How Much Profit Should A Company Make?

The question that often comes up is, “How much profit should a company make?”.  The answer to that question can be a bit confusing.  It’s confusing because if you look at most of the published numbers, they pretty much say the same thing.  The average trades company makes a 3-5% net profit.  Is that a good number?  Absolutely not!  The problem lies with our friendly accountant whose job it is to minimize the taxes the company pays.  Let’s say the company has a review with their accountant in mid-December.  After reviewing the numbers, the accountant estimates the company will finish the year with an 18% net profit.  Ouch, the company is going to have to pay a lot of taxes on that 18%.  That is where Mr. or Mrs. Accountant begins to earn their money.  The accountant suggests the company might want to prepay bills that will be due after the first of the next year or perhaps purchase another piece of equipment or vehicle and take the normal, or accelerated, depreciation.  The accountant may even suggest loading up on inventory or pre-purchasing quantities of materials, parts or even equipment.  Bottom line, the accountant wants to spend some of the earned profit now in order to reduce profit and therefore the amount of taxes the company will likely need to pay.

This process is all well and good…from the accountant’s standpoint.  The process works and taxes are reduced.  The potential problem is spending too much cash.  Most trades companies have slow seasons which often take place the first of year.  It’s not unusual for a company to lose money the first quarter, before sales pick up as spring and summer roll around.  If too much of the company’s cash is spent, in order to reduce taxes, they can easily find themselves in a cash flow crunch during those negative months.  Remember, there is a huge difference in accounting dollars and actual cash flow dollars.  Cash flow deals with the real dollars that are flowing in and out of the company.  Not having enough cash to fund short term cash flow problems, will result in the company having to take out a loan, use credit cards or creating and drawing upon a line of credit.  The answer is seldom 100% cash flow nor is it 100% the accountant’s suggestions.  It’s usually somewhere in between.

Now, perhaps, you might have a better understanding of why the average trades company does NOT make a 3-5% net profit.  It is normally much higher than that if it’s well run, but by the time the accountant completes their work, the end result shows, for tax purposes, a 3% or 4% net profit.

Now, let’s go back to the original question.  How much profit should a company make?  The simple answer to that question is a well-run company should generate a 10-12% net profit overall.  The key word is “overall”.   Most companies have several departments ranging from residential service to huge commercial building projects.  The projected profit varies widely by department and by type of work performed. 

Generally speaking, the repair/service department should have the highest net profit.  It also happens to have the highest overhead and is the most difficult to run properly.  A well-run service department should generate a 15% to 20% net profit.  If the service department is on flat rate pricing, that number can easily jump to 20-25% net profit. 

When it comes to replacement of equipment, net profit should run 10-12%.  Large commercial jobs on the other hand, generally represent huge gross dollars while generating very small net profit numbers.  Large jobs often run the in the 3-5% range when it comes to net profit. 

The final area is new home construction.  Many startup companies begin by doing new home construction work, be it plumbing, heating, electrical or any of a variety of trades.  There are reasons for starting out doing this type of work.  Builders are normally looking for the least expensive subcontractor.  That would be our startup company.  The new entrepreneur is often working alone or with one or two other people.  Overhead is low because they are likely working out of their house or garage.  With little overhead to cover, pricing can be lower (which is what most home builders are looking for) while still generating a profit.  However, when those same companies begin to grow, they often move away from new construction work because their overhead goes up and their profit margins shrink.  Bottom line, if you can make any money doing new construction work, congratulations.

The above was a pretty broad brush in terms of profitability by types of work.  There are exceptions to every area.  Companies that tend to focus on one or two areas, tend to become very efficient at what they do and can easily exceed the above numbers.  Other companies only do custom work for high-end customers.  In that case, profit margins will also continue to increase.  Even companies that do solely new construction can prosper.  Companies that do only new construction tend to have their trade, policies and procedures down to a science.  They are efficient at what they do, know how and when to buy materials at discounted prices, and they handle their cash flow well.

Back in 1987, during my first year in business, I was reading an article on an airplane.  The article was about a small company that manufactured custom-made tennis shoes.  This was well before the massive number of different shoe styles we have today, with the unbelievable prices.  This was back when a normal pair of high-top or low-top tennis shoes would cost the average consumer $12-$15 a pair.  For the benefit of younger people reading this article, tennis shoes back then only came in black or white.  While the rest of the world was selling tennis shoes for $12-$15 a pair; this guy was producing custom made tennis shoes and selling them for $150/pair.  I will never forget the last statement in his article.  It said “It really doesn’t matter what you do or what you sell as long as you are the best at what you do – you will be successful!”

That is the key.  Pick an area of expertise and become the best at it in your geographic area.

No matter what type of work you do, pricing is key.  However, even if you are priced properly, if your techs don’t believe in your pricing, they will tend to under price the customer. 

This month’s Website Special speaks right to that issue.  It is a steaming version of Why Do We Need to Charge So Much?  This program will help your techs and employees fully understand why you need to charge what you charge.  This program is normally $114.95 but this month it’s only $99.95.  Order today!

The second Website special is our online program entitled Five Customer Buying Principles.  This is an amazing program that normally sells for $39.95 but this month it’s featured at $29.95.  Sign up today and listen whenever you have a half hour or so to spare.  You will be glad you did!