a healthy profit can solve nearly every problem in the business. You can trace most of the problems in a CI company back to the lack of profit, cash flow, or both.
Historically, it has been difficult for integrators to improve their profits mainly because our industry is so focused on technology and not on business excellence. If you don’t know what’s possible and where you stand against that benchmark, it’s simply not top of mind to strive for more. Traditional profit improvement suggestions from other industries don’t always apply for CI businesses. It’s a unique animal.
Many of the industry trends that are currently circulating have failed to solve the profit problem. For example, the biggest fallacy by far in our industry is that doing more volume solves the profit problem. Chasing top-line revenue can certainly produce more profit dollars in the end, but unless your profit margin problem is resolved or improved, you end up doing a lot more work for just marginally greater outcomes. When the profit machine is working, each revenue dollar means so much more.
The Main Profit Lever
Strategic management of gross margin is the single biggest profit lever in the business, so let’s review how it’s measured. Many traditional accountants want to include the cost of labor and vehicles, maintenance, insurance and any number of things into the cost of goods to calculate gross margin. In some cases, we see revenue in buckets such as equipment and labor. Other times we come across just a big revenue number with no separation. Then you subtract all these costs and you end up with some gross margin figure that’s very unique to your business, because it doesn’t look anything like any other integrator. No other business in the industry will calculate gross margin exactly the same, unless you have a strategic process for doing so.
The most insightful way to look at gross margin is by decoupling equipment, parts, and labor. This allows us to see the top-line margin calculation before labor costs, for which we have a very clear metric across hundreds of successful companies that VITAL has worked with. Next, we look at labor margins discretely, and we manage those labor margins against established benchmarks for performance and productivity, because labor margin is the biggest variable that you have in your business.
Working this way provides obvious profit levers to manage the business and produce the ideal outcomes using profit math.
Profit Math Made Simple
The great news is we have simplified the profit math for you. When you operate your business to produce the right data, it will become simpler for you.
First, we need to start by reviewing some definitions. Revenue is the dollar amount you collect from your customers for goods and services. Cost of goods in the VITAL method is only the materials cost for equipment in parts. Gross margin is the difference between those numbers. We call that top-line margin.
We define payroll as its own discrete bucket, and this bucket includes all payroll dollars, including benefits, tax…everything. We further break up that payroll into categories such as direct labor, office staff, owners’ pay, and payroll taxes. That separation allows visibility into the management of the largest expense in your company.
The last bucket is major operating costs, or what some call operating expenses or overhead. We further divide that bucket into three categories: sales expenses, admin expenses, and occupancy. Again, what can be measured can be managed, and being very strategic about how we organize these things is critical. Gross margin minus compensation and major operating costs equals net profit. Pretty simple, right? That’s profit math.
Each market and business is unique, but the relationships between these numbers are critical, especially the relationship between gross margin and compensation — the two biggest numbers to manage in your business.
For many years, we’ve held that a 60 percent top-line gross margin, 30 percent or lower compensation, and 10 percent or lower operating costs will net you a 20 percent or better profit. However, with increases in wages and operating costs, those numbers can shift, but the relationship remains the same. It’s not your job as a business to sacrifice profit because your cost structure has changed. When compensation costs increase, you must drive more gross margin — charge more. You need to drive more productivity and keep your operating costs in line.
Managing your gross margin is critical, which is why we’re covering the topic in depth next month.
For more information about the CI Business Mastery Classes and the other services VITAL provides, visit http://growwithVITAL.com.
