PEOPLE of Construction

Business Tips for First-Time Business Owners

(Fifth in a series of Five)

This is the fifth and final of a series of five blogs intended to guide new business owners to the road of success within the design and construction industry.

In this blog, I will discuss three business points that are important, if not essential, in achieving long-term sustainable success with your company.  Those three points are the importance of choosing a lane and staying within that lane; controlling the costs of your business; and controlling or managing the cash of your business.

Success is not an easy, well paved road.  It is winding, packed with obstacles of many sorts, and often at an incline that will challenge your endurance level.  In the previous blogs, you have been provided helpful information to straighten out part of this road so keep on reading and I will do my best to give you the rest of the story and then attempt to tie everything together in one easy to read and understandable package.

If you keep this packet of information close and read through it often, I believe it will guide you to the road of success.  It is then up to you how you travel that road.  It is easy to get off base but if you pay attention and follow my tips, I am betting that you will be among the many that keep our industry strong.

Thanks for reading and best of everything to you in the years ahead.  You know where to find me if you need help along the way.

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POINT NUMBER ONE: STAY IN YOUR LANE

It seems that in our restless society, we are never satisfied with the lane we are travelling.  We see people passing us and we have a compelling desire to constantly switch lanes, either to keep with the competition, or to pass them by.  Rarely do we ever take a long trip and stay in the same lane from start to finish.  We get nervous, anxious, overcome with the feeling that we are missing out, that others know more than us, that somehow, we could be doing better, moving faster, and by making constant moves we can reach our final destination before others, and with more ease.

Let’s explore this feeling a bit.  First, let’s all clearly understand that we must choose a lane to begin with, any lane, but hopefully one that fits us.  We must decide as a business owner what our company is all about, what talents we have that others do not, what size of project fits us, and what steps we are willing and able to take to grow our company and increase our capabilities.  Until we know and accept this, it is impossible to choose a lane—or at least the right lane.

Once we have carefully and thoughtfully detailed a short and long-term plan of action for our company, we can start to decide the right path to follow.  If you–as the business owner–plan to do all the work in the field, your path is limited.  If you have a team of employees that you know and trust to perform to your quality standards, that is a different path.  If you have a foreman that can handle multiple projects at one time, and you have financial ability to take on multiple projects, that is yet another option.

My strong suggestion to all business owners searching for the right lane is that you prepare a formal or informal business plan and answer the following questions:

• What size project can our company handle comfortably?
• How much gross revenue do we need to bring through the door in the next twelve months to cover our overhead and make an acceptable profit?
• What is our sweet spot as to a dollar value for a single project?
• How many projects will it take to reach our revenue and profit goal?
• Do we have the right employees with the technical ability to perform our stated scope of work, or will we have to hire additional employees if we increase our project load?
• Do we have the financial ability to successfully manage multiple projects and to hire additional employees to meet our gross revenue goal for the next twelve months?
• Where do I want this company to be, in terms of project size and gross revenues, in three years’ time?

There are numerous questions that must be answered to develop a complete business plan, but the above list will at least help you to establish an acceptable lane for your company for the next twelve months.

Answering these questions will help you understand the size of projects you can handle efficiently; the dollar size of those projects; and the manpower requirements to complete the work of those projects to the expectations of your clients.  That will get you into a lane that your business can successfully travel in.  Now, the challenge to you is to stay in that lane until your business grows and circumstances change.  Believe me, this is hard for most business owners to do.

Switching lanes in the first years of your growing business is what gets you in trouble.  You can only handle so much and when you decide to take on more work that you can handle, that is when things start to fall apart.  You quickly get outside of your comfort level with employees, with your ability to manage and control costs, with having the necessary cash to meet payroll and other project obligations.  Once the out-of-control spiral starts to swirl around your head, it becomes difficult to focus on what is important; you simply try to exist and get by.  I don’t want to see you get in that position.

The lane you choose for your company may be the slow lane but if you choose carefully, it is the safest lane.  Let others pass by; that does not necessarily mean they will get to the finish line before you. It also does not mean they are making their revenue and profit goals.  The businesses that grow too fast in this industry are the ones that get into trouble with the IRS and the state for their withholding taxes; the union for their benefit payments; their main suppliers; and their employees.

Your business plan, be it formal or informal, must be reviewed on a quarterly basis, if not monthly, and adjusted to accommodate your appetite for more business and your financial ability to handle more business.  I am a big proponent of changing lanes assuming business owners look both ways and convince themselves, and their business relationships, that it is safe to do so.

Just as in highway road traffic, you will quickly find that there are obstacles in every lane.  Make sure you are prepared for the obstacles in the fast lane between you make a move.

POINT NUMBER TWO:  CONTROL OF COSTS:

It seems there is a natural inclination for new businesses to avoid keeping track of their costs in an organized manner.  This may be the primary reason they avoid keeping accurate and timely financial records.  Or it may be for a lack of understanding of how easy it is to keep track of costs—which, of course, is the first step to controlling costs.

Let’s start this discussion with some very basic information.  In this industry there are two types of costs.  You have direct job costs which are the costs incurred in performing your scope of work on the various jobsites.  This would be the labor costs to do the work; the materials purchased that went directly into the work; the equipment rented to assist in the work; any subcontracted costs that you may have to incur; and any miscellaneous cost such as clean-up costs, or field office costs, permits, bonds, insurance, safety costs, or any cost that was incurred as a direct result of doing the scope of work included in your contract with the GC or owner.

The other type of cost is referred to as general and administrative costs and those are costs necessary to run your business but are not directly related to a particular job.  This would include any office equipment costs, computers, software expenses, auto and truck expenses, fuel for company auto and truck expenses, copy machines, office supplies, office utilities, telephone expenses, marketing and advertising expenses, legal and professional expenses, insurance expenses, or any miscellaneous expenses not related directly to a job site.

There is a third type of costs which I see mixed in quite often and that is the personal expenses of the business owner.  This may include groceries, fuel for their wife’s car, meals, entertainment, and a wide variety of other expenses totally unrelated to the business.  Personal costs are not business expenses and should never show up in a company bank account.  Make a huge mental note of this right now.  There may be certain expenses that you pay personally that are allowable business expenses but those can be dealt with on your tax return at the right place and right time.  All business owners, assuming the business is an LLC or corporation or partnership, should maintain a business account and a personal account and should never mix the two.

All costs need to be managed and controlled but I want to focus some attention on direct job costs.  It is absolutely essential that you understand the costs involved in completing the work involved in a residential or commercial contract.  This knowledge will have an impact on your future estimating and bidding and will help you to control your job-site costs on future projects.  I see so many profit and loss statements where the business owners have general and administrative costs mixed in with their job-site costs and this totally distorts the picture of what it takes to perform your scope of work on a specific project. 

If you get nothing more from this discussion, please understand the importance of keeping your general and administrative expenses separate from the costs you incur performing your scope of work on job sites. 

Also, if you as the business owner and perform work on the job, and if you pay yourself a salary—which you should—charge that cost directly to the job.  This is a direct job cost.  If you have other employees doing the direct jobsite work and you spend your time managing the company and directing traffic, record your salary expense as general and administrative expense, separate from the direct project expense. Salary managing multiple projects is considered an office business expense and not a direct job cost.

Let’s take a quick look as a specific example:

You land a contract for $50,000 and you estimate it would take you $38,000 in costs to complete the work.  Somewhere in that estimate, you have so much for jobsite labor, so much for material, an amount for rented equipment, maybe some subcontracted costs, costs for supervision, and some costs for the indirect administrative costs.  It is your hope and desire that when the project is complete, you will not spend more than the estimated $38,000 and the remaining $12,000 will be free and clear and available to pay your office expenses and leave you some excess for profit, which will be used to start your next project and continue the growth of your company.

If you estimated the project correctly, your material costs and your subcontractor costs will probably not change much, if at all.  The biggest variable you have is your labor costs.  If you estimated you could complete this scope of work with two workers over four weeks and you ended up using four workers over six weeks, you will exceed your estimated costs, right?

The goal with cost control is to know the costs you are incurring on a weekly basis.  This will allow you to make an adjustment in your workforce on a timely basis.  Maybe you cut back one or two workers and work an hour overtime every day; maybe you have a discussion with your workforce and get their ideas as to how you can trim costs.  Sometimes a little cheer-leading discussion along with a little education as to how important it is that this project makes money, goes a long way towards getting a little more production from your team.  A general discussion with your workers may also put the spotlight on certain workers that are not doing their share of the work.

There are a couple of numbers I want you, as the owner of the business, to understand.  The first is “Gross Revenue.”  This is the amount of money received directly from the owner for the various contracts where you are performing work.

The second is “Gross Operating Profit.”  This is the amount of money left after you subtract your direct job costs from your Gross Revenue.  You should aim for this number to be in excess of 20% of Gross Revenue.  This would make your direct job costs in the 80% range of Gross Revenues.

The third number I want you to understand is “General and Administrative Expense (G&A Expense)” You will want to keep the total of G&A expenses to somewhere under 20% of Gross Revenues received.  For a small, start-up company this will be hard to manage but it is a percentage you will want to try to maintain on order to make a bottom line “Operating Profit.”

There are two ways to make a profit—increase your gross revenues or decrease your direct and G&A costs.  The marketplace will keep you from earning more than 25% of your gross revenue, after deducting your direct job costs.  As a small company, there are general and administrative expenses that are unavoidable so there is only so much you can do to cut these costs to less than 10% of gross revenue.  Therefore, you will quickly realize you need to increase your revenue if you want to make a decent profit at year end.  You cannot survive by doing one project and resting.  You must be constantly on the lookout for more work, more revenue.  This is a simple fact of life in this industry.

If this all sounds Greek to you and you find your eyes glazing over these words, email me and let’s talk.  You simply have to have some basic understanding of a profit and loss statement if you are going to find success.  This is important.

This should go without saying but I am going to put this in writing anyway—in a separate paragraph so you can read it over and over; maybe even cut it out and paste it on a bulletin board somewhere in your office. 

In order to control costs, first you need to record them, so you know what they are.  If you are currently not keeping track of costs in an organized manner, there is no logical way to control job cost.

There are simple ways to keep track of and control costs and there are complex ways.  Start with a very simple method of looking at your payroll hours worked every single week.  How are they stacking up against your estimate?  Is the project progressing the way you imagined when you put together the estimate?  Just because your workers spend 40 hours on the job and record 40 hours of time, does not necessarily mean they accomplished anything, right?

I have a very simple cost control report included as an example in my Guide to Better Business book which I would love to share with anyone wishing to take this discussion any further.  I also would welcome the opportunity to help business owners set up a cost control system.  Cost control sounds a bit scary and somewhat outside of the capabilities of a business owner that grew up in the field, but once you understand the importance of knowing and controlling your costs, and the benefits that good cost control will bring to your bottom line, you will be thankful for this gentle encouragement.

Business owners that find long-term success in this industry know and understand their costs.  Their job costs, their general and administrative costs, and probably their personal costs.  Understanding costs and recording them in the right place and paying attention to costs incurred in relation to progress made on their projects is what makes them successful.

If this discussion feels a bit complicated to you, I completely understand.  I realize I dived into more detail than intended but I hope you forgive me and feel the importance of this business point. 

Give me a call if you are feeling a bit lost and I will help you get on the right road.

POINT NUMBER THREE: CONTROL OF CASH

There was a time in this industry when cash flowed.  Owners would pay their general contractor by the tenth of the month and the general contractor would pay their subcontractors by the fifteenth of the month, if not sooner.  If you were a small start-up business, most general contractors would work out a weekly payment schedule with you, if required and if felt beneficial to both parties.  They could make these prompter payments to their trade contractors as it was quite typical that they could rely on getting their payment from the owner by the tenth of every month.

Unfortunately, those times seem to have disappeared.  When an owner delays payment for 30 to 60 to 90 days, this eliminates the concept of “cash flow” for trade contractors as there is no cash to flow.  Trade contractors must pay their workers weekly, their union benefits or health benefits weekly, their federal and state withholding taxes weekly, and most suppliers of material within thirty days.  Unless the business owner has a substantial amount of cash when entering into a contract agreement, or unless they successfully negotiate a prompt payment agreement, they will quickly run into a cash or working capital problem on every project.  By the time they receive any payment for their work, they are starved for cash, and every penny is accounted for multiple times over.

The pressure of meeting your payroll requirement every Friday afternoon can paralyze a business owner and cause havoc with all other major business decisions.  Do not let this happen to you.  This may be a good time to read over the first business point in this section, the importance of staying in your lane.

There are several avenues for help with working capital, but most of them are expensive and oftentimes difficult to obtain.  Conventional lending tends to shy away from commercial construction projects as the risk is great and usually misunderstood.  RISE CDFI is an option for MWBE and small businesses seeking working capital to support a specific project.  Justine PETERSEN is also an option for smaller firms, and they will work with you in multiple ways assuming you meet their qualifications.

I know of no source of financing that will be available without the providing of financial statements, tax returns, and specific project information.  Yet another reason for accurate and timely financial records.

There are numerous predatory lenders in the marketplace, but the costs are high, the terms are demanding, the repayment techniques are unforgiveable, and working with these lenders wipes away the already thin margins you have placed on your work.  Stay away from these lenders.

I could easily go into an elaborate detailing of a cash flow reporting system but if you are working in the design and construction industry, such a reporting system would be rendered useless by the payment practices of our industry.

My best advice for controlling cash is to stay in your lane; choose projects that you can manage within your existing cash on hand; keep your manpower down to manageable levels to where you can comfortably meet your payroll obligations weekly; and request payment clauses in your commercial construction contracts that will reimburse you for costs incurred within a workable time period.

You need to respect cash as it is hard to replenish a worn-out cash account.  The expenses keep on coming while the refilling at the top of the bucket seems to take forever.  If you follow all the rules and still run out of cash, do not hesitate to talk to the jobsite superintendent who can direct you to the right individuals within their firm to possibly help you with a prompter payment.  Do not try to fight this battle alone.

You should not be embarrassed to say that your business has run out of cash.  The industry did this to you.  You may have carefully chosen the right project, worked the right number of hours, pushed all the right buttons, and still come up short due to the owner’s payment being delayed beyond your control.  Speak up!  It will be to the benefit of your company and to the benefit of the individual project.

Until we change the payment practices of our industry, controlling cash will be a top management issue for small business owners until they retain enough profits to build a sizable cash account.  Be careful, be smart, be vigilant, be vocal.  This is a problem that should be understood by all in our industry.

This is the fifth in a series of blogs on tips on how to start and manage a successful business in the design and construction industry.  This is also the final blog.  Please read my Summary of Thoughts for a quick summary of all points discussed.

All blogs are posted on my website at PEOPLEofConstruction.org and are available upon request by emailing PEOPLEofConstruction@gmail.com.