In this issue…
Years ago, one of our companies implemented a profit-sharing program for its employees. All was well and good in year 1, when the company made money. Not so much in year 2, when the company made less than hoped for. And a disaster in year 3, when the company lost money and company execs had to explain to 60+ employees why there wouldn’t be any profit-sharing that year.
Employees were not just disappointed, they were angry. Their unhappiness with management came from a simple question: How could a multi-million dollar business lose money?
Well, how about not charging enough for the goods and services you sell? This is a common issue, especially as companies strive to remain competitive. But charging enough is only the first part – you have to do enough business to cover and exceed costs. This can sometimes seem at odds with charging enough. And, regardless of revenue volume, you have to manage costs to a responsible level.
The economics of success can be expressed in a simple formula we call “Profit Math”:
Gross Margin minus Compensation & Operating Costs equals Operating Profit
Here’s how Profit Math looks on our integrator dashboards… Pretty Simple, we think.
Gross Margin is the first component of economic success – the more margin you generate, the easier it will be to cover costs. Some managers think the way to cover costs is by generating more revenues. But growing revenues typically requires additional costs. Much better to achieve healthy gross margins first, and use the resulting profits to fund future growth. GM of 60% or higher gives the headroom you need for a cost structure of 40-50% of sales. Note: Our GM includes Labor Revenue but not the labor costs. You will need a high mix of labor to get there; typically greater than 30%.
For every integrator, the biggest cost is people. Compensation, which is the second component of economic success, needs to be managed to a responsible level. Measured as a % of revenues, total comp (including subcontractors, pay taxes & benefits) should come in at under 34%.
Major Operating Costs is the third component. Active management of fixed costs is difficult, but variable expenses like Travel & Entertainment can be contained. The table shows these at 15% which, with COMP at 32%, gives a total expense of 47% of sales. With a 62% GM, this yields a 15% operating profit.
A 15% net operating profit is a GREAT result. But it doesn’t come about by hoping it will happen. Use Profit Math to sketch a management outline for your company, and set your monthly operating targets accordingly.
Sign up for our dashboards to get monthly feedback on all the metrics that contribute to the Profit Math outcome (www.bi4ci.com). Manage your metrics throughout the year, year after year, and become the owner of a truly valuable enterprise.
Here’s to your economic success!