The Business Side: Why can't I make a profit?
However, the real reason is almost always the result of a lack of project management or overstaffing. After studying the records of many different companies for more than 30 years, I want to share some of my conclusions. I feel as though I have been working on this article for years, and the time has come to put it on paper. Some readers may not agree with everything I am going to write, but let the chips fall where they may.
Surveying/engineering businesses share many similarities. They carry out the same basic tasks, buy the same supplies, pay about the same wages, have similar benefits packages and share about the same amount of profit with owners and employees. When times are good, the profit may be 5–15 percent of gross revenue. If economic times always remained good, everyone would be happy. But in a free market system, we will suffer an economic downturn every so many years. Most companies react slowly to these downturns and start by borrowing money, which can result in many sleepless nights for company owners and managers. The big question is: How can you, as a company owner or manager, keep your company profitable through a downturn?
First, let’s address the issue of project management. Survey companies that do not provide engineering services find that their clients generally set a very short time frame for delivery of a survey product. This quick turnaround allows the survey company to complete jobs quickly and hold cost overruns to a minimum. However, this principle does not hold true on the engineering side, where many projects are developed over a longer period of time. Dragging out the project, with the inevitable twists and turns along the way, almost always results in a loss of profit because many engineers are slow to ask for additional monies as the client corrupts the project’s original scope and time frame.
The old adage “over time, over budget” still holds true today. The results of my research show that the older and larger a company becomes, the more difficult it is to show a good profit for the effort put forth. For effective project management, larger jobs should be broken down into manageable pieces, and employees should be held accountable for completing each part of the work in the agreed amount of time.
A final note is that sometimes getting paid after an engineering project has been completed can be a real struggle. If things drag on for too long, the engineering firm may need to borrow money to keep functioning. And the interest paid on that money cannot be recouped from the client. I’m not trying to pick on engineers, but I want to make the point that a lack of project management can lead to wasted effort and a loss of profitability.
When a company is in growth mode, every employee is busy and possibly working overtime. Most companies in growth mode are looking to hire additional personnel. The problem is knowing when to shut off the hiring switch. Being a little understaffed always results in higher profitability. Employees can be at their best when they are challenged to deliver jobs quickly and work some overtime to supplement their income. Conversely, working too much overtime can burn out employees and force them to look for other employment. This is the balancing act many company owners and managers face.
This leads to a subject I have written about many times-the “cash cow” business. The cash cow is a method of running a company where the owner has only one intention: to make maximum profit and close the company upon his or her retirement. The cash cow always suffers from underemployment and burns out many employees along the way. But a funny thing often happens with cash cows: Because it is so easy to find a buyer for a company that always makes a great profit, many cash cows are not closed. I think this should tell us something about operating a business-if you want to make money, run your business more like a cash cow.
The Key to Profitability
Not long ago, I did some consulting for a company that had a wage ratio higher than 60 percent. They were overstaffed and practiced no project management, yet they wondered why they owed the bank more than half a million dollars in loans.
As a company owner, you have to monitor certain financial records. The trick is knowing what records to monitor. For many years, I have pored over reports, graphs, profit-and-loss statements and other records for different companies trying to find a common thread that would indicate the health of a company. After looking at many different options, I think I have found the key: To stay profitable, you must have the proper number of employees for the work the company generates each year.
I have developed a system where you as owner or manager can check to see if the
employee cost is the proper percentage of total revenue. This system works best
if it is based on the numbers from an entire year, but it could also work on a
monthly basis if the right income numbers are used. You start by separating out
the total raw wages paid in the year without any benefits. You divide this
number by the total cash income of the company for the year. (Notice I use
cash, not accrual. If you can’t collect the money, you have not made a profit.)
This division should result in a percentage that shows what part of your total
income is labor cost. See the sidebar to the right for real-life examples of these calculations.
The only way to skew this percentage is if the owners are paying themselves a higher-than-normal amount of money. If the owners’ pay is in line with that of other professionals, the break-even point is about 45 percent. At less than 45 percent, you should be showing some profit for the year. As this percentage approaches 50 percent, you start to show a loss. At anything lower than 40 percent, you are starting to operate a cash cow. Some cash cow profit-and-loss statements show a labor-to-income ratio not much over 30 percent. But keep in mind that cash cows pay very little in benefits and experience higher-than-normal employee turnover.
This system only works for a professional service company because we buy very little in the way of raw materials to produce our products. Remember that this ratio is only the ratio of total wages to total income.
If your company has struggled for years with making money, I want to make the following suggestion: Pull out the last three or four years of profit-and-loss statements and review them carefully. You may not have too many employees, but you may be spending too much in wages to put the project out the door. If you control total wages paid to less than 40 percent of total cash income, you will become profitable. Make that your goal.