[EDITOR’S NOTE: VITAL holds monthly CI Business Mastery Classes where it addresses important CI business topics via a webinar. 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 third CI Business Mastery Class was on CI Profit, and it was supported by Origin Acoustics.]
Last month, we covered the truth about CI that most integrators despise accounting and simply ignore or abdicate it. We also learned that the bank balance is an incredibly dangerous and severely lagging indicator of business health, despite it being a very common metric used to run businesses. Great accounting provides timely feedback, drives management decisions, and is the ultimate scorecard for business results.
Today’s topic is CI profit math and what is possible when you make more money, as most integrators don’t know their true profit. They often confuse revenue, collecting money, or selling jobs with profit. Those who do know their net profit number often find that number to be lower than double digits when asked what they could or should make. Very few integrators have a target beyond “I want to make more money than I did last year.”
This is the single biggest area of opportunity for integrators: knowing your profit, having a realistic target, and knowing what to do to get there.
Why is it historically so difficult for integrators to improve their profits? First, our industry is incredibly focused on the technology, as it should be, but there’s such a focus on the technology that there’s very little focus on business excellence. If you don’t know what’s possible in your business or where you stand against what’s possible, then it’s not top of mind to strive for more. Since these business discussions have rarely been present throughout the industry, integrators simply don’t know how to improve profits.
We also find that many integrators are making what they consider to be good money. They’re settling for good enough. What if you could improve profits without doing any more work? That sounds like it is too good to be true, but our clients are doing it every day and we know that it’s possible.
Some people simply don’t know what they would do with the extra money. This is a very important topic — creating a purpose statement for expecting more from your business. Anything you’re going to emphasize in your business requires a purpose, and you need to live that purpose in order to understand the “why” behind the effort. So, the purpose for generating more profit in the business is to solve problems and provide greater opportunities. Every single problem in your business presents an opportunity. When you have the profit and cash to maximize those opportunities, you’re able to operate on a totally different level.
So where do I start? You start with yourself as the owner. “But Matt,” you say, “I don’t have time to invest in my leadership.” Profit can solve that problem. “I don’t have leadership training. How am I going to become a better leader?” Money, or profit, can solve that problem. You get the theme here. Many of the problems turn into opportunities when you have the capital to invest in yourself, your team, and your company.
Now let’s review gross margin and how it’s measured. Many traditional accountants want to include the costs of labor, vehicles, maintenance, tools, insurance, and any number of things into the cost of goods to calculate gross margin. Now, in this case, we see revenue sometimes in buckets, such as equipment and labor, and other times we see revenue as just one big number. When you subtract all of these costs, you end up with some gross margin figure that is unique to your business. No other business in the industry will calculate gross margin exactly the same as you, unless you’ve intentionally worked with other integrators to come up with a strategy and a plan to count in the same way. You’re measuring gross margins differently than everyone. How do you know what to improve? How will you know an improvement has been made?
The most insightful way that we have found to look at margin is by decoupling the equipment, parts, and labor. This allows us to see what we call top-line margin before labor costs, for which we have a very clear metric across hundreds of successful companies. Next, of course, we have to look at labor margins. Why do we measure gross margin in these buckets? Because it provides very obvious levers to manage the business and produce the most ideal outcomes. (As a little teaser, next month we’re going to deep-dive into driving better margins by using these three buckets: equipment, parts, and labor.)
We need to start with some definitions. “Revenue” is the dollar amount that you collect from customers for goods and services. The cost of goods in our VITAL method is only the material costs for equipment in parts. So “gross margin” is therefore the difference between what we collected from our customers and what we paid for that equipment and parts. We call that top-line margin. Over the years, we have seen cost of goods include everything in the kitchen sink, which is just fine for tax accounting, but it will not provide you usable metrics to compare against best practices.
More VITAl Business Tips: Getting in the Right Headspace
The next bucket we define is payroll. We call that “compensation,” and we define it as a discrete bucket, which includes payroll dollars for everything, benefits, taxes, and payroll. We do break up that compensation into direct labor, office staff, owner’s pay…all of that. This allows visibility and management of the largest expense of the company, which is compensation. Our last bucket is major operating costs, or operational expenses, and we divide this into sales expense, admin expense, and occupancy. What’s left over? When we take gross margin, we subtract compensation and operating costs. Then we have net profit.
Clearly there is a relationship between gross margin, compensation, major operating costs, and, of course, net profit. When you’re able to see the numbers clearly using the big buckets, you can drill down into the category level to manage those levers and improvements.
For many years, we have held that 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. We’ve held that for years, but what we’re experiencing now is an increase in wages and operating costs. That generally happens, but it’s accelerated over the last few years. These numbers might shift, but the relationship stays the same. So, in our example, 70 percent gross margin, 40 percent compensation, and 10 percent net operating costs still nets a 20 percent profit. These numbers are related to managing gross margin — that top-line number is so critical, and that is why it’s one of our topics for next month.
Each month, a different CI Business Mastery subject will be addressed. Participants will receive a CI Mastery Business Class Certificate at the end of the 12-month series. Dealers can register for live and recorded sessions at https://growwithvital.com/