Contractor Wake-Up Call: What's Draining Your Revenue?

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ℹ ABOUT THIS EPISODE

You can't fix what you can't see. Most contractors know their overall margin but have no idea which parts of their business actually make money. 

Wade Carpenter and Stephen Brown break apart the 'green smoothie' of blended P&L statements to reveal hidden profit pockets. 

Through real case studies, discover how segmentation helped contractors work fewer hours while increasing profit by $80,000-$137,000. 

Learn why your proudest projects might be killing your business and how to identify your true profit makers.

⌚️ Key moments in this episode:

• 00:00 Introduction to Profit Visibility in Construction
• 01:13 Recap of Previous Episodes
• 03:15 Case Study: Commercial vs Residential Profit Margins
• 06:14 Case Study: Electrical Contractor's Profit Analysis
• 09:59 Case Study: Mechanical Contractor's Profit Breakdown
• 14:50 Case Study: Remodeling Group's Financial Insights
• 21:33 Conclusion and Next Steps

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

Transcript

[00:00:00] 

Wade Carpenter: You can't fix what you can't see, and most contractors can't see their profit clearly, because it's blended into averages that hide the truth.

You might know your overall margin, but that doesn't tell you which part of your business is actually making money, and which part is quietly draining.

I'm Wade Carpenter with Carpenter & Company CPAs, alongside Stephen Brown with McDaniel Whitley Bonding and Insurance. And this is Episode 3 of our joint collaboration between the Profit First Construction YouTube channel, a brand new channel, and the Contractor Success Forum podcast.

Up to this point in the series, we've been building the math behind identifying Profit Improvement Potential, adapting it to construction, and exposing the cash flow dynamics that don't show up in a standard Profit & Loss Statement.

But there's a hidden assumption underneath all of the work. It assumes that your business operates as one system, with one margin, and one economic behavior.

In reality, construction businesses [00:01:00] make money in pockets, and those pockets don't behave the same way.

Today is about breaking apart those averages, because until you do that, you don't actually know which parts of your business deserve to grow, and which ones are quietly holding everything back.

Stephen, before we get into segmentation, let's rewind for a few minutes. Can you walk everyone through what we covered in the first two episodes and why this step matters from your side of the table? 

Stephen Brown: Sure, Wade. This is a great topic. And remember how we've talked so many times about, business models for construction companies aren't generic with other businesses. Things are different. I think your comment about your Profit and Loss being like a smoothie. You see the final color, but not all the ingredients involved.

Okay, so think about that a little bit. You pick up your smoothie and it's green, and you assume you know what's going into that smoothie. Maybe it's kiwi, I don't know. But there you are. So Profit and Loss is the same thing, and we [00:02:00] talked in a fascinating way about the economics of raising your prices versus lowering your prices.

Your optimizer program that you developed to show clearly how sometimes your perceptions of change and decisions you make affect everything on down the line in your Profit and Loss.

And again, this is all about profit, right? That's what this whole series is about, is understanding every minute detail of your Profit and Loss statement, and how one thing greatly affects another.

I was just reading this morning about certain medicine side effects. We'll tell a doctor that there's a disease and then they'll give another medication that creates another set of symptoms, and it just goes on and on.

I feel like it's kind of the same thing going on in the construction industry, Wade. There's all these small factors that affect everything else, and when we're focused on profit, that's what I think we're gonna talk about and try to move on with [00:03:00] in our series today.

Wade Carpenter: I love your analogy, the green kiwi smoothie. That could also have some kelp in it or kale, you never know

Stephen Brown: It could have any ingredients in it.

Wade Carpenter: Yeah. It just got green. I think maybe they blended all this stuff together. That's part of the problem. So I like that.

Today I did the same thing I did last time before, Stephen, I didn't give you any context. So we're gonna walk through some case studies and hopefully it'll resonate with you today. But if we had a company that just said, we did $2 million and they had direct costs, so they showed a gross profit of $ 500,000.

That's not before overhead. That's gross profit, not net, but that's a 25% gross margin. Depending on what industry you might say that's not too bad. It might be maybe slightly below where you really are. Maybe you bid for 20, 30%, but it never really materialized.

But what is made up of that 25%? And digging into that, I think has some value. What do you think?

Stephen Brown: Most certainly do. 

Wade Carpenter: Let's jump into this particular [00:04:00] example. You know that $2 million were made up of commercial build outs versus, some residential service. So $1.4 million was done for commercial, $600,000 as residential. So, percent of revenue, 70% of our money came from the commercial side, and most people assume that's where we're making every, you know, we need to make dollars, we need to turn some averages.

But when you start breaking down, at least from a high level, the direct costs and things like that to go into it, you start seeing things like, okay, well, we're self performing things like the residential service.

But you know that $ 1.4 million actually costs us $1,176,000, only gave us $224,000 of gross profit.

And again, a lot of contractors never break it down this way, but they're only making 16% gross margin. But when they're looking at their residential side, only 30% of their money came from that, but in this example, more gross profit came from the residential side of it was [00:05:00] 46%, gross margin percent. Does that make sense? 

Stephen Brown: It does, but I'm thinking like a contractor and I'm saying this is all I could do. Yeah. I'm making more margin in my residential service sector, but that's all I can do. I've gotta fill that work in with more volume, so I'm gonna do more commercial work.

Wade Carpenter: And just like we said last time, maybe 1% or whatever, we're not gonna bet the farm. But if we don't take some kinda of strategic look at what we're doing, then most people would've never realized that we're actually making a lot more money on this side, and this is actually a lot more headache and a lot more exposure.

And I love your saying, where there's a limit on how much you can make, but no limit on how much you can lose, right? 

Stephen Brown: That's a fact. 

Wade Carpenter: Yeah. So when you start looking at the truth of the whole thing, the percent of your total gross margin was actually coming from the service side of his business. It was 55% of that.

We're gonna break this down a lot further, but I just want people to start [00:06:00] thinking about, okay, we did X number of jobs last year. Put them in buckets. These are anonymized cases. I'm not gonna show anybody real numbers, this is not a real company. There was an electrical contractor this was based off of.

Well, this was an electrical contractor and he had 15 employees. And he grew pretty quickly from 1.8 million to 2.6 million over three years. I mean, for him that was good, be cause he had a long period of stagnating his profit. Pretty much stayed flat. We talk about that a lot of times.

He didn't understand why. He was doing 2.6 million. So we started breaking it down. It's okay, that 2.6 million in this case was commercial versus residential service, he was doing like repairs and service stuff.

This sort of goes with the other model, we start looking at where his margin was, and this was breaking down that 12% versus 45%. These are slightly different cases in that first example.

In this case, one of the aha [00:07:00] moments came to him when we started looking at the same kind of analysis where the percent of gross profit is actually generating, in this case, more money.

I didn't really say this, he was running, there's several use cases where the owner is running like crazy, 60 hours a week or more. But he actually had somebody running this service business. Basically his office manager was running it plus one major, main guy, but it was running on autopilot. And this side, he was just running himself ragged.

So the realization is, if I could generate 58% of the gross profit over here, am I just really chasing dollars over here?

So here's a little bit more about what they did. We took a look at it. If you've got to a certain level. You can't really say we're gonna go cold turkey. But we did start getting very selective on the commercial stuff that we're doing.

What you'll find is you start breaking this down further, like, okay, break it down by general [00:08:00] contractor they were working with, they had two general contractors that, you know, 18, 20%. And these three other ones that fed them a lot of work, but they were only getting like eight, 10% of their margin.

They stopped bidding these low margin general contractors. They always squeeze them on price. And again, we'll get more into how fast the cash turns. The fourth episode is coming.

When we actually looked at it, his service prices were actually lower than most people in the area. So we actually got him to raise that service price. The margin went up to another 3% when he did that.

He ended up adding a second service truck. I'm not trying to go too deep in the details, but the results for him:

He did 2.6 million. The next year he actually dropped to 2.4 million, but he was completely okay with that because $137,000 increase in gross profit, working less, making more, and actually enjoying the business.

Stephen Brown: I was going back to not [00:09:00] bidding to the GCs that they made lower margins on. I think one good point to make here is that certain GCs will get a subcontractor stuck in a rut and they promise so much business, but they won't let you get the gross profit margins.

Well, I just wanted to remind our listeners, it costs money to put out bids, to give someone a bid. So you say, I'm not giving you prices anymore. I can't make my margin quoting stuff for you. " Just gimme a price. Just gimme a price." That sounds harmless, doesn't it?

But there just some relationships that just need to go.

Wade Carpenter: Well before we move on too much, if this is helpful to our listeners, if you would, subscribe to the brand new Profit First Construction YouTube channel. We appreciate it. Like the video leave comments on both channels, it really helps us out. Helps us reach more contractors who need this kind of conversation.

So anyway, if it's okay, let's dig into a couple more use cases and maybe build on these concepts a little bit.

[00:10:00] Again, this is a mechanical, he mainly did plumbing stuff, had 80 employees. This is a common theme, but the guy was working like 60 plus hours a week and barely breaking even.

The owner was running the job sites himself. He also had his wife working in the business, which I won't get into it too much, but he was strained in the marriage there for a while. He started at $1.4 million revenue.

We started breaking this down. If our listeners are listening, just think about going back and seeing where all this made up your money. This is a residential mechanical mainly. He did some custom homes, remodeling some service type work.

He loved these custom home jobs. He was very proud of that. That was the ones that went on his website, he just was like, I put my name on this project. When we started breaking it down, we made some money from revenue, we start looking at the profitability. That's where we start breaking these down.

We found out these custom homes were only doing 15% margin. He ended up with a lot of issues with change orders. [00:11:00] He was making pretty good money on these remodels too.

$208,000 was coming you know, as gross profit from these remodels versus $220,000 on his service side, which he was getting a 55% margin.

When you blend all this stuff together that $ 500 plus of gross profit, where does it come from?

This is one of the ones that at a breaking point, especially with his wife too. He started looking at where he was really hands-on guy and he didn't really have the leverage.

He started breaking down, where are my hours spent actually on the job site? And he was actually spending 600 hours of his time on these custom homes. The service order ran itself, six times more hours on these custom homes than at the service side.

And he was getting burned out. So if we started looking at the math on that, he was making, this is again from one spin of it, but he was making $120 an hour on these rate remodels for the hours he was putting in. He was [00:12:00] netting $1,040 per hour. As well as the service side was pretty much running itself, same kind of thing, $2,200.

So

Stephen Brown: I love that math, Wade. I mean, you put in the number of hours and who tracks how many actual hours that you put into something, but just by simply tracking and analyzing the data, look at the difference between custom homes and service per hour, not to mention all the strain that it's putting on his marriage.

Wow. 

Wade Carpenter: Well, the work that he was most proud of, it's really killing himself as well as killing the business.

He had some custom homes he had to finish out, it did take a little bit of time to get past some of this, but he actually stopped cold building these custom home projects. 

Stephen Brown: Yeah, there's a little bit of vanity involved. The custom homes are higher dollar clients, more prestige. Your name is associated with higher dollar wealthier clientele, and that's gonna mean more prestige and income for you, and that [00:13:00] just wasn't the case, was it? 

Wade Carpenter: Yeah. Same thing here. He's like, okay, I'm running like crazy. He hired a plumber to go for the remodels and stuff. And then he took himself out of the service side even more. Because he kept getting involved in some of that stuff.

He turned some of that over to other people on the team and, basically, after all this he dropped his hours to 45 hours a week. He was done by six every night instead of 10:00 PM every night. And so he got his life back as well as the margin. It grew by $80,000 even though his top line dropped some. That's what Everybody's like, oh God, I can't make it if I drop my top line.

The point is making smart decisions, and sometimes they're not intuitive decisions, but taking a step back and not completely betting the business on it.

Stephen Brown: And Wade, I love the way you've presented this. I like the tabs where you can click through it. [00:14:00] I like how clearly it communicates the points you wanna make. And yet again, I think about the owner getting 15 hours of his life back, just to think of what that does for him personally, and what it does for his family.

And then you think about $2,200 an hour. Wow, that's a lot of money. I'd say if that Contractor obsessed about working 60 hours a week, put that 15 hours back into doing service work himself, huh?

Wade Carpenter: I see so many contractors running themselves crazy. And finally, when we sat down with him and said, this is what's happening, it was really hard for him to accept.

Stephen Brown: Well, he didn't like it. He was proud of the direction he thought he was going, that all of that hard work was paying off in custom homes.

Wade Carpenter: And again, there's a lot of ways to slice and dice this, but let me go through one more case study here. Remodeling group did major remodels. He had basically three different customers.

This regional developer that fed him a ton of [00:15:00] work. He also had some stuff that he was doing for a luxury custom builder, like the other guy, as well as some working directly with the homeowners. And again, any kind of number of ways you can break these things down.

What I'm hoping our listeners are getting out of this is, when we start looking at different things that drive the business as well as start looking at the profitability but also looking at some of the hidden costs on these things.

Just looking at the gross profit is one thing, but how fast are they paying us? The developer took 90 days to pay him. He also looked at the cash flow effect, the luxury builder. He was faster, 45 days to do it versus the stuff he was doing with these homeowners, it wasn't a lot of money. But he was making pretty good margin on it. They paid him pretty quickly.

And he was caught up in this trap of still looking at, okay, I'm only make 200,000 and I've gotta keep the lights [00:16:00] on. 

Stephen Brown: Yeah. 

Wade Carpenter: This is where I think a lot of contractors really don't realize how much, I mean, they think about it, but they're the bank for the owners, the general contractors, whoever they're working for.

And when we started, he had a line of credit and had some heavy borrowing on this thing, and we started looking at like, why is that happening? Breaking down the financing costs for this developer holding that money. In this case it was like $16,000 we could directly attribute to this developer, some to the builder too, but it was less because we weren't holding it as long.

We started looking at where we're getting change orders, stuff like that, where we had fights with these kind of things, and he had a lot of disputed change orders with this developer that was killing him. That luxury builder guy.

When he was working with people with a lot of money, he almost never had, they didn't question his invoice.

He had a little bit of problem with the homeowners, too, but, [00:17:00] he talked about the time for management and all that stuff. So we factored some of that in.

Stephen Brown: Well also Wade, remember your customer. You're working for a developer, their job is to get projects done with as little or no money on their own parts as possible. That whole key to developing anything is the finance of it. So they're gonna push that financing to anyone that's doing business with them, that's just a fact.

You look at the luxury builder, you know, there's a situation. If it's causing extra headaches, but you like to do it, then you know, raise your cost 50%. Just say I'm gonna price myself out of business, but hey, you are really good, but so am I. You want the best. This is what you'll pay for, because this is what I have to go through to do business with you.

And then the homeowners, it just seems like the work so much smaller and it's so tedious. It's just a grind. But I love the [00:18:00] fact that your owners, in both situations, were able to set up the service techs pretty much on their own. That's fantastic.

Wade Carpenter: Well, and one other thing that just bears mentioning, but for him, the developer never sent him any referrals. A luxury builder was actually sending him some jobs every now and then. These homeowners sometimes would do some of that stuff. So just different ways to look at that.

So when we started taking a look at, what is the reality of this, the margin that was really coming from that and adjusting for the financing costs and the change orders and stuff like that, the margin was actually like 13% on-- it didn't look as good when we started really factoring in things like how much it was costing us, as opposed to, where we're making some margin here, we're getting adjusted margin for taking some other factors into account. Things like the change orders. Well, you're not collecting all those change orders, [00:19:00] and what they thought they were bidding at was at 18% and then only getting 13.

We basically repriced some of this stuff. You tighten some of this documentation. He did start for some of these, moving the cash forward. We talk about that all the time. Material deposits. He dropped some of that stuff and actually pissed off the developer a little bit, but he was okay with that.

But his profit actually went up. So again, I hope it's helping our listeners think about how we build our business and what goes into the factors that make up the different jobs we do.

Stephen Brown: I think that's a great point. And Wade, if our listeners wanna know more about this, we've got yet another follow up to this podcast, don't we? Would you tell them about that a little bit? 

Wade Carpenter: Well, yeah. Remember we talked about that constraint theory and how fast we're turning business?

I think that, the throughput, and actually in that one we're gonna show, would you believe that a [00:20:00] 15% margin job could actually be making you more money than a 25% margin job if you're turning it faster?

We did a couple of episodes and I think those were the most popular Contractor Success Forum episodes, and we didn't really dive into the mechanics behind it, but I think that one's really going to wake some people up to thinking about the time factors involved in how fast you're turning this.

Stephen Brown: I love it. And Wade, love the way you present to our listeners and in your book as well. These concepts that can really be made simple once you understand the math. There's a difference between being a bean counter that you referred to yourself once. Which is absolutely not you at all.

You are an accountant. The numbers speak louder than words sometimes. Absolutely. But analyzing those numbers. In this situation, look at a number of hours [00:21:00] worked, looking at your cashflow.

In the last episode, Wade, there was even a calculator that showed your cashflow turnaround in number of days, and how that affected your net profit after you just lowered those days by a day or two.

Just amazing what that does to the numbers. Thank you for doing this and thank you for sharing these concepts with everyone. I can't wait to hear more about how our listeners are taking this to heart and what they plan to do about it.

Wade Carpenter: I appreciate you letting me blindside you one more time. I feel like I did that. Two episodes now number three here. I think I said at the start of these, I called it voodoo math. And it's not really rocket science math, it's just taking a step back and looking at it in the lens that maybe you never looked at it before. I've seen it make huge differences. And we talked about this little 1%, but this kind of segmentation stuff, finding that [00:22:00] sweet spot is where it's all about.

What I want our listener to think about, this is the fun stuff for me. When I can make a real impact rather than giving somebody a tax return back. 

Start segmenting your jobs, whether you wanna talk to me about it, it's one thing. But if you wanna do this yourself, just break your jobs down.

Some of the examples I showed, just not just, okay, we do residential versus commercial. It may be churches versus industrial versus retail shops or whatever you're doing.

And yeah, you can have them in different buckets. But then you may also think, okay, the job's under $250,000 versus the $500,000 versus these million dollar jobs. Finding that sweet spot is, you're gonna find that, especially when we get into the next one, maybe the lower margin ones, but you're turning them so much faster, you can generate the profit.

So again, looking [00:23:00] at who your customers are, how much revenue they give you, this is just some thoughts for our listeners. What are you making per customer? How fast do they pay you?

Just looking at categorizing, are they high margin, low margin? Are they quick to pay, slow to pay? That kind of matrix probably can help people think about this in a different way.

I wish I had more time to walk through some of these examples. I know we're getting long, but also just a quick other okay, you're doing jobs in outta town versus in town, what's your margin like within a certain area? I know for commercial guys going out of state, you may have a higher margin, but what is that really costing you in all the extra time and travel?

Well, this one's gone a little long, but I hope it made our listeners think about it some more. Got any thoughts to wrap up?

Stephen Brown: No Wade. Everything looks great. I [00:24:00] love seeing diagrams. I love how they communicate information, and you've just done a wonderful job and thanks. You've talked me into looking more closely at my smoothies as well, so appreciate it. 

Wade Carpenter: Well, we're gonna start using that a little more. The kale versus the kiwi versus the kelp, or, I don't know. 

So anyway thank you all for listening. I hope this has been helpful and insightful for you. And if you didn't look at the first couple of episodes, I would invite you to go back and watch those or re-watch those.

It may get some insights that will set it up for this one, as well as walking into the fourth one that we're gonna do the following week is going to be on how fast you're turning jobs. And so I hope this has been informative for you.

Again, if you would like, share, subscribe this on both the Contractor Success Forum channel as well as the Profit First for Construction YouTube channel. [00:25:00] We appreciate it and if you would comment on what you like, what you didn't like, and if there's anything we can do better next time. We do this every single week and we will see you on the next show. Thank you.