By Tom Grandy, Founder
Last month we discussed how most companies allocate every dollar they spend…except Profit. We then discussed the differences in “accounting” net profit and “real” net profit from a cash flow perspective. As a reminder, cash flow deals with the real dollars that flow in and out of the company. From an accounting perspective, last month the company made a $21,000 net profit. However, cash flowed out of the company in four other areas that were NOT accounted for from the accounting perspective. When those areas were considered, the company’s “real” adjusted net profit was reduced to $13,021. Those four unaccounted for areas were:
- Equipment Replacement
- Hill & Valley Account
If you would like to review last month’s article before proceeding, click on Part 1.
So, now we know the “real” profit for the previous month was $13,021. If you have finished high school, chances are you have heard the term “All of nature abhors a vacuum.” Simply stated, if there is empty space or a period of time that is unscheduled, it will tend to be filled with something. It’s kind of that way with net profit. Any profit left in the company’s operating account tends to disappear! To keep that from happening, we need to determine ahead of time how any net profit generated, from a cash flow perspective, will be spent.
Net profit needs to be allocated in four (4) areas:
- Profit Sharing
- Debt Reduction
- Hill & Valley Account
- Money Left in Operating Account
Let’s review each area.
Profit Sharing (5%)
Chances are the company made a net profit because of the team. The team is made up of all employees from the owner to the parts runner. All worked hard to help the company make a profit therefore, all should share in the profits when the company makes money.
Typically, the company will want to take 5% of the net profit and share it will all employees. The company not only needs to pre-determine how the overall net profit will be spent ahead of time but it likewise needs to determine how the profit sharing will be allocated ahead of time as well. Below is an example.
Allocations can literally be based on any criteria you wish from income earned to years with the company. How you allocate the profit sharing is up to you. The important thing to note is that the percentages are determined before the profit is earned.
Debt Reduction (40%)
Debt is a ticking bomb. When all is well and the company is growing, debt is seldom thought of. However, there is a good chance that at least some reading this article lived through 2008-2009 when the world, from an economic standpoint, came crashing down. Those with low overhead and little debt made it through, others did not. Being totally out of debt should be every company owner’s goal. The sooner the company becomes debt free the better the owner will sleep. When it comes to telling our net profit how it will be spent, 40% of it should be used directly for debt reduction.
Hill & Valley Account (40%)
What are the chances that it will rain in your area of the country at some point over the next 12 months? Certain areas of California see little rain while the mid-west generally see lots of rain. In either case, it’s going to rain at some point. It’s just a matter of how often and how much. Guess what? Your company has slow times too. The typical trades company has roughly 90 slow days per year. During the slow times, how do bills get paid? Most borrow money through a line of credit, utilize credit cards or delay payments to suppliers. Although those work, they are expensive and make the company less financially stable. A better way is to have monetary reserves held back for those rainy days.
When we were talking about cash flow, one of the things we subtracted from the accountants net profit figure was a pre-determined amount of money the company was going to put back to fund the Hill & Valley account. In addition to that money, 40% of the “real” net profit should also go towards funding the Hill & Valley account.
Now, some of you have been doing a bit of math in your heads. If you are sharp at math, you have noticed we have accounted for 85% of the net profit. Now the question is, “What happens to the remaining 15% of the net profit?” The answer is that it stays in the company checkbook therefore building up a bit of extra cash flow.
We have now achieved our goal. We have pre-determined where every “real” net profit dollar will be spent. As time goes on the company will have funds to invest, buy extra inventory when it goes on sale, fund increasing inventory and accounts receivable, and/or invest in expansion.
Company owners sleep a lot better at night knowing what their “real” net profit is. They also rest better knowing that slow times are funded, debit is systematically paid off and the worries of increasing inventory and accounts receivables are funded.
Rewarding technician performance is important. However, data must be collected in order to evaluate performance. This month Grandy & Associates is featuring it’s Profit Smart KPI Tracker. This program tracks nine (9) Key Performance Indicators for each individual technician. This program will allow contractors to pay bonuses based on real, accurately measured, performance. The good news is that it only $299 this month! That is a $100 discount.
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