Correlating Your Business Model to Profitability

Whether you identify your business model or not, your company does have one. Your company operates with specific infrastructure that includes processes, culture and priorities. 

I practiced in public accounting for 18 years, specializing with contractors, and I oversaw 125 audits and reviews each year before I sold my practice. One perspective gained was the disparity in profitability across companies with similar projects, specialties and size. Business is competitive where creativity, infrastructure, leadership and organizational skills make a difference.

A business plan lays out a map for marketing, financial planning and operations. A business model describes how an organization creates, delivers and captures value in economic, social, cultural or other contexts. This article focuses on the part of your business model that makes your company profitable. It should provide visibility with respect to your financial position and where you are heading financially. It should include the mechanics of how you control costs and make money.

Identifying, analyzing and documenting your business model can help with visibility, perspective and improvements. Changes in the field can be driven by the quality of your information flow. This flow should include estimating, field, office and other processes. It should include financial statements that provide accurate results.

Managing your company through your financial statements is where every larger organization started. They would not have gotten to where they are without this priority. Managing your business with good project and financial data is the key to profits and growth. Improve the quality of your monthly financial statements so it becomes a great scorecard or report card.

Software is not better just because many companies you know use it. Distinguish yourself by using a system that is more efficient, is easier to use, is flexible, supports both the field and the office, and has the features that provide better visibility and accountability. Features should include automating the percentage of completion method of accounting where wage and over/under billings accruals are automated and where a full summary of contracts (the schedule ties to the income statement) is generated, and wages are reported as of the work date (geo timecards and automated accrued wages). A system should facilitate retroactive allocation of over/under allocated indirect costs to provide the most accurate picture at the close of an accounting period.

Companies stuck in a software that was extremely expensive to implement have a disadvantage. The fact that the software is expensive to implement is the first clue that you are in the wrong system. Software should be intuitive, comprehensive and easy to implement. Use a relational system rather than a modular system.

How do you make your information flow into a great scorecard? I’ve seen consulting firms charge enormous fees for fairly simple concepts that make sense and that are not in place. Here is a list:

Committed costs controls — Buy out your materials and subcontracts for your projects. Create purchase order (PO) and subcontract commitments, create your accounts payable (AP) invoices from these commitments, and have adequate reports that include the commitments, AP invoices, balance of the commitments, AP checks and what is in AP.

Top-down, bottom-up and break-even financial statements budgets/projections — Understand fixed versus variable costs. Understand the three primary types of costs a contractor incurs (direct, indirect, and sales general and administrative/operating expenses). Understand that you job cost to your gross profit margin. Thus, job cost includes direct and indirect job costs, but not operating expenses. Properly capture indirect costs. Indirect costs are job related but difficult or impractical to directly apply to your jobs. They must be pooled and burdened onto your jobs. Understand your break-even point (operating expenses divided by gross profit margin). Correlate your income statement to an estimate. 

Utilize budget actual variance reporting during your projects (and with real-time data) using an effective cost-code list, and track concept application to your projects —

• Labor hours
• Budget dollars
• Production units

Percentage of completion reporting —

• Monthly percentage of completion financial statements that include a full summary of contracts (closed and open jobs) that ties to your income statement and includes wages as of the work date.
• Effectively utilize project projection tools that drive your percentage of completion over/under billings, and that drive projections by your best determinant (dollars, hours or production units).
• Track monthly projections by project manager to gain perspective and feedback on profit fade and gains.
• Just because something ties out, doesn’t mean it’s accurate. Thorough test of balances on your balance sheet and thorough review of performance by budget line on open jobs can drive accuracy. 

Documenting Guidelines

There are many parts to your business model. The financial aspect is only one part. Your business model should include many aspects of your business, such as your expectations and goals. There are specific formats you can follow, or you can create your own. Sometimes less is better when it comes to trying to follow specific guidelines. I believe your business model documentation needs to be simplified and meaningful to your organization. Outline your model with your vision of your world, and grow your outline over time. Your outline should be a working model that is never complete. Your vision should be ever-changing, conforming and optimizing. Make your own rules and differentiate yourself and your organization. 

Conclusion

Conquering your own world has less to do with volume and a lot to do with being very profitable. 

Some contractors are, but most fall short of being very profitable. If you want to be different, do something different. Be more thorough, gain better perspective, gain better visibility and don’t be afraid of what you don’t know. Pursue what you don’t know, and pursue it with lists that make sense and that are concise.

Don’t discount what you do know. Set high expectations. Those expectations can inspire creativity, growth and ever-improving ability. Expanding your ability includes continuously seeking advice and information, but take it all in with a
grain of salt. Try to include what rings true to you, and discount what doesn’t make sense.