Yoho: Is ‘Poor Pricing’ Impacting Your Net Profit?

by Kyle Clapham

In a recent article, I stated that a well-run specialty home improvement company that sells a single product line such as replacement windows, roofing or siding—or offers a combination of these (or similar) products—should set a target to earn at least a 10 percent pretax net profit. Conversely, a general remodeling company should set a target to earn at least 5 to 6 percent pretax net profit.

Exhibit A (below) breaks down how to analyze profitability using your operating statement, which is also referred to as a profit and loss statement, or P&L. Despite what you may believe, a proposal, estimate and/or “contract price” must be calculated based on the individual circumstances relating to your business.

Exhibit A: Analyzing Profitability With Your Operating Statement (P&L)
I. Gross Margin
II. Operating Profit
III. Miscellaneous Income & Expenses (These are added to or subtracted from net operating profit)
IV. Net (Pre-tax) Profit
V. Net Profit
VI. Assess E.B.I.T.D.A. or Earnings Before Interest, Taxes, Depreciation and Amortization

Most contractors start in the right place, with the cost of labor and material necessary to produce a finished job, but many get off track after this. Standard formulas, such as multiplying your direct costs by 1.5 or doubling your labor and material, might not be a valid formula for your company, and once you’ve sold and installed the work, it’s too late to find out that you have made little to no profit on a contract.

Pricing formulas must be based on actual and specific costs within your particular business. You need to know (not guess) what your overhead costs are.

Start by separating your sales and marketing costs from your overhead. Every ad, promo, internet marketing initiative, jobsite sign, display piece, home show exhibit and similar is a marketing cost. Also, remember that even if you are the sole individual who is responsible for sales activities in your company, you will still have sales costs attentive to your efforts.

Not allocating something for your preparation, prospect visits, sales follow-up and phone time is to deny your value in this part of the process. At a minimum, allocate the percentage that similar companies in the industry pay their sales representatives.

Once you have these costs separated out, factor them against your total sales to achieve a percentage for each and then project the net profit that you desire to achieve. The chart referenced below, Exhibit B, breaks this down.

Exhibit B: Modern & Factual Pricing Formula
(Percentages are for example only)
Marketing 10% (Accountants often classify these under gross margins)
Sales 10%
General and Administrative (G&A) Overhead 18%
Net Profit 10%
TOTAL:  48%

The total percentage above (48 percent), when subtracted from 100 percent (the selling price), represents all other costs (plus a 10 percent profit allocation) outside of labor and material or direct costs/cost of goods sold.

This is a basic formula. It might require modification depending on the size and style of your product offerings or projects. However, nothing changes the fact that if the above listed classifications were to total 48 percent, the cost of labor and material to complete the job cannot exceed 52 percent of the selling price, or you are eating into your profit.

Most contractors don’t get the price to which they are entitled, and it’s not because the finished product isn’t worth the money. The problem often lies in the inability to sell the value when presenting to their prospects.

Now, you are equipped to assess the profitability of each contract sold prior to starting the job. It’s simple—on any job sold (if your percentages match the above example) if the cost of your labor and material exceeds 52 percent, you are sacrificing a portion of your profit.

Such circumstances might require an adjustment to the commission on a job (contract) prior to accepting it. This might also be true of a completed job exceeding 52 percent based on additional promises to the customer, or when mismeasures occur.

The following categories are all listed on your operating statement

  • Fully loaded marketing costs
  • Fully loaded sales costs (commissions paid to salespeople, project managers, sales managers, etc.)
  • General and administrative costs
  • Allocation for profitability

Any percentage increase in this accounting method should appear on your internal (prior to the year-end) operating statement.

If you analyze your actual revenue (installed contracts) against what you are spending to acquire and install your work, this can/will enable you to examine whether your collective installed contracts were or were not profitable to the degree that you intended with your pricing plan.

By further explanation, the operating statement (P&L) reports a company’s revenues and expenses over a period of time. If revenues exceed expenses, the company has a net profit. If not, the company has a net loss. Revenues (installed sales) in our industry are defined as “inflows” mostly resulting from the completion of contracts requiring the installation of products (a combination of goods and services).

Expenses are defined as “outflows” resulting from the purchase of goods, rendered services and attendant expenses to support the advertising, sale and installation of home improvement contracts.

Operating statement (P&L) accounts are temporary and reset at the beginning of a new period. For example, at the end of the year, revenues are closed, and the accounts are usually set back to zero.

The operating statement (P&L) accounts become part of a company’s retained earnings. When all the accounts are closed at the end of a period, the net addition to retained earnings will be the “net income” or “net loss” that resulted during the period. As the account title indicates, retained earnings are earnings that are kept and reinvested in the company.

Caution: Profitable operations do not necessarily create positive cash flow. Net profit comes from getting the proper price to begin with and then working within the projection of all expenses.

To make your company more efficient and profitable, start by examining your pricing methods then correcting them to ensure you are earning the profit to which you are entitled. QR

Dave Yoho is president of Dave Yoho Associates, the oldest and largest consulting group serving the home improvement industry. If you have a desire to earn the net profit you are entitled to, register for the 2023 Peak Profit Summit on May 9-11 in the Chicago area. Industry retail operations can receive up to TWO (2) complimentary tickets with a refundable deposit. Learn more at HIPSummit.com.

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