Tuesday 6 February 2018

Can Your Business Pass It’s Financial Stress Test? How Well Are You Really Doing?

Posted by at 10:13 AM in

To grow your restoration business your company must pass several critical financial stress tests. Following the 2008 recession Americans became painfully aware of the importance of financial stress tests for banks that were just too large to fail. Stress tests whether financial or physical are indicators of health. Do you have the time for a check up to see how your business is really doing?

Stress Test #1 – Is your business financial investment growing by at least 10% per year?

Most financial investors are happy if they earn a 10% return on their investment. Trying to top this with a higher return is risky and a lower return is disappointing. How is your ROI and how do you assess how well you are doing? Let’s begin by comparing your year-over-year revenue. How much did your company revenue increase or decrease compared to the year before? If today’s number is larger than last year’s most owners tend to feel good about the increase. But wait a minute – that is not a very good gauge of success.

A more valuable way to look at revenue growth is to look at the past three years as a single unit of time. The three year average annual growth rate does a better job of revealing your company’s growth trend and more accurately shows its current growth trajectory. Complete this simple gross revenue exercise to identify your growth trajectory. Identify the gross revenue for each of the years 2015 – 2017 and follow this formula for each year – (2017 GR – 2016 GR)/2016 GR = %. This is pretty simple math. Subtract 2016 from 2017 and divide by 2015 equals the percentage difference between the two years. This is your annual growth rate stated as a percentage of change for 2017. For example if your 2016 gross revenue was $570,000 and your 2017 gross revenue is $625,000 your calculation is (625,000 – 570,000) ÷ 570,000 = .096 x 100 = 9.6% increase in revenue growth for 2017. Do this for each of the three years; add the three percentages and divide by three; and you will have your three year average annual growth rate. This trend is worth identifying. Do it now and then come back. Did you pass the stress test by earning at least an average 10% return on your investment per year? Now apply the Rule of 72 by dividing 72 ÷ by your 3 year average to show how many years it will take to double your business at its current average annual growth rate. What do you think about that?? Are you satisfied or not? The Rule of 72 shows investors that if they earn on average a 10% return their money will double in 7 years. Not bad! Most restoration owners have invested everything they have into their businesses. What rate of return do you expect? If your business investment is growing at less than 10% on average annually you need help!

Stress Test #2 - Are you making at least 20% profit off your operation?

Read this carefully – The 20% Overhead and Profit a contractor earns from each damage repair job is a given. You are given that regardless of how well you manage your operations, equipment, material and labor costs. This stress test is about how much you earn beyond that 20% given. If you earn nothing more than 20% Overhead and Profit you fail the test. How much effort do you think it takes to earn an additional 20% through operational controls and efficiencies? One would think that would not be too difficult for most contractors. So if you earn 20% from Overhead & Profit and another 20% savings on equipment, material and labor charges (those are the classifications Xactimate uses as payment categories) you have a combined 40% net profit on your work. 20% profit that is a given and another 20% profit you have earned through good business practices. That is not bad and if you can improve still further and earn 30% profit from operations resulting in a 50% per job profit you have done really well.

Here is how you calculate what you are currently earning: Most contractors clearly identify construction expenses for equipment rental, construction materials, and subcontractor labor under the Cost of Goods section of their profit and loss report. These three categories happen to coincide with the 3 classifications of charges that Xactimate calculates in every damage repair estimate. Totaling these three expense categories and dividing by the year’s total construction revenue will give you a good view of your percentage of profit on construction work. Do that now for 2016 and YTD 2017 and see what you find out about your profitability. I talk with a lot of contractors every month and I find that most have little idea of their actual percentage of profit from operations. They have no process in place to track actual expenses against job revenue to determine the per job profit they typically earn.

One of my client contractors earned 21% profit last year on over $1 million in construction revenue. For all the work his company performed he earned 1% beyond Overhead and Profit. My experience is that the typical “well-run” construction services division earns around 28% - 32% from construction services. That is a mere 8% - 12% profit earned beyond Overhead and Profit. In other words, on a typical $10,000 rebuild most contractors spend all but $800 - $1200 of what they are paid to do the job. Wow, how tragic. All that work and effort for a pretty measly return! If it weren’t for the Overhead and Profit that is just given to contractors most would go out of business in a year. What we need are contractors who are doing a great job and are earning 20% - 30% from their operation. The good news is that it is not that much harder to run a really good operation than it is to manage a mediocre one. That’s the truth!

Stress Test #3 – is your 10% return on investment funding your retirement and personal wealth building or is it going back into the business?

The truth is business owners needs a 20% net profit for both personal wealth building and for business development. Without a 20% net profit something or someone is suffering loss! The most common story for restoration business owners is they forego their own retirement savings and wealth building in order to put their meager net profit back into the business in the form of equipment purchases, new hires, and debt service to help the business grow. If sufficient attention were given to earning a net profit of 20% there would be 10% profit to meet each personal and business needs! Let’s identify your net profit as a percentage of gross revenue for years 2015, 2016 and 2017. Simply divide your net profit (the bottom line of your profit and loss statement) by gross revenues and convert to a percentage. For example if your gross revenue is $1.2 million and your net profit is $90,000 your net profit as a percentage is 7.5%. Do this for three years and then divide by three in order to get an average annual net profit percentage. This gives you the clearest picture of how well you are doing at protecting your net profits.

Industry net profit benchmarks:

  • Less than 5% = horrible
  • 5% – 10% = poor
  • 10% – 15% = average
  • 15% – 20% = good
  • 20%+ = outstanding

How did you do, and what do you think about your company’s net profit margin? Is there enough profit to fund your retirement and business expansion?

Stress Test #4 – Is your financial float increasing faster than your revenue growth?

Now move to your company’s Balance Sheets for years ending December 31, 2015 through 2017. Identify the year end number for Accounts Receivable. Just like you calculated the percentage of change for each year’s annual revenue follow the same process for the percentage of year-to-year change for your Accounts Receivable. The formula is (2017 AR – 2016 AR)/2016 AR = %. Compare each year’s percentage of change against the corresponding years revenue change. If your AR year-end percentage is increasing faster than your revenue growth you have a problem.

Many companies become less and less efficient the larger they become. If your collection process is deteriorating the larger you become I can already anticipate that you are facing significant cash flow problems. The easiest way to determine the severity of the problem is to recall the scramble that occurs every pay period. Are you frantic to collect everything you can, to put off paying other bills until payroll is met, or have you ever missed a company payroll deadline? These are clear signs that you have a cash flow problem and this is dangerous. Stress tests reveal indicators of business health. These indicators say that everything is OK, or they reveal weaknesses that need attention.

In business there are few tests more important to an owner and the survivability or thrivability of his or her company than financial indicators. Let’s get a grip on your financial indicators and determine what if anything needs to be done to put your business in a stronger safer position for the future. If you are interested I would love to hear from you! Send me your numbers for each of these four stress tests and I will tell you what I think about them and what you can do to improve them. I hope to hear from you!!

Reference:9-Month Coaching Plan – The Business Transformer - Double, Even Triple Your Business In 18 - 24 Months Subscribe and receive our weekly blogs in your email inbox at http://growmyrestorationbusiness.com/blog/