The Big Five
In my role as a business coach, I have the good fortune to review many monthly P&L statements from contractors across the United States and Canada. This includes plumbing, drain cleaning, HVAC and electrical contractors performing both service/replacement and new construction.
During these rough economic times, much of my day is spent discussing and developing action plans to control expenses. Now, when it comes to controlling expenses, action plans are great, but it is important that you use the company P&L as the final scorecard.
The challenge for most owners is that P&Ls have too much information. When they look at this blizzard of numbers, their eyes start to cross and they put it in the file and go off and do other work that they understand and are good at performing. As a result, an opportunity to make good management decisions based on sound financial information is lost.
Many owners just take a quick look at the top line - revenue or sales - then the last number all the way on the bottom - profit or loss. That leaves all the really important numbers in the middle - expenses - breezed over or not even reviewed at all. During challenging economic times, this can be a mortal sin.
KISS PrincipleFrank Blau taught me years ago about the “KISS” principle when running a business. “Keep it Simple, Stupid” was a phrase thrown in my direction more than once.
Nowhere is this concept more important then when reviewing and managing your business’ P&L.
So let’s start with the most important expense numbers on your P&L. I call these the Big Five. Keeping the KISS principle in mind, you should start with the Big Five if you are looking for ways to trim expenses in your business. If you can manage these five expense categories and keep them in line, you will have a hard time not making money.
The Big Five are the following:
- Direct labor. The wages and benefits we
pay the people doing the work in the field.
- Material expense. The net cost of the
materials we sell to customers.
wages and benefits we pay the people who support the people in the field.
- Advertising. Service contractors only;
this is an insignificant number for new construction companies.
- Vehicle expenses. All expenses including lease/depreciation and interest, maintenance, repairs and fuel.
Table 1 is a sample P&L that is greatly simplified from the average P&L (a lot fewer lines!). I have highlighted The Big Five.
As you can see, the Big Five represents total expenses of $1.365 million or 78 percent of the total. If you have a profitable company, these items together likely represent around 70-80 percent of sales. If you are at breakeven or worse, they may represent as much as 85-90 percent of sales.
In order to control expenses in your company, focus your energy on where you can get the biggest return on your efforts. That’s going to come from the Big Five!
Here are a couple of tips when focusing on the Big Five:
Of the Big Five, these are the most important expense items to monitor. Your profitability is in serious jeopardy with any significant increase in percent of sales here. Conversely, any decrease in these percentages will greatly improve profitability.
You should be able to recite on demand these two percentages (both your actual and your budget or goal percentage for these expense categories). They are that important.
An important point to remember is that, if your sales are declining, these expense items better be declining faster than sales as a percentage or you are virtually guaranteed to be losing money. If you know your sales are going to be off, get these items in line - now.
Next year will no doubt be a challenging year. It will be more important than ever to learn to manage your business by the numbers.
Keep it simple; get a firm handle on your Big Five expenses. Commit to memory your average monthly spend in dollars and percentage of sales for these important expense categories. Develop action plans around containing or reducing these items. You will be controlling at least 70 percent of your expenses and will go a long way to thriving in a challenging business environment.
If you would like some help with developing action plans to get these expenses in line, give me a call.