According to the late quality guru Phillip B. Crosby, “Good things happen only when planned. Bad things happen on their own.” The financial aspect of your business follows a pattern — it’s a true economic cycle. You can either get ahead of and master this cycle, or you can get run over by it. Like surfing, it’s best to be ahead of (on top of) the wave.
For my clients and me, the mid-year review (MYR) is one of the most important planning events of the year. Three years ago, we covered the MYR process in the June 2019 issue of this magazine. However, it’s such a strategic event that it bears repeating and updating. Here’s how it works and why it’s so important:
Timely, accurate data is the lifeblood that feeds and fuels your company. It’s raw and granular. Properly processed, formatted and provided to the right people at the right time, it generates the knowledge that entrepreneurs and their teams use to create high-performance cultures and organizations.
The MYR allows you and your organization an opportunity to slow down at mid-season, take a breath, gather the appropriate information and analyze how the company is doing compared to the key performance indicators (KPIs) and benchmarks established in your annual budget. Here are some of the things that you should review:
1. Review your profit and loss (P&L) statement: You want to check to see how your actual year-to-date (YTD) results compare to your budgeted amounts for sales and direct costs (materials, field labor and burden, truck and equipment, subcontractor and rental equipment costs). You should then check your general and administrative (G&A) overhead costs to ensure that they are not out of line with budgeted amounts.
2. Calculate your break-even point: Next, calculate your break-even point (BEP). You achieve it when you’ve accumulated enough gross profit margin (GPM) dollars to pay your total G&A overhead costs for the year. To calculate it, you divide your G&A overhead dollars for the year by your average company or division GPM percent. For instance, if your budget is $1 million, your G&A overhead budget for the year is $250,000 and your GPM is 35%, it calculates as follows:
$250,000 divided by .35 = $714,286 BEP
You should reach your BEP when your revenue totals just over $700,000. Once you reach your BEP, any revenue above your direct costs goes directly to net profit, as long as the job is completed and billed in the current year.
Knowing that you are near your BEP allows you to bid year-end work more aggressively. For instance, if you’re bidding residential installation work with a normal GPM of 35- 40% and a resulting net profit margin (NPM) of 20%, you could theoretically reduce the GPM on the bid to 20% and still achieve your desired 20% NPM.
3. Review your 2022 budget and prepare your budget for 2023. I like my clients to simultaneously review their current budget and prepare the one for next year five to six months before the end of the current year. Doing so during your MYR is a great time to get it done. Any necessary adjustments for your 2023 budget can be made at the end of the 2022 season.
4. Review your pricing for 2022. Once you review your 2022 financials and prepare your 2023 budget, you then should make any adjustments to your 2022 pricing. Doing so could add thousands of dollars of additional revenue (and net profit) at the end of this year.
5. Review your “preliminary” pricing for 2023. You not only want to plan for 2022 price adjustments, but you also want to begin planning for any increases in 2023. Fuel costs, labor cost increases, truck and equipment cost increases, and general inflation will be with us well into 2023. Now’s the time to begin planning how you’re going to calculate these costs and include them in your pricing for next year. As an example, for every dollar that your field-labor average wage cost increases, you need to increase the price of your services to your customers about $3. It’s roughly a 3:1 ratio. I recommend that you raise your prices every year even if it’s just one or two percent. Doing so will help prevent the customer “sticker shock” that can occur if you only raise your prices every two or three years. Program your customers to expect reasonable price increases every year.
The Wall Street Journal tells us that about 14% of small businesses create annual budgets. I think that this figure is much smaller for green industry entrepreneurs. This means that these contractors and their teams do not take the time to adequately analyze the financial data in their businesses. Remember, as Phillip B. Crosby says, if you want good things to happen, you need to plan for them. Otherwise, lots of bad things will probably show up at your doorstep. Next time, let’s cover a few more things to look at during your mid-year review.