Understanding your numbers Transcript

Greg Wilkes (00:01):

The construction industry can be a tough business to crack from cashflow problems. Struggling to find skilled labor and not making enough money for your efforts leaves many business owners feeling frustrated and burnt out. But when you get the business strategy right, it’s an industry that can be highly satisfying and financially rewarding. I’m here to give you the resources to be able to create a construction business that gives you more time, more freedom, and more money. This is the Develop Your Construction Business podcast, and I’m your host, Greg Wilkes.

Greg Wilkes (00:40):

So, welcome back to the podcast. This week, we’re going to be looking at your numbers and discussing your profit and loss. Now, this might be a podcast you might think, right? Oh, let me turn this off and skip to something else, because numbers a lot of us find really boring and mundane, not something we want to talk about. Much more interesting to talk about branding or marketing, something like that. I completely get that rather than discussing your P and L report. But although this podcast might not sound very interesting, it’s probably one of the most important podcasts you are going to listen to in your business. It might be one of the first ones that you want to listen to and look at again and again. What we’re going to discuss today is what is a profit and loss report? And we’re going to look at what’s contained in a P and L report too.

(01:26)
So what should be in there and what are the key figures you need to be looking at and analyzing in your business to make sure that you are earning profitably? Because that’s the name of the game, isn’t it? We want to make sure we’re earning money. Now, the reason we say this is one of the most important things to understand, to understand your numbers is because the Small Business Association did a statistic that over 50% of businesses fail within the first five years. That’s an incredible statistic really when you think about it, because it means that some of those businesses, they’ve managed to get through the early hard years, so they’ve got through the first few years, but then they fail as they start to grow. So that’s really concerning, isn’t it? So you can get through the first bit, okay? But as you start to grow and scale up the business, that’s when they fail within those first five years.

(02:17)
Now, if you have a good understanding of your profit and loss report, well that’s really going to reduce the likelihood of you failing in business. And not only that, if you want to grow past a million pounds turnover, you’ve got to know your stuff on your numbers. It’s absolutely crucial to your success that you understand your numbers fully, and you understand your profit and loss report. Now, what a lot of people do is they make a mistake of relying on a six monthly or even a yearly meeting with their accountant to discuss their figures. Even if you’re having it quarterly, that’s not enough. You don’t want to rely on your accountant for that information. You want to know where you are at any single month, at any point in time. You want to be able to pinpoint where am I? Am I in profit at the moment?

(03:06)
How’s my business looking? Is it still healthy? If you wait three to six months or even worse, a year to talk to your accountant, it’s too long. You could be absolutely bleeding money before you know it. You could be about to fail or go bust without you even knowing it. So it’s really important that you get on top of your figures and start understanding them from day one. Now, the benefit, once you start to understand your profit and loss report, you can start to sense when dangers on its way. You can have a look and think, right, are sales starting to slow down? Is my turnover slowing? Or maybe the cost of products is increasing, your materials are costing more, and your margins are being squeezed. Maybe your subcontractors and your traders that you’ve got with you, their prices are going up. So you can start to see that quite clearly when you’re looking at your profit and loss report.

(03:59)
You’ll also be able to fully understand your overheads. How much do you need to make each month in fixed overheads before you even make a penny in profit? Because every month you’ve still got to pay for your van insurance, maybe rent on an office, and heating and fuel and things like that. So all these things, these are fixed overheads. You’ve got to pay all these things off first before you even make a profit. So you need to know exactly what that figure is. You also want to be able to know how much tax you need to set aside and what you can draw in dividends and salary, because during a growth phase, you are going to see your cashflow at its tightest. There’s no doubt about it. When you’re trying to grow and you’re investing in your systems and you’re investing in your team, that’s when you’re going to really feel the pinch in your cashflow.

(04:48)
And sometimes it can feel like you’re not making any money at all. There’s hardly any spare cash in the bank, but you could actually still be really profitable even though your cashflow might be tight, you can still be really profitable, and it’s your P and L report that will show you that your profit and loss report will give you a sanity check during those difficult times and give you the reinsurance to be able to go and make informed decisions. So, it really, I can’t stress the importance of being able to understand your P and L report and the benefits that will give you when analyzing your business. Now, just to illustrate it, if you’re a business owner and you are trying to grow without understanding your PandL report, really you’re like a blindfolded captain of a ship that’s heading for the rocks. If you don’t understand your PandL, you are really blind to whether your business is navigating well or not in those seas, or you’re about to be sunk by a hidden rock.

(05:44)
And when you hit that rock, it’ll be quick, it’ll be sudden and unexpected, and if you’re not prepared, you’re not going to survive. And that’s the sort of thing that can happen in business. Things can come out of the blue and there could be hidden dangers there, because we’re blindfolded to it, we’re just not recognizing those hidden dangers. Now, it’s not a coincidence that some of the world’s richest men, some of the most wealthy people in the world, they absolutely love their numbers. Take for example, Warren Buffett. Now, this is old. He was worth, I think he’s like a hundred billion or something he’s worth now, when the statistic I’ve got is from 2018, it says he was worth $87 billion. So I know it’s much more than that now. Now, Warren Buffet, one of the richest men in the world, is absolutely numbers obsessed.

(06:33)
Now as an investor, he spends all day reading financial reports. He pours over the numbers, and his understanding of these financial reports has helped him invest in the right companies over the last 50 years and propelled the growth of his fortune. To give you another example, you’ve got JD Rockefeller you’ve probably heard of. He was argued to be the richest man who ever lived. Now he was an oil magnate. Now, he was worth some $1.2 billion in 1918. That’s equivalent to 340 billion in 2018. Now, Rockefeller was an accountant and then a bookkeeper. When he first started out, he loved his numbers, and he kept a strict accounting of his finances at all times in a ledger. And even when he was ridiculously wealthy, he still poured over those ledgers, correcting even the smallest areas that would literally just save cents or dollars. So that’s how numbers obsessed these people were.

(07:35)
Now, I’m not saying you’re not going to be like, well, you might be one day, but we’re not like Warren Buffet, and we’re not like Rockefeller at the moment. But really, it’s just to illustrate the point that we can learn from some of the richest men in history that they’ve learned to love their numbers. And even if you absolutely detest math and you detest numbers, well, I just urge you to really think about, if you don’t love it, just try and understand your P and L report. Try to interpret it because once you know the basics, it’s surprising how much you can gain from that. And so many business owners don’t even know the basics of their P and L. So if you listen to this podcast as we go through it, we’re going to go through what a P and L report is and what are some of the crucial things you need to be looking at.

(08:20)
Now, what does a P and L report look like? Well, if you’ve got some accounting software, hopefully you have, you can click on maybe Xero or you’ve got QuickBooks, you can do a search on there and look for your profit and loss report. This is your P and L and what you want to do if you’re on there at all and you’ve never looked at it before, maybe download last month’s profit and loss if it’s been filled out by your accountant or by yourself. So download your full profit and loss report. Now, what you’re going to see typically in a typical P and L report, you’re going to notice five things in there, five key numbers you need to be looking at. The first is your turnover, or it might say revenue at the top. So that is how much you’ve brought in sales. We’ll go into it in a little bit of detail in a second.

(09:11)
So, first of all, you’re going to look at your turnover. How much have you actually invoiced? Second, you’re going to look at your cost of sales. So, how much have you actually spent in order to achieve that turnover? So, what’s it cost you in materials and labor to deliver a project? So those two figures are then going to give you when you deduct one from the other, your turnover from your cost to sale, you’re going to get your gross profit. So this is how much profit you’ve made in the month. Then you’re going to see your administrative costs or your fixed overheads. So that will be like we said before, or your insurance and fuel and things like that, other wages, fixed assets in there. So that’s your administrative costs. And then the fifth figure you’re going to look at is your operating profit. So that’s what you’re left with, right at the end, once you’ve taken your fixed overheads away from your gross profit figure, you’re left with your operating profit figure, and this is where you can take your tax out of that and then take your wages that’s left for you.

(10:12)
So let’s just analyze what those five things are, one at a time. So as we said, turnover, cost of sales, gross profit, administrative costs, and operating profit. So, first of all, what is turnover? So nice and simple, turnover is simply the total amount of invoices you generate per month, the amount of work that you are billing for. Yes, the total amount of this work. So, for example, you might have two categories for turnover. Let’s say you are a design and build company. Maybe you’ve got two chargeable services, maybe you charge for architectural works. So that could be sales architecture, and then you could have sales for your building company. So you might have two different products there that you’re selling, but ultimately they will give you one total turnover figure. So that’s really important. So you can break that down as much as you want.

(11:07)
Maybe if you’ve got a plumbing business and you’ve also got an electrical division on the side, you might want to split those out. So it’s nice and easy to analyze how each side of the business is doing, but ultimately what we’re looking for is the total figure of turnover that we generate each month. So that’s turnover. The second one we said was the cost of sales. So what’s the cost of sale? Well, this will be all the costs associated with providing your service or your product directly. So it’s not going to include overhead costs, which we’ll cover in a minute, but some of the costs that, again, let’s use our design and build companies. Think of what costs of sales will be in there. You may have, for example, architecture costs, the fees paid to architects and other professional services might go in there. You would have your labor in there or the CIS labor and your subcontractors would all sit in there.

(12:05)
And sometimes subcontractors invoice for materials. You might want to split that out and have your subcontractor material costs in there too, if that’s the way they split it out. Or you could just lump them together. You may have council planning fees that go in there. You may have equipment higher. You are going to have materials that sit under there. So these are the sort of things that you’re going to need to deliver a project. They’re very specific to the projects, and that’s what it costs you to deliver that project. So they would go in as a cost of sale, and the total of that will give you your total cost of sale. So we’ve got two figures so far. We’ve got our turnover, which is a plus, and now we’ve got a minus, our cost of sale. So once we’ve got those two figures, we can work out our third important figure to analyze, and that’s our gross profit.

(12:58)
So gross profit, that’s not what you are left within your back pocket. You can’t take the gross profit, and this is the mistake a lot of people make. They finish a job and they think, oh, Sandy, I’ve earned 10 grand profit out of that job, and they pocket the 10 grand and they forget they’ve got all these fixed overheads they’ve still got to pay for and allow for. So gross profit is just simply the difference between your invoice revenue, all the money you invoiced, minus the cost of sale, those direct costs we just discussed. So it’s really good for your gross profit to try and track this not just as a figure, but as a percentage. This is really helpful for analyzing it. So you can just divide. Let’s give you an example. If you turned over 100,000 pounds, for example, and your cost of sale was 50,000 pounds, it cost you 50,000 pounds to go and deliver that work, then your gross profit percentage nice and easy is 50%.

(13:57)
Yeah, you could do that on a calculator. So you just divide 50,000 divided by a hundred thousand to get your gross profit percentage. So you want to keep track of that gross profit figure and you can start using that gross profit figure to set targets. So it’s a really important figure to track. Now, in the industry, that gross profit figure can really vary. It can be anything. If you’re a huge construction company, you can see sometimes gross profit as low as 10, maybe 15% for the average construction company, maybe a residential construction company. You’d want to really be seeing that around 20%, 20 to 25. If you are a maintenance company, someone that does small callouts and things like that, that gross profit percentage might be a lot higher. You could sometimes get them up to 45, 50% even. So it really does vary depending on what type of industry and what business you have.

(14:56)
But obviously, the higher that figure, the better. You want to try and get a nice, healthy gross profit percentage. So somewhere between 20 to 30% would be pretty good for a general building company. So you’ve got your gross profit figure. So we’ve got three things. We’ve covered. Turnover, cost of sale, and thirdly, your gross profit. The fourth thing we spoke about was your administrative costs or your fixed overheads. So these are pretty self-explanatory, but you’ll have things like, there’ll be things in there that your accountant and talk to about depreciation and amortization. And then you’ll have things like national insurance and things like that. That’ll all be in there too. But other usual things that you’ll get in there that you will understand will be things like, like we said, your insurances for your vehicles, rent on office space, electricity and gas costs. You might have leases for vehicles.

(16:02)
There’ll be all things like that in there. Or maybe fixed salaries. Maybe you’ve got a PA that works for you or a va. So you might have a fixed salary in there too. So all these are the sort of things that might be your fixed overheads that are going to come out every month. Now, what you want to do with some of these fixed overheads, sometimes you pay things annually. For example, like your insurance. Let’s imagine you pay your insurance for one of your vans and it costs you a thousand pounds. What a lot of people would do was then divide that by 12. And even though you may have paid it off annually, put it as a monthly figure in your p and l so you can see exactly how much your fixed overheads are every month. Otherwise, you’re going to get massive fluctuations month upon month.

(16:41)
So that could be quite good just to budget that way. So that’s your fixed overheads. Now, our last figure that we want to focus on is our operating profit. Now, simply put, the operating profit is what remains after your fixed overheads and your administrative costs are deducted from the gross profit figure. So going back to our example before, remember we said we had a hundred thousand pound turnover. We had 50,000 pounds that was left in gross profit. And let’s say for example, our administrative costs were 10,000 pounds, that leaves us 40,000 pounds in net profit. I mean, if you had 40,000 pounds in net profit at the end of the month, you’d be absolutely over the moon. You’d be smashing it. So let’s say we’ve got 40,000 pounds as net profit. Now that’s still not the amount you can take for yourself in your back pocket, don’t think, right?

(17:39)
Great, I can take the 40,000 pounds. Out of that 40,000 pounds, you’ve still got your taxes, things you can’t escape in life, death and taxes as they say. So, your tax rates vary from country to country. So I’m not going to go into what that is, but tax has got to be taken out of this figure too. So, once your tax is taken out, then you are left with your retained earnings, which is the amount that you can take in your pocket. You could take that out as a dividend. Yeah, so that’s your five key figures and the five key drivers of the business. Just to clarify them, again, that was turnover, cost of sale. That then gives you your operating profit figure, and you can also apply that as a percentage. Then you’ve got your total overhead costs or your administrative costs, and that then gives you your operating profit figure or your net profit figure.

(18:39)
So, I hope that’s helped you a little bit, just analyzing what a P and L report is and how you can understand it in your business. It’s really worth, if you’ve not done it before, go and download a profit and loss report, Xero or QuickBooks or whatever accounting software you’re using, and just take your time to go through that or just take your time to go through what your accountant sends you so you understand it fully because it’s absolutely crucial that you understand your numbers. And once you’re doing this, I mean it’s not just understanding numbers, but it’s then the ability to be able to interpret the figures and set targets. That’s where the real skill comes, because once you can do this, you’ll really see significant changes in your business and you can start manipulating the profit and things like that.

(19:25)
So I will do a part two on numbers. It’s quite a lot to take in for part ones. I don’t want to overwhelm you, but part two, we’ll look at how you can start setting growth targets. Once you understand these figures, how you can set a budget, how you can save during the good times, how you can make sure you’re not wasting money in the business. And we’ll also look at what are some of the key net profit figures you should be aiming for to make sure your business is healthy and enable you to grow. So we’ll look at that in part two, which will be another podcast episode. But I hope you got some value out of that. See you on the next episode. If you’d like to work with me to fast track your construction business growth, then reach out on www.developcoaching.co.uk.