Chapter 10 – Running a Small Business Profitably

Once you have collected the money, there is only one thing left for you to do. You must be sure that you make a profit on the job.

Pretty obvious, right? But, believe it or not, hardly any small contractors actually do it. I know this may be hard to believe, but it’s true. Let me give you an example of this:

Pete is a plumbing contractor. Besides himself, Pete employs two other plumbers. So, Pete runs a three man company.

Pete sells a plumbing job to a general contractor for forty-six hundred dollars. Pete has his two men work on the job. They finish the job in two days, and Pete collects forty-six hundred dollars.

Now let’s see if Pete made a profit. First of all, let’s agree on what “profit” is. When I say “profit,” I mean THE MONEY MADE IN A BUSINESS ACTIVITY AFTER ALL THE EXPENSES HAVE BEEN MET.

Pete sits down and calculates his company expenses on this job as follows:

AMOUNT OF MONEY PETE SOLD THE JOB FOR $4600
LABOR $2400
MATERIAL $1200
AMOUNT OF EXPENSES $3600
AMOUNT OF MONEY PETE COLLECTED FOR THE JOB $4600
AMOUNT OF MONEY PETESPENT TO DO THE JOB $3600
REMAINDER $1000

Terrific! Pete has made one thousand dollars. He takes the thousand dollars home and sits down a second time. This time he pays all the household bills that have been stacking up for the past couple of weeks. Rent, phone bill, credit cards…. Terrific again! He has now paid off all the household bills and still has fifty dollars left. To celebrate, Pete takes his wife out to dinner.
Now the question is — What was the profit for that job? One thousand dollars? Fifty dollars? Unfortunately for Pete, the answer isNO PROFIT. That’s right, no profit. Not a penny. Now let me show you why there was no profit for that job.

Remember, the definition we are using for profit is: THE MONEY MADE ON A BUSINESS ACTIVITYAFTER ALL THE EXPENSES HAVE BEEN MET

When Pete was calculating his expenses, he forgot one thing.Heis an expense. Remember when he took that thousand dollars home? Well, the minute he took that money out of his business and gave it to himself, that money became an expense to his company. Now if he had taken only nine hundred dollars for himself and left one hundred dollars for his business, his company would have made a profit of one hundred dollars.

It doesn’t matter to the company if Pete is the owner or just another employee. The important thing is that, just like an employee, or a material bill, or any other kind of bill, Pete, himself, is an expense to his company. This is perfectly fine, of course,aslongasafterthecompanyexpenseshavebeenmetthereisstillmoneyleftforthecompany.

Why is this so important? After all, it’s Pete’s company, so as long as all the bills get paid, why can’t he take whatever money he wants? He can, of course, and a great many small contractors do exactly that. These are the same contractors who struggle along miserably for years and finally give up in disgust or are driven out of business by angry creditors.

I really want you to get this point, because as a contractor you are completely in charge of your company’s finances. So the question isn’t how much money youcantake from your company, because you can take it all! The question is, how much moneyshouldyou take?

In order to discuss the answer to that question, I will be using four terms that haven’t been brought up yet in this book:
DIRECT JOB EXPENSES
OFFICE EXPENSES
GROSS OFFICE PROFIT
NET OFFICE PROFIT
DIRECT JOB EXPENSES

DIRECT JOB EXPENSES areall of the expenses directly related to doing the job.This includes all employee pay and employee related expenses such as worker’s compensation, liability insurance, and various employee tax contributions that the company is liable for. Other DIRECT JOB EXPENSES are any material purchased for the job or any tools rented to get the job done.
Basically, any money that you spend in order to get a specific job done is a DIRECT JOB EXPENSE.

OFFICE EXPENSES
Your company has other expenses besides DIRECT JOB EXPENSES. These are expenses such as advertising costs, office rent, phone and utility bills, the salaries of anyone who works in the office of your company, and also,yoursalary.

If you do your own work in the field, you might wonder whether or not you should consider your own salary as a DIRECT JOB EXPENSE. The answer is no. From the first minute that you have your own company, you must consider that your salary is anofficeexpense. Even if you are the only person in your company, your main job isnotto do work for your customers. Your main job is to make sure that your company is doing what is necessary to become a successful contracting company. First and foremost, you are in charge of your company, and any money that you take out of your company,whatever the reason, must be considered an office expense.

For our purposes here, there are only two types of expenses: DIRECT JOB EXPENSES and OFFICE EXPENSES.Allexpenses of your company are either one or the other.

From time to time, you may run into an unusual expense that you aren’t quite sure how to categorize. If you run into a situation like this, ask yourself this question — If I hadn’t done the job, would I have this expense?

If you would have had that expensewhether or notyou did any particular job, then it is an office expense. If you have that expenseonlybecause you did a particular job, then it is a direct job expense.

GROSS OFFICE PROFIT
GROSS OFFICE PROFIT isthe amount of money left after paying all the direct job expenses.

NET OFFICE PROFIT
NET OFFICE PROFIT is the amount of money left after paying all the direct job expenses and all of the office expenses.

When you want to know how much profit your company is making, the NET OFFICE PROFIT is the kind of profit that is important. This is the profit that is left over afterALLof the bills are paid, including your salary.

Let’s take another look at Pete the plumber and see if we can figure out what the NET OFFICE PROFIT is from that job we looked at earlier. Here is the job cost breakdown again:
AMOUNT OF MONEY PETE SOLD THE JOB FOR $4600
LABOR $2400
MATERIAL $1200
AMOUNT OF EXPENSES $3600
AMOUNT OF MONEY PETE COLLECTED FOR THE JOB $4600
AMOUNT OF MONEY PETE SPENT TO DO THE JOB $3600
REMAINDER $1000

But, wait! The REMAINDER isn’t really an accurate statement of the profit at all. It is only a statement of theGROSSOFFICE PROFIT. What we are really looking for is theNETOFFICE PROFIT.

All we have done so far is subtracted all the DIRECT JOB EXPENSES from the total amount of money that Pete collected from the customer. This gives us the GROSS OFFICE PROFIT. To figure out the NET OFFICE PROFIT, we still need to subtract the OFFICE EXPENSES as well.

In this case, Pete works out of his house, and he relies upon word of mouth advertising in order to get work. So, his OFFICE EXPENSES are very low.

Still, he has a phone bill, gasoline and truck maintenance costs, and other small monthly bills that add up to an office expense of about $250 per week. This expense must be subtracted from the one thousand dollars REMAINDER because this is the only job Pete did this week.

So, after paying off both the direct job expenses and the office expenses, Pete has $750 left. Now, should Pete write himself a check for $750? Unfortunately for Pete, the answer is no.

The title of this chapter is MAKE A PROFIT. If Pete takes home all of the money left over after paying company bills, he will have made one of the biggest and most common mistakes in the contracting business — HE WILL NOT HAVE MADE SURE THAT HIS COMPANY MADE A PROFIT.

There are two very good reasons that you must make sure that your company makes a profit:
1. YOUR COMPANY WILL NEED MONEY TO EXPANDIf you don’t invest some of the profit back into the company, you will never have the money with which to expand. So, you must leave a certain amount of your company’s profit in the company.
2. YOUR COMPANY WILL NEED MONEY TO COVER UNEXPECTED LOSSESThere will be times when your company will lose money. No matter how skilled you get as a contractor, not once or twice, but on an annoyingly regular basis, your company will lose money. So, if you take all the money out of your company when itmakesmoney, what are you going to do when your companylosesmoney?

For these two reasons, you must never take home all of your company’s profit, but must leave some of the profit in your company. In this way, it will be able to expand and to protect itself against unexpected financial setbacks.

The question is, how much profit should you leave in your company? Here is the answer:
SAVE TWENTY PERCENT OF YOUR GROSS OFFICE PROFIT

Let’s take another look at Pete’s job, and see what Pete must do if he wants to save twenty percent of his GROSS OFFICE PROFIT. All Pete needs to do in order to figure out his GROSS OFFICE PROFIT is subtract his DIRECT JOB EXPENSES from the amount that he charged his customer. In this case, that would be:
AMOUNT OF MONEY PETE CHARGED HIS CUSTOMER $4600
DIRECT JOB EXPENSES $3600
GROSS OFFICE PROFIT $1000

If Pete wants to make sure that his contracting company is going to be successful, he will need to leave twenty percent of his company’s profit in the company. For this job, then, Pete would need to leave two hundred dollars in his company. He can spend the rest any way that he chooses.

Remember when we figured out that there was only really $750 left after taking into account both the DIRECT JOB EXPENSES and the OFFICE EXPENSES? Well, if Pete wants to make sure that his company is successful, he willnottake home the $750, but leave two hundred dollars in his company and take home only $550.

Incidentally, when Pete brings home his $550 and then goes over his personal bills, he is going to realize that he made only about half of what his family needed. If Pete is smart, he will take some time to figure out how to get his contracting company to make him more money. AND HE WILL ALWAYS MAKE SURE TO LEAVE TWENTY PERCENT OF THE GROSS OFFICE PROFIT IN THE COMPANY.

If Pete does this, no matter what the temptation is to use his company’s twenty percent profit for personal expenses, Pete is much more likely to succeed as a contractor.

If you can keep 20% of your gross office profit in your company, you will be successfully applying the most basic of all basics; you will be MAKING A PROFIT.