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Discussion Starter · #1 · (Edited)
This is an article I wrote for my DIY Chat Forum. (I have a section there that is hidden from public and is for the PW'ing contractors so no one sees it)
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How To Make More and Do More

Numbers analysis is a tricky thing. There are guys that will take up arms when you say their company nets 25% of gross billing. These are usually one man shows and are indicative of not understanding what each number means. I'm going to show you how raising your prices ten percent will increase your net profit by 40% as well as ultimately increase your volume. What?? Raise prices AND get more work? Read on.

Definition of Net Profit
First its important to clarify what net profit is. This is whats left over after ALL expenses. I think where many people get confused is that they add in the amount they take out of the business (salary) as part of the net profits. Net profit is what your company makes at the end of the year, not what you make. If your business is setup properly, you pay yourself a salary. That salary is a constant. Its your compensation for your role in the company (your job). Let's make it simple and say you pay yourself $1,000 per week, every week all year. That's $52 K per year. That's barely enough to support a two kid household with a mortgage unless you have a wife/partner that also makes money but its a round number.

That money disappears from the business every week as an indirect labor expense regardless of whether you do 20 jobs or just one. Understanding the terms overhead, direct costs, indirect costs, depreciation, gross profit and the ilk, I'll leave for another conversation. For now we'll just call them "expenses". Back to the topic at hand.

Lets say you billed for $150,000 in 2007. Your "expenses" totalled $115,000. Again that includes materials, owner salary, employee payroll, insurance, truck payments, equipment depreciation, advertising.. everything. The money left over is 35,000. This is the company's money also known as "cash flow" or "net profit". It represents 23%.

Here Is Where One Should Take Notice

Now, in 2008 you decide to raise your prices. The first thing you have to do is factor your cost of doing business and raise based upon that. This compensates for increased gas prices, rising chemical costs etc. I add 3% every year. This is a profit neutral raise. It breaks you even for last year. But lets say you are tired of doing 300 jobs per year to make your gross of $150K. You decide to raise your prices by an additional 10%. Your Housewash goes from $.10 per s/f to $.113 per s/f. Your decks go from $1.50 per s/f to $1.69 per s/f. You think your customers are going to abandon you for that little of an increase? Some may, but so what.. here's why.

Scenario One
Its unlikely you will lose much business with a 10% increase. To keep things simple to understand in scenario one, we'll say everything stays the same. You still do your 300 jobs. Instead of doing $150K in '08 you'll do $165,000.

All your other expenses are also the same (your cost of doing business price raise compensated for any rises in gas etc). Now your company net profit went from $35,000 to $50,000. There's your 40% increase.

Guess what you can do with that extra $15,000? First, give yourself a raise of $5,000 per year (try getting that in the corporate world). That means you now have an additional $10,000 sitting in your company coffers. Upgrade your equipment, enhance your image or what I like to do.. invest it in advertising. $10,000 will yield me $100,000 in work.

"So let me see if I am summing this up correctly. By raising my prices ten percent I can make more money for myself as well as nearly double my volume?" Yep.

Last Note: Some guys may say "if I raise my prices I will close less sales" Perhaps. But all your other expenses like payroll and materials will also drop so in the worst case scenario, you still get the raise and don't work as hard.

I know this sounds too good to be true but it is what it is. Please, ask questions or throw out your thoughts. I am far from the be all end all authority in business. I'd like to hear from you guys.
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Above article copyright Ken Fenner and PressurePros, Inc
 

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Thanks Ken

Ken,

Thanks for a simple, yet very effective illustration of basic business concepts. Perhaps you could continue with some more articles on the basics. If your time permits, I know I would certainly appreciate the information.

JTP
 
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Ken,

Very good post. I particularly like that you defined your terms.

You hit on 3 key points that are often overlooked by small business owners: the owner drawing a regular and consistent salary, investing the profits back into the business, and knowing your ROI for advertising.

I agree with JTP-- let's see more.

Brian Phillips
 

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Good Post

Good Post Ken! Definitely a lot of good content in the article.

One comment/clarification is that cash flow is not always (actually it rarely is) equal to net profit. I think it is a big challenge for business owners to look for expenses that are not so apparent (i.e. no cash going out in the current period). Examples of this would be costs of equipment that are used for multiple years, use of a vehicle or trailer that you own, a prepaid item such as insurance, etc. Granted, you paid for these items at one time, however they should still be considered when evaluating your "net profit." If you write articles frequently, you could cover a whole topic on just cash flows.
 

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One comment/clarification is that cash flow is not always (actually it rarely is) equal to net profit.
Cash flow and net profit are not the same with accrual accounting, but are the same with cash accounting.

Accrual accounting records income when earned and expenses when incurred, so a company could be highly profitable and broke because of poor cash flow. Cash accounting records income when received and expenses when paid (i.e., when cash changes hands), so net profit and cash flow would be equal.

Good point PainterKevin, and good article Ken.

Brian Phillips
 

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This is an article I wrote for my DIY Chat Forum. (I have a section there that is hidden from public and is for the PW'ing contractors so no one sees it)
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or what I like to do.. invest it in advertising. $10,000 will yield me $100,000 in work.




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Above article copyright Ken Fenner and PressurePros, Inc
Ken great post:thumbsup:

their is one thing I thought should be brought up, I think the term is
called "diminshing marginal rate of return" not sure about the term but it sounds good lol, but basicly their is a point whear , whear you can keep throwing 10,000 at advertising, and you will see a lot less work in return, then the normal rate of return of 100,000 that your used to seeing. Just thought that was worth a thought.

thanks
dave mac
 

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Ken, I'm a Jonny-come-lately, but I appreciate the post(s). It's what this site was meant for. Keep it coming.

As to the diminishing rate of return, good point. This is something that tracking addresses in marketing campaigns, as the market changes and folks move, etc. Keeping a solid eye on ROI should minimize that. Good point, Dave mac.

BTW: I moved from NC to ID recently (so we're no longer in the same market, Dave.)
 

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some further points

Ken,

Bearing in mind that you will want to include your increased salary and advertising in your annual costs, they have just increased by about 22%
 

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Correction

Ken,

Sorry, I overstated the increase in costs. However, the message is basically the same. You must now factor in higher costs into your quotes.
We tend to leave out overheads when making our initial calculations as these will sometimes price us out of a job (when things are really tight). By doing this we can cover our prime cost and be contributing to the overhead burden which is there irrespective of whether we get the business or not.
We can only do this for a while of course otherwise we'd go bust, but it has its uses at times.
 

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Discussion Starter · #18 ·
Ken,

Bearing in mind that you will want to include your increased salary and advertising in your annual costs, they have just increased by about 22%
Hi Patti. It depends upon what you do with the increase in net. (if I am understanding you correctly). This is "free money" so to speak. You can allocate it to salary (I would). I kept it simple to make sure the numbers analysis was clear. What I left out, and of course its important but is minimal, is the increase in cost of lead generation/advertising. Historically for me, raising prices 15% usually results in a loss of approximately 10% in closes. That doesn't bother me because the dollars, not customer count is what pays the bills. Its optimal to increase both but increasing your gross dollars while increasing your customer count is no small feat. It definitely requires expanding your advertising budget.

Business analysis is like a puzzle. If you miss certain pieces, the picture is not complete. Its difficult to put things into writing without it turning into a confusing flowchart of numbers that all start blending together.
 

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The costs matter at the margin

Hello Ken,

I take on board what your saying about advertising and business generation. if you can get that sort of response it would certainly justify the increase in your overheads. However, I'm pretty sure that would not be the case for a lot of businesses, imparticularly those that rely on their reputation to gain competitive advantage. Advertising can easily produce a scattergun effect.
In the credit-crunch effected residential sector, I guess businesses are earnestly looking for new kinds of tie ups within the real estate chain to enhance their business model. That requires a lot of leg work beyond advertising. However I do not question your own proficiency in this area of the market.
The other point I was trying to make, was the effect of full-cost pricing, which automatically includes overheads. In an intensely competitive market it is very easy to cross the point where you become too pricey. If estimates are built up initially on prime costs you at least get the opportunity to decide what to do about overheads, including your rise in salary.
 

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Discussion Starter · #20 ·
I like you already, Patti :thumbsup:

I think what you are describing is more akin to commercial work where advertising as well as sales ability and presentation are less dominant over price closes.

Here is why I say that:

Generally residential customers, including myself, have no idea what things cost. I've shared on other forums that I am in the process of planning a kitchen remodel. The first bid came in at over $100K. My house is currently worth about $300K. To say the least, that would be an impractical amount to spend. I was very turned off by the price. Was it the contractors fault? Yes and No. He gave me exactly what he thought I wanted. Unfortunately, he is a craftsman, not a salesman. He didn't ascertain my needs or a realistic budget. He is a professional and as such should understand that resale value and recuperation of costs play into my decision making. He did not sell me on the benefits of using top of the line materials and appliances. If he were to find out that I am going with a contractor that bid half of what he did, he would be apt to go on Contractor talk and write a diatribe on lowballers. At worst, he would think he would start having that little demon whisper "maybe you are charging too much". That would be an improper assessment and could lead him down a slippery slope.

What's my point? Bear with me, I'm trying to get there. He could have sold me. He had the reputation, the image and the knowledge of remodeling that I trusted enough to hire him on the spot. It came down to the sale. By giving me that type of bid, he prompted me to seek out other estimates. In my mind, whether true or false, he was never going to be able to work within my realistic budget.

It also came down to his marketing. My initial impression of his company came via a postcard. After I researched his reputation, I called him in. If this guy is used to doing $100K+ kitchen remodels, he should not be marketing to my neighborhood.

I am not trying to come down on this contractor but to make a point of connecting the dots of cause and effect. In his mind it went down one way, but as outlined above, my reality and his are on opposite pages. To bring it all home and make it relevant.. if you are marketing to the correct customer and understand the importance of selling solutions, not paint jobs, the factor of experiencing an "intensely competitive market" is lessened if not eradicated.

This is based of my model beliefs of margin over customer count. If your company is more volume based and deep residential selling is cost prohibitive, I suppose a 10% increase could affect you greater. I don't personally believe that to be true for any company that is selling the customer experience over just a paint job.
 
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