Do You Know Why You're Losing Money?
Tuesday, October 20, 2015
Your accountant just called. "Bill, you lost $12,000 over the past few months. You better make some changes or else this is going to be a really bad year." You hang up the phone, feeling really low and a bit upset, thinking " I'm paying this guy $200/hour to tell me I'm losing money. I already know that. I can look at the checkbook and come to that conclusion for free! My question is: What went wrong and how do I fix it?”
The process of understanding why we lost money should have begun months ago. Step one is to create a month-by-month cash flow budget. That process involves projecting what our sales, cost of goods (labor and material costs) and overhead costs are going to be, on a monthly basis.
When it comes to overhead costs, it's not enough to know that insurance is estimated to be $14,000 next year. We need to know what month the down payment will fall in and how much our monthly payments will be after that. When it comes to labor projections, we need to estimate which months we expect to be working a lot of overtime, and which months the techs are likely to work less than a 40 hour week. The cost of materials and equipment normally goes up and down with billable hours, so projecting what we will spend each month is relatively simple. Once we project the total annual purchases we can pro-rate those dollars monthly based on our projected billable hours. Bingo, our month-by-month cash flow budget is now complete. We now know what months are projected to be profitable and which ones are projected to lose money. By the way, once we have created our budget, the budget will be our basis for creating profitable hourly rates. That, however, is a different topic that we will have to discuss at a later time.
Back to the call from our accountant. Yes, we lost $12,000 over the past three months. But the question is whether that loss was expected or unexpected. If your company is like most trades companies, there will be some months that lose money while other months will be very profitable. That is the nature of the industry.
So how do we know if losing $12,000 over the past three months is a real problem or not. Perhaps our month-by-month cash flow budget projected a $15,000 loss over those months. If so, we can now relax a bit. Knowing that we lost $3,000 less than what was projected might even cause someone in the office to actually detect a smile on your face since you now know if the rest of the year comes in close to budget that you will actually make $3,000 more profit, for the year, than you projected.
But, let’s look at it from a different angle. Consider if the budget forecasted that the company should have actually made a $5,000 profit over the past three months. That means our real net loss was really $17,000 ($12,000 loss plus the $5,000 in profit we had projected to make.) What happened? Since we now have a budget, and we know what we actually spent, we should be able to pinpoint the problem. Here’s the process:
- Review Sales – Step one is to look at the projected sales for each of the three months. After checking, sales were pretty much what was expected. Conclusion, sales were not a problem.
- Material and Equipment Purchases – After reviewing the budget we find the company spent about $8,000 more than expected on equipment and materials. By digging a bit deeper we find out that our supplier offered a one-time 20% discount on XYZ equipment. Since this is the equipment we normally sell it was a wise investment to “bulk purchase.” Yes, it hurts cash flow right now but it will actually increase our overall profitability by the end of the year. Good move!
- Labor Costs – Upon review, labor costs were pretty much in line as well. Sure, we worked a few more overtime hours than expected but it wasn’t enough to account for the remaining $9,000 loss.
- Overhead Costs – The next step is to review each and every overhead cost in light of budget verses actual dollars spent. After review, most seem to be in line with two major exceptions. First, our workman’s compensation insurance was about $6,000 more than we had projected, which still leaves us looking for the other $3,000. Bingo, gasoline was up a bit over $3,000. Now the question is why? Perhaps we did more work and therefore used more gas. After checking, that was not a problem. Perhaps the cost of gasoline per gallon went up. Nope, the cost per gallon stayed pretty much the same. Lastly, perhaps one or more of the techs was abusing the company credit card. After we checked the records we found the problem. Seems Willy has been buying gas for his friends. Bye Willy!
The owner now knows what happened. Some things, like the gas situation, can be corrected. When it comes to the increased cost of W/C that cost will simply have to be built into a price increase since it will NOT go away.
The objective of creating, and tracking, a budget will tell the owner what’s going on. At that point it’s up the owner to do something about it. Bottom line, you can’t fix a problem unless you know what the source is. Creating a month-by-month cash flow budget, and tracking the monthly costs, will clearly show what is going on. Don’t depend on your CPA or accountant to tell you what’s happening. It’s your responsibility to know what is going on within your business.