The Secret to Contractor Success: The Simple Math That Boosts Your Bottom Line

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ℹ ABOUT THIS EPISODE

Ready for the construction-specific math that transforms your bottom line? 

In part 2, Wade reveals how different job types, pricing strategies, and cash flow cycles impact your real profitability. Discover why collecting receivables just 1 day faster could put $186K more in your bank, how job segmentation reveals hidden profit centers, and the simple scenarios that help you stop growing broke. 

This isn't theory, it's practical math every contractor can use.

⌚️ Key moments in this episode:

• 00:00 Introduction to Profit Improvement Potential
• 00:01 Recap of the First Episode
• 00:10 Understanding Construction Project Mix
• 02:03 The Importance of Pricing Strategy
• 06:15 Segmentation in Construction Business
• 06:56 Analyzing Different Job Types
• 14:24 Cash Flow and Profitability
• 23:14 Conclusion and Final Thoughts

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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com

Transcript

[00:00:00] 

Wade Carpenter: What is your Profit Improvement Potential? In part one of this series, we introduced simple math that I hope changed how you think about your business. Now it gets real. We are going to forget this is a one widget company and realize that construction is a mix of different projects, with very different outcomes.

If you got some of those aha moments in the first one, maybe you wanna watch that one first if you haven't, but I hope you're gonna get some real value out of this one.

This is the Contractor Success Forum and also along with the second joint episode with the brand new YouTube channel, Profit First for Construction. I'm Wade Carpenter with Carpenter Company CPAs, alongside Stephen Brown with McDaniel Whitley Bonding and Insurance. And today we are continuing with the mind blowingly simple math that can transform your company's profitability.

Stephen, I kept you in the dark again on this one, but hoping you are locked and loaded to jump in on a new one. I know it is a little unfair, [00:01:00] but I hope you got something out of the first one. What are your thoughts?

Stephen Brown: I did. And between the first podcast of which you kept me in the dark, and then the second one, we did a lot of talking. And you still held back from me, Wade, what I wanted to know, so in the last podcast, just a refresher, Wade was introducing, we were talking about widgets, okay, because we're using a very simple way of explaining whether you increase your sales 10% or decrease your cost, how does that affect your business? And the numbers just blew my mind. And it is simple. But the logic is there. 

Wade Carpenter: And like I said, we talked about, maybe not just working on the revenue but working on small things like your costs, and your overhead, and that kind of stuff. We also talked about this 1% improvement. And small changes, they don't have to be big changes, can turn into bigger values.

But one of the other things that I think you [00:02:00] mentioned was the fact that we had a 30% gross margin. In the first episode, we demonstrated if you have a 10% price increase you could actually afford to lose 25% of your customers, do a lot less work, and still make the same level of profitability.

By the same token, we also showed-- and if you don't believe the math, it's right in that first episode, so go back and look at it. But if you decrease your price by 10%, then you would have to gain 50% new customers to be able to do that.

I can show you the math, we talked about a 20% price increase, you could lose 40% of your customers and still make the same gross margin, all other things being equal.

Today I want to go into the contractor stuff. 

Stephen Brown: Well, of course I do too. And I'm hoping that if you increase your cost and you lose some customers, you're losing some customers you didn't want to begin with.

But what about the flexibility of understanding how you're pricing for each and every customer? When I think about a [00:03:00] construction company, I think of multiple projects, and they're all different to some degree.

The timeframe of completion, the variables of the environment and risk involved, and other trades that you're depending on. I'm really interested in hearing where we're going here, Wade. 

Wade Carpenter: I wanted to start a little simpler. This is another version of this, where we take 500 customers buying different quantities, all those different things, number of times they buy from us.

What we went through in the first episode is, what happens if we work on our customer retention, or reduce the number of customer defections? What does that do to our business? If we raised our prices by 5%, that has a lasting value in your profitability, and even if you're not increasing your value multiple.

In this case, it would be a $44,000 increase in the value of your business. We talked about things like increasing the quantity, number of times they buy from us. I'm not trying to [00:04:00] recap the entire episode, I'm just trying to drive the point of there are a lot of little things that we can build in a construction company that we think about that the math doesn't have to be some drastic change to actually put a lot of money on the bottom line.

We also talked about, okay, if we can work on how many times they buy a year, or if we can reduce the costs, that's where a lot of contractors are living in: okay, how do we reduce our job costs? Those kind of things. Be as efficient as possible.

And then we also have overhead reduction. I'm doing high level here, but a dollar saved on overhead is a dollar increase in the value of your business. Up here where we have a multiple and a percentage of our gross profit, we'll be changing by moving these revenues. We can raise our price by 10%, but if our cost to get sold to do that goes up by [00:05:00] 11%, then we're still going the wrong way.

Stephen Brown: My first thought is, if you raise prices 10% and you can lose 25% of your customers and still make the same profit margin, you're not necessarily gonna lose 25% of your customers immediately by raising your price. But the thing that I love about this math is it really hits home about not low balling your prices as a contractor, and how that affects your bottom line.

You absolutely can't low ball your prices until all the other elements have been low balled too, or you're gonna shoot yourself in the foot. And I love this analytic tool that you've invented Wade, that lets you see all the moving parts. If I was a CFO of a construction company, I'd be looking at how every small amount tweaks the bottom line and what you can do without stressing the system. That's the job of a CFO, isn't it? 

Wade Carpenter: Yeah, and again, I know this is something that I [00:06:00] normally pull out for my biggest clients and I rarely show this, but the aha math that comes about when we put some of this stuff, it's amazing to me to see the realizations. We don't have to throw everything out and start over.

One of the things that we're gonna get into is segmentation. In my book Profit First for Commercial Construction-- that was something I was actually just speaking with a client about, new client, because sometimes we have different lines of business. One division makes this level of gross profit. One division makes a different level, and how do we mix that into Profit First?

But there's also commercial versus residential or something like that. You're going to have different cost inputs and different ability to you know, maybe a different market. A residential might be more susceptible to price changes and those kind of things.

Stephen Brown: Yeah, absolutely. 

Wade Carpenter: So if it's okay, let's bring this into [00:07:00] construction.

We were originally talking about widgets. In this case we're talking about jobs. So if we have a number of jobs, like 40 jobs that we do, an average job size of $25,000. Usually these are one time a year jobs in construction.

As I was saying, we've got different inputs on this, right? So labor, material, subs. Trying to fit that into one model, if you do everything exactly the same, maybe you can do that. But for a lot of contractors, every single job is very different. We all know that we have different customers and different costs.

We do have to think about, what really goes into this? And when we're talking about from a top level, it doesn't make a lot of sense to be able to like, okay, we just pick one job and then they're all the same, and then we just ramp up that number, because there's gonna be fluctuations in gross profitability.

But what I'm getting to [00:08:00] is how are we going to find that sweet spot for us? We talked about that years ago, how we can plan and, finding that sweet spot for the contractor.

There are different inputs. Your overhead and your your inputs that go into that are different. But does this start to show you how we have the same kind of things like increasing our prices that play into it. It is a different game for contractors.

So if we start saying, okay, this is where our baseline is and we're projecting it to get there, where can we make some profit up? 

Stephen Brown: Every contractor I know has certain jobs that they made huge profits on, and they dream and think and talk about that all the time. Some projects are extremely difficult, that they're very proud of. Others just made a ton of gross profit. They were able to bring it in a whole lot less than the estimate. They don't go back and analyze the variables that may have been the case back when they [00:09:00] did that particular job, but these variables may have changed.

I love the fact that this profit analyzer can help you tweak that. Because what you think in your mind is a slam dunk dream job may not necessarily be the case today. 

Wade Carpenter: Well, that's another place where we can go with this thing too, is when you start segmenting your jobs. A lot of people don't realize, they chase the big number and that's not really where they're making their profitability. We'll get into a little bit of that here.

Even if you're planning a business, it does make a lot of sense, even just from this level for a contractor to say, if I raise my price, if I'm chasing a different type of work, and obviously, if you're talking about reducing your overhead, it's gonna be the same no matter what you do.

We get into things like segmentation. I just have an example here, but let's just say that same million dollar contractor this is a slightly different one, but they had a division that did [00:10:00] residential and some commercial and some service work. Their average price for residential was a $5,000 job and the commercial was 25, or maybe it was an electrical contractor or something, service-- 

Stephen Brown: Sure. 

Wade Carpenter: And we have different inputs. Our labor, materials to make that same $5,000 job than what makes up the average job. So in this case, we have a 34% gross profit for that. We also may find that, our commercial, we have bigger dollars. Sometimes that's not the case. A lot of times we may be making more money on a commercial, we do fewer jobs, 20 jobs at $25,000 in our inputs that go into it. By the time we add all that up, that's essentially a 30% gross margin. Ultimately, if we look at last year, we had an overall 31.9% gross margin.

We came up with a paltry, $5,000 in profit. [00:11:00] We're also looking at this overhead, but we look at our service work, we also find that the service work have a hundred jobs and the average job is 500 bucks, but we're also making 40% gross margin on that.

So there's a lot of questions that start trying to answer. Maybe you're making more, but a lot of times this service work might be having to have extra trucks or whatever, and all the mileage and all the stuff that goes into it. Ultimately what we're getting at is how can we build a plan for a construction company so that we can maximize our profitability, right? 

Stephen Brown: Right.

Wade Carpenter: And obviously we can look at our overhead and we can drill into different items of overhead that makes that up and work on, not just from the top level. But how can we reduce things like subscriptions to software that we don't use and those kind of things? Can we reduce our rent? That's not the sexy stuff, but that is a good part of it.

[00:12:00] Following that, just taking a high level look at last year, what happened? Where did we make our money? We may have had gross margin that, say, residential was a 34% gross margin, but it only brought us in $85,000 of gross profit.

We also said our commercial was 30% gross profit but it brought in $150,000 of brought bottom line gross profit. And even our service work at 40% gross margin, it only contributed $20,000 to our profitability. You following where we're going with this? 

Stephen Brown: Yes. You can't look at a certain gross margin and say, I'm gonna ramp that particular profitable line up to the detriment of the others. It's gonna affect your business model, isn't it? 

Wade Carpenter: Yeah. And since we're talking about segmentation, I know we did a couple of episodes where we talked about the constraint theory and [00:13:00] throughput on jobs, you remember my example in that one.

We had a single job that we did, and on paper we had a higher gross margin, but it took all year and the whole crew to do versus another one that was like, okay, four jobs made up the same level of revenue and it actually had a smaller gross margin, but we could turn it so much faster. So that throughput is another way we can get at a higher level of gross profitability.

Stephen Brown: I remember that podcast we did on throughput accounting and philosophy. Didn't that podcast go back to when there were the three of us, you and me and Rob? That's how long ago that was. 

Wade Carpenter: Yeah, I think we did a couple of them, but that was one of our more popular episodes. I think it may actually be our highest viewed episode on YouTube. Anyway, those are the kind of things that people don't think about. And this is what I'm trying to do is get our listeners to think about [00:14:00] this.

Also didn't mention on this one if you're following on Spotify or Apple Music or whatever, you may want to jump on YouTube and see some of these numbers that we're putting out here because we're not making up math here. 

Stephen Brown: Right. 

Wade Carpenter: So again, this is just a tool that I built that I was explaining to Stephen. I built all these things in Excel over the years and now that I can show it a little more graphically, it makes a lot of sense.

But when we put that with your actual numbers, your Balance Sheet and your Profit and Loss and looking at your changes there, there's some very big things that I want to get to on this episode that we've been working on profitability.

And my book is all about cash flow, because cash flow is exactly what builds a construction company. You can have all the revenue and backlog you want, but if it doesn't translate to cash flow, then how do we do that?

Stephen Brown: Okay.

Wade Carpenter: Before we do that to any questions or-- 

Stephen Brown: No, [00:15:00] I want you to hit that scenarios button up. It's my favorite screen. 

Wade Carpenter: All right. Well, again, I built this tool to where this is more like high level, but we can build out different scenarios. And I'm not gonna go through the whole model right here, but we can change and compare different things like raising our price and this one and reducing our quantity, whatever.

If we can reduce our prices, what does that do? And ultimately we're getting at, we can compare--

Stephen Brown: The baseline is where you are now, right? And then the scenario is what you want to consider. 

Wade Carpenter: Yeah, and I mean, like I said, we can put out here 10 scenarios or however many. Any number of ways we can skin that cat. But one of the points I was getting to, these are all the same numbers. And as we were saying, we have different levers that are driving our profitability.

If we raise our price, we're gonna raise our gross profit percentage. And that changes the mix a lot. [00:16:00] But the other drive of cash flow, that's why I had pulled out, okay, your balance sheet and looking at these other episodes we've done on the cash conversion cycle.

Let me get back to the original scenario. So in this case, we started the year, it takes 44 days on average for this contractor to collect a receivable. And then also we're paying our vendors or subs in 55 days. I know it says inventory and that's one of the things of the cash conversion cycle percentage.

And I will talk to contractors and they'll tune out on this part of it all day long. They say, I don't have inventory.

Stephen Brown: Yeah.

Wade Carpenter: I think you know where I'm going with this. This is your WIP. And a lot of people do not quantify in their brain, okay, we've been paying for labor every single week and we accumulate that for a month before we start billing it, right? We've also incurred all these other costs, and until we actually get the [00:17:00] bill, we're not talking about how long it's sitting in AR. And this is a measure of how fast our cash is turning.

If we have 44 days plus our WIP days, I'll call it 73 days, and then we pay in our payables in 55 days. Our cash conversion cycle is 62 days. That's essentially 62 days to roll that cash from the time it gets put on the job in your pocket and you can net any of this, right? 

Stephen Brown: Sure. 

Wade Carpenter: So if you follow where I'm going with this, we can work on these profit drivers, but that doesn't also mean that we are going to put that same amount in our bank account. Eventually it will get into the bank account, but it may take longer to do that.

This concept also explains why contractors get in this growth mode and they can't get out of it. They're growing a perpetual problem and they have to get deeper and deeper in debt to grow.

This math gets a little more complex, but I've built it into my model here. But if we could reduce our [00:18:00] base-- let's just say we collected our receivables just one day faster. That would be a hundred in this scenario. That sounds amazing, but $186,000 cash impact on this contractor. 

Stephen Brown: Wow.

Wade Carpenter: If you could slow down your paying your payables, you gotta be aware of what it does to your relationships, your subs, your material, suppliers. That also bumps your cash conversion cycle down. It runs it faster.

And in this case, we're talking about this, and I won't get into margin of safety, but you know what your cash impact there, that's where when we're growing our company, we can't just wrap our head around just the profit drivers because that's not what's gonna happen to her cash.

Same thing with our WIP. If we've got money tied up in our materials, just the simple explanation is can we bill up front for that material, stuff like that. How can we reduce that amount that's sitting in WIP as far as how long it takes to turn it into cash?

Stephen Brown: We talk so much about [00:19:00] cash flow and how that's not properly accounted for. And I love that factor of just reducing it a day, what it does to the bottom line, but also what it does as far as your stress level is concerned. There's a certain amount of stress for you financing things, and you are always financing things. And there you've got all these balls up in the air and you've got all these variables that you're trying to minimize the risk on. I love that part of this scenarios.

I also love, Wade, how you break this down to understand all the components that affect everything, because I think you're going in an incredible direction that all of our listeners need to hear.

Wade Carpenter: I know I'm playing with numbers really quickly but as we said in the first episode, sometimes small drivers can make a big impact on your profit. 

 And that's where when we're doing high level planning with CFO clients, this is the kind of thing that can make or break a contractor. 

Stephen Brown: Absolutely. 

Wade Carpenter: You can say, okay, now this is what [00:20:00] it would actually do and throw some scenarios up there. I know this is what you look for, is what does that do to our bonding ratios, our debt to equity working capital, those kind of things. I played with numbers and I didn't really churn that a lot.

The big thing here when I'm talking about these cash flow levers that we didn't talk about in the first model is, this is driving changes in our working capital. 

Stephen Brown: Absolutely.

In your book, Wade, Profit First for Commercial Construction, you use a scenario with a contractor that crazy low bid a job at least apparently to the other bidders. So there's a huge bid spread. Yet the bond gets approved, the job gets finished, and there is a modicum of profit involved.

What I love so much about that scenario is how rethinking every bit of that job produced a happy ending, and how you analytically look at that. I just don't see a lot of [00:21:00] contractors looking at situations like that, especially, the logic, Wade, is I'm going to bid the job at my profit. You got the ones that are gonna low ball to try to grow revenue that eventually are gonna go out of business, but they're still stressing your marketplace.

You've got the contractors that are gonna do a hail Mary pass on every bid with crazy profit margins and they just don't care. They might get one job out of a hundred, but no architect or engineer is gonna let that happen. It may be you're the only game in town doing what you do and you can command those kind of profits. That's wonderful. But I think this is just a great analyzer, Wade, to help a contractor that's stuck in one right or the other, get out of it. 

Wade Carpenter: Well, thank you for that. And again, doing this in a complete high level because going back to the segmentation, finding that mix of the right, where are you making profit? We didn't really even show [00:22:00] the throughput stuff. But looking at it from okay, scenario 1, 2, 3, what does it do to our ratios?

What does it do to our working capital and our marginal cash flow? Which again, not getting into that, the fundable growth rate. How fast can you afford to grow? And this is another tool that basically says, unless you're gonna stick additional money in, there's only so fast a contractor can grow without growing past their cash flow.

The different inputs and I know I was just playing with stuff, but what happens to your break even when we do these kind of things, what do we need to do at different levels? And if we say we're gonna go all in on this one, what does it do to our break even, power one, which that was that thing where we talked about okay, if we do 1%, what does that do to the profit impact as well as the cash flow impact? 

Stephen Brown: Okay.

Wade Carpenter: I did wanna say, there's a lot of things to think about this. What's best for profit, what's [00:23:00] best for cash, and coming up with a high level, this is a plan that we have in place that, again if you remember the first episode, this is not genius level math, right? 

Stephen Brown: Right. 

Wade Carpenter: So have you got any final thoughts? I know we've gotten a little long on this one, but I hope there's been value for-- 

Stephen Brown: My final thought is what a great tool. And thank you for bringing this to my attention. The thing that I'm processing here is not only can you analyze and tweak everything regarding your pricing and how it influences everything from your cash flow, but particularly your bottom line can be done and should be done.

Also, think about the same market analysis that you can use this on to seeing what your current marketplace will bear.

Thank you. 

Wade Carpenter: Well, again, thank you. I know I've blindsided you on two different episodes here without giving you context, but I do appreciate the impromptu reaction on this. I know I hadn't shown you any of [00:24:00] this, but this is the stuff that if a contractor will stop and really take stock of what they wanna do.

If you've got questions about this or thoughts, we'd love for you to put them in the comments below. If you got questions, reach out to Stephen, reach out to me. We're always here. This has been a joint episode between the Contractor Success Forum and Profit First for Construction YouTube channels.

Hopefully you got value out of it. If you would like, share, subscribe, and subscribe on both channels, we'd appreciate that as well. It always helps us out.

With that said, we do this every single week. We hope you'll join us on the next one, and we will see you on the next show.