Verify In Field: The Millwork Podcast

If the Math Ain't Mathing Part 1 - Revenue, Cost and Margin

• Yuksel Nunez Araujo • Season 2 • Episode 9

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In this episode of Verify Infield, host Jacob Edmond sits down with returning guest John VanErem, Executive VP at Adams Group, to break down the financial fundamentals every millwork company should understand, but many overlook.

This isn’t just another chat about spreadsheets. John brings real-world clarity to the concepts of revenue recognition, cost tracking, and contribution margin, using real data from the AWI Cost of Doing Business Survey. If you're a project manager, estimator, engineer—or just trying to understand how the money actually flows—this is the episode for you.

About Our Guest

John Van Erem is the Executive Vice President at Adams Group and an AWI instructor, known for his practical approach to millwork finance. With years of experience managing complex projects and leading financial analysis, John is passionate about helping millwork teams—from the shop floor to the C-suite—understand the numbers behind the work.

Where to Learn More

Final Thoughts

If the math ain’t mathing at your shop, this episode will help you decode why and what you can do about it. Whether you're tracking hours, chasing change orders, or trying to justify a raise, understanding revenue and margin is critical to your success and your company's future.


📌 Stay tuned for Part 2: High-Profit Habits

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John:

You can almost have like a ghost company that you're competing with or saying like, Hey, I, I know there's a millwork company down the street. I wonder what they're doing. There's a good chance that they're just like everybody else. And Cost of Doing Business is that person, if you will. So how do you compare to that is a super valuable tool. I challenge your guys that, you know, owners, accounting people that are listening here, like go through the process.

Jacob:

Welcome back, everybody to Verify in Field. Today I have a good friend of mine and all star guest actually, if you'd haven't already seen his past episode, one of our first season episodes, and still to this day, one of the most viewed. Uh, John er, who's Executive Vice President over at Addams Group. And, uh, today's gonna be a little bit different than past episodes. We're actually gonna have some screen share here, and John's gonna go through and, uh, we're gonna talk about revenue. We're gonna talk about numbers, we're gonna talk about direct cost and margins, and how that, uh, works. Or if you don't do it this way, how you maybe should be exploring, uh, tracking your, your numbers for revenue recognition in, in millwork. So thanks John for joining me.

John:

Thanks for having me again, bud. It's been fun.

Jacob:

Well to get started, yeah, do you want to just, uh, you know, cause you've got up here, um, if the math ain't mathing and AWI cost of doing business, um, Survey Edition. For those who don't know that acronym there. And so you are, for those who maybe don't know, um, you do some of the seminars for project management and estimating for AWI. Right. And I imagine there's some of this maybe that overlaps with, with those seminars.

John:

Absolutely, absolutely. I'll give you a little rundown. Like I said, if you want to know about me, if this is the first time you're here, I'm gonna challenge you to go back and watch that video that Jacob said. It kind of gave you my life story, but what I'm really passionate about is kind of this, know, getting deeper in the numbers, kind of explaining how, um, how revenue and profit works, but really kind of dissecting that to the best of our ability. And what I've found is AWI Cost of Doing Business Survey, like really helps kind of normalize it. A, it's a common language for everybody that's helpful. Uh, so it's not just Addam's group versions and, and verbiage. Um, it's really doing that, but you can actually see what the average company is doing. And what's exciting about that is that you can almost have like a ghost company that you're competing with or saying like, Hey, I, I know there's a millwork company down the street. I wonder what they're doing. There's a good chance that they're just like everybody else. And Cost of Doing Business is that person, if you will. So how do you compare to that is a super valuable tool. I challenge your guys that, you know, owners, accounting people that are listening here, like go through the process. It's painful at first, I'll be honest. Like they, they ask you a lot of information and kind of organizing it can take some time, but year over year you kinda get the hang of it. And knowing, knowing what they're gonna ask, super valuable if you're able to compare one-on-one. So we're gonna use it as a tool today, um, to kind of take my company out of it, any of your companies out of it and just really see what it shows us. So, so if you're math ain't math on this, um, and your numbers aren't what you thought they would be, hopefully you could kind of see what other companies are doing. So.

Jacob:

And for, for those who aren't familiar with it you know, we will try to put a link in the show notes to AWI and where it talks about that. And so, one, this is, um, the results of the Cost of Doing Business Survey from the latest year. And I think past years you can go pay for it and get access to them, but also if you participate, you're an AWI member and you wanna participate, it's way more valuable because you can actually see, like John is saying, your company's numbers against the rest of the people who participate. So it's anonymized, it's totally done through a third party, but there's actually analytics you can access and slice and dice the data.

John:

Yeah, absolutely. Could even get it by region, by size, by, so if you're like, man, I'm not the average company, um, you could really dissect it really well. It's, I can't speak enough. You know, I'm hoping that I'll convince you by the end of this podcast to, to go take a look. So

Jacob:

Awesome.

John:

Do I get started?

Jacob:

So yeah, let's jump right in.

John:

All right. I love it. We're gonna give you kind of an overview here. Um, we're gonna start with some basics. Again, some of you may know what this is. Some of you may misunderstand what some of this is. I think there's gonna be some misnomers about what revenue really is. Some people get that confused with billings and we're gonna talk through that. Then we're gonna kind of break it down to what is direct cost? How does that actually apply to what we're talking about? Ultimately resulting in contribution margin. This is just the basics to really get the, the show started. The majority of this podcast is gonna be diving into different metrics in and around these values. So. All that being said, let's start with revenue. Um, you know, this is really where we start earning money on a financial statement. And so often get it confused with billing. Like I said, I'm gonna keep it simple stupid, is that revenue is more of an internal metric. Billing is more of an external metric, and I think those are kind of clear your head around is like, we need to get billings out to our customers a hundred percent. Like that is an important metric, but it doesn't ever really tie to the financial statements because there is kind of an over under billing adjustment that happens in accounting that says you might have billed a hundred thousand dollars for this job, but you only did 10% of it, right? You only built 10%, you only installed 10%. Whatever the number is, you can only earn 10% of that contract. Um, as an example. So what then, let's just call that 10%, 10,000 bucks just for, for reference to say I only complete about$10,000. Accounting will then take that$90,000 difference and back it out of our financial statements and say, yeah, we're over billed by$90,000, which is great. It's great for cash flow, it's great for paying bills, you should be over billed. But that being said, it doesn't necessarily help you understand where your company is in that month, that quarter, that year. So,

Jacob:

And to, to jump in a little bit and add some context there that I think is important because I remember before when I was just a worker bee, you know, and I was an engineer and I was releasing shop work to the floor, I had no clue what any of this meant. I didn't understand or have any visibility in my company to billings or revenue or uh, margin or any of that stuff, right? But. And, and this I know is true in many companies, a lot of companies who don't have very granular data, especially at the estimate level, there's still so many companies who are estimating by linear foot or even estimating by box, but it's estimating in dollars. And so I remember when I was trying to get to some metrics that I could use to improve my department's, performance was okay. And I know a lot of engineers are doing this is how can I measure performance? How can I measure how we're ultimately leading to the best success of the business? And it's hard to relate that to just dollars and cents, especially if those dollars aren't related to earned revenue. And so that was, that's why I think this is so important that people understand the difference between this, because my boss might be saying, Hey, we're low on billings this month, month, but what they're billing is what I did last month.

John:

Yep. Yep.

Jacob:

Or a combination of last month and the month before or whatever, right? And so I don't have an ability to impact that today. And if I don't know what the numbers mean of what I'm doing today.

John:

Mm-hmm.

Jacob:

To put that into simple terms, every job you sell in general in millwork, right? You have a fixed contract price for a fixed scope of work.

John:

Yes,

Jacob:

so usually what happens at the beginning, I'm, and I'm probably gonna be jumping ahead on some of your points here, but

John:

That's alright.

Jacob:

say, you know, you have a, a schedule of values, right? That, that your accounting department has to, to put together for a lot of times for the contract. And what that does is that assigns a dollar value to everything you're gonna do. Sometimes you might be able to assign a dollar value to the engineering for the whole job. Sometimes you might be able to assign it to completed products. But either way, the work that every single person in your business is doing today, particularly direct labor correlates to a billing in the end, earn revenue today. Right? And so what we're trying to do is track that so that we know, hey, the work that we're doing today, is it profitable or not profitable? Right.

John:

A hundred percent. Yeah. And the, and the revenue definitely points to that profitability, non profitability. Billing is, is just like how far along we are. And again, you bring up this as a great lead into my next point is as manufacturing people, there's a lot of accounting methods. I actually GPT them to understand like, what is the technical term?'Cause I have my own words. It's, uh, percent complete or product price. That's kind of how we terminate determine them. But I'm gonna try to help your listeners determine what you might have at your company with maybe some other buzzwords that I've heard in our industry. The most common we're seeing is cost to cost. And so what Jacob was just pointing out is that have a contract price. We expect it to be, I'm gonna say a hundred thousand dollars to keep my numbers equal. We think we're gonna spend a hundred thousand dollars to do that project on the cost to cost or percent complete method. We're now tracking cost that we've actually spent up to that a hundred thousand dollars as a percentage. So when we hit$10,000 of cost, it could be drafting labor, it could be material purchasing, it could be install, right? It could be all those direct labor items. Now we're saying what percentage of that budget is completed. Now, multiply that percentage to our contract price so we can, now, in my hypothetical, we've earned 10% of the cost, so we must be able to earn 10% of the price.

Jacob:

Right.

John:

That is the most common. You hear it as WIP reports, cost to complete other things. Maybe Jacob, you've heard some other words, but that's kind of the common language. That's normal for manufacturing.

Jacob:

Yes. And something else I'll, I'll point out here, you know, particularly business owners have probably heard the difference between cash based accounting and accrual based accounting.

John:

Mm-hmm.

Jacob:

That correlates heavily to most of what we're talking about here. And so, and also I think what's important there is just because you work with your CPA to file your taxes as cash based doesn't mean you can't also check internally accrual based, what we're talking here for revenue. Those can be two different things. And you can have your internal, which is what most of this is, just because, like you said, you file your taxes based on cash based doesn't mean there's not value in tracking accrual based for internal performance purposes.

John:

That's a great point. Thank you for, I, like I said, in my last podcast, I'm more of a big company guy. We can't do the cash based, mess based method anymore. I, I think you hit a certain revenue threshold. It, it forces, they force your hand a little bit. Um.

Jacob:

Yeah.

John:

So that's a great point. The, the last one is something that we're doing here at Addams Group, and because we have systems and softwares in place to give us this information. I'll be a hundred percent honest. It could be an SOV thing, like you said, Jacob, but it's a, it's, the technical term is point in time and I, I stole that from them. But we call it product price. So when a product is done in there, so I'm gonna just narrow it down to a cabinet, which is usually on a work order for us. So we earn a work order, but stick with me for a minute. The cabinet we sold at$200, right? Once that cabinet is staged and done. It's nobody else's but their cabinet. Like I, it's not my inventory, it's not anything, it's theirs. And now I can earn the revenue on that$200 as soon as it's complete once I install that cabinet. And I said that install costs$50 of that cabinet. Once I install that, I earn$50. And so again, you've gotta have systems in place to do this. And the other caveat is that the product price must sum to the contract price, right?

Jacob:

Uh,

John:

And so there's some, some things you gotta be careful of in that. But, uh, all in all, it's a really good method to kind of keep, keep this equal.

Jacob:

I, I think that's a great example for those, those who are listening that this is all Greek or news to you. You right, you've never had to think about this or, or learn about this yet. I think that is a great example to illustrate how really all this works in, at, at its core is if you think about a cabinet and your contract, say you have, uh, however many cabinets, but the unit price of one cabinet is like you said,$250. The, the max revenue you can earn for completing that cabinet is$250.

John:

Yep. Yep.

Jacob:

That's it. And so what we're doing with the difference between revenue and billing, billing, you'll bill$250. That might be next month, but you're doing work today to complete that. And once that's shipped and installed right, you get all a hundred percent of that$250.

John:

Yep.

Jacob:

But what we're trying to track is also how much did we spend to earn that$250?

John:

Correct.

Jacob:

And it is very possible, it happens from time to time that you spend more than$250 to earn$250.

John:

Never!

Jacob:

That's what we definitely want to avoid. But that is why this, there's a difference between earned revenue and cost and earned revenue and billings. And I think that's what confuses so many people, especially when you're converting earned revenue into earned hours and actual hours or earned dollars and actual dollars is, it's like, well, I'm dealing with the same units on both sides, but one is, what did we actually spend or expend to yield this result? The revenue you can earn is fixed at the contract price.

John:

Yep.

Jacob:

But you can spend tons of money in labor getting there, and that's why you're tracking this is to try to say, okay, well, we said it should only take us five hours to build this one cabinet, but we'd spent 10, we lost money.

John:

Yep. A hundred percent agree. So I want to just give the reasons why Adam's Group ended up moving to point in time, and this is some of the failures I've seen at my past companies as well, is I'm gonna go back to our a hundred thousand dollars cost budget. What naturally happens with project managers or whoever's managing that budget number every month and accounting asked, Hey, is this still gonna cost you a hundred thousand bucks? They're like, nope. And I saved some stone buyout. I saved$10,000 on my stone buyout. This thing is only gonna cost us$90,000. Accounting team celebrates and says, that's great. I'm gonna adjust it down to 90,000 bucks. But what happens at the end of the job when we're, COQ after COQ or remake after remake or install didn't go how it was. All of a sudden that 10,000 bucks now kind of creeps back into, you know, the a hundred thousand dollars number that we were at anyways. For us, we just got rid of that noise and said, Hey, we, you know, it doesn't matter how much we saved or didn't save, that cabinet is worth this value and it's a grouping of cabinets. It's just made it a heck of a lot easier for us to, to manage billing and kind of equal that out. Um, so we didn't get too far ahead of ourselves, but also gave us that, that correlation to really understanding where the products are coming from and not having to guess and, and do a lot of adjustments. So,

Jacob:

So just to be clear, Adam's group has switched from cost to cost or percent complete to point in time, meaning you have a fixed schedule value and you earn that fixed dollar amount at those points in time.

John:

Yep. Internally, that's what we're doing. Externally, we're still doing an SOV. Like there's you, as long as your systems tell you this and your accounting team is on board, you can easily do this at your company. You've gotta have the data that says that cabinet's 250 bucks. So if you're not,

Jacob:

Right.

John:

if you don't have that, you're, you're outta luck. So as an Innergy user, I'm gonna say this too, those Innergy users, you guys have that data at your fingertips. Depending on how you take it off. You just gotta figure out how to get the system to tell you it. So got a couple examples here. Uh, I'm gonna probably screenshot those, or Jacob's gonna share'em as we talk here, um, to give us, we might've used different numbers, I apologize. Um, but there's some really good examples. I'm gonna suggest that those that are listening to this via Spotify or other other things, I really challenge you to kind of come look at the YouTube videos with yourself and your teams. I'm gonna give you examples that you can then use to take back to your team on what you've heard. I, that's what I was hoping to give you something tangible to take away. Um, and so we did talk kind of through this cost to cost. So, uh, I won't run through it again. Jacob will screen share, um, that through the podcast video and we'll, we'll go from there. uh, we got also got point in time, kind of the same thing we talked about. The cabinets are a hundred dollars, the soffits 40, the toe kicks 10. There's a lot of value to having your estimates get you the information this way, so you're able to do this. This is the key to that. If your estimate's not doing it, you're gonna have no luck doing anything like that. All right, so we've talked about revenue. What's normal? Um, I said I was gonna bring in Cost of Doing Business Survey. I have to go back to 2024, which I'm gonna caveat to really say is 2023's data. So I want you all to remember that. Go back in your time machine and say, where were we at 2023? That's really what I have. If Jacob and I were to postpone this another couple months, um, I would probably have 2024's data from the 2025 survey. Um, but here we are. So an average millware company in our industry, I think there's like over 170 people that have, uh, contributed to the survey giving us this average is right at 7 million. They also, on Cost of Doing Business, take all the average in everybody, but they also separate those high profit firms saying these are the companies that are making more than everybody else on a profitability standpoint. So I wanted to kind of give you both to say, Hey, we should all be striving for a high profit firm if you're not, you're not as competitive of as my other millwork friends in this industry. but everybody should be striving for that. What's fascinating about it is that they're not that much different. It's not because of big companies, small company, whatever they are, they're right at the average as well. So this is a great data set that says it's not just because they're big or smaller. Um, whatever. We are getting some really good apples to apples data here once we start getting into it. So any comments on that one, Jacob? Um,

Jacob:

Um,

John:

Do we wanna move on to direct cost?

Jacob:

No, I think that's good. I think, you know, obviously, you know, the caveat here is, like you said, this is the average of the people who participated in the survey or the companies, and two high profit firm. What, what percentage of profit does AWI categorize as high profit and, and two, can you define what their categorizing as profit? Because I think depending on how companies do their books, that might be a different number.

John:

Yeah. I'm gonna have to probably get back to you on that for the show notes. I think it's upper quartile, so I think they take the top 20%, um, if you will. And

Jacob:

I feel like it's 12% or higher or somewhere in those marks.

John:

That, that usually is, but they're not gonna, they're gonna take the top X percent is what I think happens.

Jacob:

Okay.

John:

And so if everybody was having a bad year, they still have a hot, high profit sector, if you will.

Jacob:

Yep.

John:

So it's a decent sample size, not just one or two companies. So I think they protected themselves with the data that way. Um, but I'll, I'll verify and we'll get that in the show notes for sure.

Jacob:

Okay.

John:

All right, next up. So we got revenue at the top, earned revenue. Now we need to subtract all the direct costs. So the direct cost that we're looking at is, what's kind of, put on the project, and this can be confusing and needs to be identified inside of your company is what is direct cost, what is not. Because there's what AWI cost doing business has, and it's actually all of these categories on my screen, which I'll read through for the listening folks. But you may not have drafting as an example, as a direct cost to your job. You might have drafting as an overhead cost. And we don't actually have them clock into the project and, and get cost to the job. That is a company's preference if you will, and how they manage those people. I strongly recommend you actually do drafting, you do engineering to the project, where project management is kind of one of those things that I'm like, man, it's so hard to kind of isolate their time to, did they really work on this job? Did they not? I suggest that project management actually moves to overhead. You're gonna have them, they work overtime. Like it's really unfair to kind of track their hours, if you will, to a project, as an example. But I'm gonna challenge all of you to actually, see what your estimates are picking up.'Cause that's, that's the first thing. And see if that estimate actually aligns with your accounting method, because if those don't, you gotta fix that.

Jacob:

And I think that's the important thing to remember here. One is that what your operations team is considering a direct cost needs to align with what accounting is.

John:

Mm-hmm.

Jacob:

What your estimate is, needs to align with what your accounting and operations is. And, two is that what you're, what's after this, which you're gonna get to. Margin.

John:

Mm-hmm.

Jacob:

Um, is gonna vary based on what you categorize where. So if you move drafting labor and engineering labor to direct costs, then your margin should go down and your direct costs are gonna go up. And so the most important thing is that you're able to compare apples to apples. you know, at, at its definition direct cost is anything that you can say every single dollar or every single hour. What job were they working on or what, you know, I can categorize it. So people who clock in and clock out ideally are, are the, the main ones. Um, but outside of that, what's important is that that's how you're estimating and you're saying, okay, this job is gonna have this many hours or dollars of direct cost. And that's how you plan on a monthly, annual basis. Your budget as a company is, okay. I know we need 60% margin, so every job needs to contribute to that. And then that's, you measure against that throughout the course of the job, which is what all this is ultimately getting to.

John:

Yep. And we'll get to kind of how to predict revenue in a future, slides here, but so mainly what it is to everybody is material, labor, install, shop labor, install, like those are common. Everybody has that. These other categories you need to evaluate. To Jacob's point AWI puts all of these in direct cost. I'm gonna be clear. So when you're gonna see some direct labor percentages that I'm gonna show you on the slide and contribution margin that I'm gonna show you, these have them in direct cost. Now, if you want to take them out saying PMs do not clock into a job. Luckily for you, cost of doing business has the percentage of that and you just. Literally remove it out of that. It's a, it's a simple math equation, so you can still get the data. It's not, you know, throw it out. We can still get some of the good information on how your company's performing against AWI. So, so we wanna see the numbers on how

Jacob:

Yeah.

John:

much people are costing? Here go. This is where we start getting some differences, is our first one, um, of many. So average, a company, uh, let's just use a hundred dollars or a hundred percent, they spend$62 of that a hundred dollars to produce product that you're making. A high profit firm is at 56 and a half. Now we're starting to see the difference. What are high profit firms doing on a cost basis that is interesting to evaluate, analyze all those different things. We're gonna get into a lot of that in our deeper dive on what I think and what actually the data shows us. But on the surface, this is where we're at. Okay. Does that make sense?

Jacob:

So,

John:

Everybody's got their how to look at the book, and this is your measuring stick that you're measuring against.

Jacob:

And, and for those that are, you know, doing math in their head, it should make sense that high profit firms have a lower percentage of revenue, of direct costs, because the difference is what goes to the bottom line.

John:

Yep. Know what you're gonna get to. Math is math, right? All right, so let's get into it. Contribution margin, also known as margin. It's um, we use contribution'cause you're contributing to pay for the overhead. And so that is why I think the word: contribution. I am not the world's best speller, which is super obvious here. I, they say, they say intelligence comes from those who can't spell. So those that pick apart my slides, uh, must be, I must be super intelligent. I don't know. but these are the dollars after direct cost to pay for indirect cost or overhead, if that's what you're. That's what you're used to hearing. And so we ask ourselves, so what is then indirect cost? Right? Those are the things could be from the previous slide. Now project management needs to move over just to, just to show you what's not on my slide, but usually it's things like rent, utility, IT, sales, estimating, vehicles, all those things that it takes to run a company that we can't directly attribute to the project, but they definitely are needed to produce the product, right? And so that's why we say they're indirectly involved in that, but not directly. So, um, so I put the, the note on here. It says, man, this is really where most of your listeners, outside of executives that kind of manage indirect budgets and some of those things, like this is the line that y'all need to measure to, right? You should be getting this target margin from your estimating team. Not profitability, nothing like that to say, what was my revenue? What were my direct costs? The subtraction of those two things is contribution margin. That's the number I need to be hitting right? Outside of that, you guys probably don't have much control over how much rent they're spending, what vehicle the owner may be driving. Those kinds of things get, get tied into that. So, wanting to see, wanted to just make sure that we're clear, like, this is, this is it. This is where you should stop. So.

Jacob:

And I think what's important is that also, this is mostly all your fixed costs. Mostly all the things that, you know, you have to pay rent, and you know how much you're gonna spend on that in a year, regardless of how much work you do. So whether your revenue goes up or down and you're keeping the same space, you have to pay that much rent. You know how much you're gonna pay your accountant, you know how much you're gonna pay your cleaning people, you know how much you're gonna pay in leases for trucks or whatever, right? And so that's all the stuff that goes in here and that's why it's important that you know those numbers up front. And I see a lot of people work backwards and they will kind of, you know, reinforce a bad budget by saying, well. This is what our contribution needs to be because this is what we've already said we're gonna spend.

John:

Yep. Yep,

Jacob:

So I think that's why it's important, but also when you get into measuring by your job is you're gonna have jobs that don't contribute your goal contribution margin. Right. It's going to happen.

John:

yep.

Jacob:

And so that's why it's important to measure it so that you know, okay, can I make that up on these other two jobs? Right? Can I make up that dollar amount that I lost here?'cause it's gonna happen somewhere.

John:

A hundred percent. We're gonna get into a deeper metric on that, on the, on the shop hour here, later on the slides, but you're hitting the nail on the head. Not all jobs need to be at or above a threshold that your company is set for you because jobs will offset themselves, uh, that your company

Jacob:

Sales might consciously choose to sell a job lower to get it, you know, and say, okay, strategy is, we're gonna go low on this one because we know we can go high here.

John:

Yeah. Yeah. Look at the airplane industry and how you buy airline tickets. It's very different. They're making very different margins for that same seat, depending on when you buy it, time of year, all the different things, because math is math. Those that are probably mathing in their head, uh, really we're just taking that a hundred percent revenue minus our direct cost to get these contribution margin numbers. So not a huge, uh, thing here, but the average is about 38% for the, uh, millwork companies in 2023. But high profit was up in around 43 and a half. So that being said, high profit firms are doing something different. Um, we just gotta figure out what that is. So to kind of bring everything into full context to kind of give us a summary of what we're doing, to this point, we're gonna get into indirect and some of the percentages there.'Cause I know some of you listeners might be curious on like, Hey, what is normal? But just to recap, uh, to an average, I'm gonna just go average AWI firms for now. An average AWI firms makes$7 million. They spend about$4.3 million to do that work directly, leaving them with about$2.6 million, of contribution margin. That is not profit. I said that on a previous slide, like a lot of comp, a lot of employees, even my, my, some of my past friends that I've worked with is, man, I made this guy 2.6 million bucks on this job. Let's say it's a$7 million job. That is not a, that's not true. It's, you gotta pay a lot of stuff to, to be able to, to do that. So,

Jacob:

But I think that's important. So what's up on the screen for those who are listening and can't see is kind of a summary of everything we've talked about, which is essentially your P&L, your income statements as total revenue. Minus direct costs, yields your contribution margin, right? And the math, maths, right? Direct cost and contribution margin equals a hundred percent. But something that, you know, why, another reason why this is so important, and I'm hoping this will be a little bit of a layup for you. Who manages direct cost and who, who's responsible for direct cost in most companies, or who should be and who is responsible for contribution margin.

John:

Yeah.

Jacob:

or.

John:

So direct cost. Yeah. Usually in our company, usually direct cost is held by those, those managers or employees on the floor. Like it really starts with the employee on the floor, knowing what their budget is, their hours are. That's visible in our organization to say, we gave you this much, try to beat it, right? As long as we're doing that, now, the managers are watching that. Now, contribution margin is usually managed by our project management team, sales team to some degree. Now, there's some savings that they can do that are margin only moves for us, like for example, we charge for storage when things are not shipping out on time, as an example. That's not really a direct cost, like we're still paying rent inside of our indirect, but now we've gained margin to cover that. To say, Hey, I, you took up this footprint of my shop. Now I'm, uh, contributing to the contribution margin side as a, as a margin only type of change order, so.

Jacob:

And I think that's important for project managers to hear if nobody else right is. Like I, how significant, just whether you get a change order or not can be, because that math goes straight to margin here.

John:

Yep.

Jacob:

Especially if it's something, Hey, we've already done the work, or we know we're gonna do the work. The only difference is, are we gonna get paid for it or not, right? So you've already added direct costs to your job, to your budget, which has already directly reduced your contribution margin. And so if you're a PM out here or you're anybody who has the ability to, to go and chase a change order and get paid for it.

John:

Yep.

Jacob:

That goes straight to the, your, that bottom bucket.

John:

Yep.

Jacob:

And that can make a huge difference in the performance of your job as well as the performance of the company.

John:

This is a little bit of a squirrel to this, but I, you led me to it and so I'm gonna take it when a project manager is pricing change orders do not pump up cost to get margin. That's just going to really screw up our, what I'm gonna call a postmortem evaluation or some project evaluation. If I, if I'm a project manager and I was like, I wanna stick it to this gc right? And I want to add a hundred hours to drafting. And to do so, what's that gonna do when we go to evaluate drafting got all these hours? Like they just crushed it, drafting. Like, man, we need to probably lower our drafting time, our estimating team's doing too much with drafting. A risk there that you start getting into this evaluation or somebody's looking at these numbers inside of your organization when you really should have just said, probably five hours of drafting to redraw this thing, but I'm gonna put it all as margin, right? Which is, in this case, contribution margin. I'm gonna put it all as contribution margin to get the price up. So make sure that you're, when you're pricing change orders, it's super important on where to put the cost for a postmortem evaluation. Not part of the slide, but thanks for it. Thanks for that.

Jacob:

Yeah. Yeah. No, that makes sense. Essentially, it's a lot better to be, you know, price it and just say, Hey, I'm gonna have a really healthy margin in here than you, as the person who priced that looks good, as opposed to,

John:

Yep.

Jacob:

you put it in a bucket, it shouldn't have been in.

John:

Yes, sir. All right. So those are the basics. We're gonna add more later on, but let's now get into some fun stuff here. So now that we got a basic understanding where this is, now we're gonna dive deep into kind of, how do I set revenue? Like, is my company actually at the right revenue targets this year? I could give you Cost of Doing Business analysis on how to do that with some, with some information we just learned. How is indirect as a percentage of my revenue, how important those relationships are, are vital to your profitability if you're built for a certain size company because your overhead is built for that, but you only perform a much lower amount of revenue. How does that affect your bottom line? We should have just learned, hey, we might be crushing it on everything, but that indirect is so heavy as, as such a burden that it's, it's affecting our profitability. I wanna dive into plant processed as a non-plant processed. I think that's where the key on high profit firms are. They're kind of. They're attacking all of these things in different ways, but I really think plant processed versus non plant processed and how you, evaluate your bids are gonna be huge. And then, really the, the metric that kind of brings it all together is kind of margin per production hour. And I'm super excited to kind of share some, some interesting thoughts. Now, again, you gotta have a bunch of data to be able to do this. You can do it manually, but I'm, I'm gonna show you how I think that's a super huge, valuable metric to kind of see where you're at. Then we're gonna, unfortunately look at install for those installers listening, stick with us. Like there's gonna be some interesting stuff on Cost to Doing Business that install shows us. And then finally, I want to just talk quickly about slippage.'Cause to be honest with you, slippage affects all of this. If, if revenue slips out, like how much of an impact that has on your profitability margins, like there's a lot of different things around that. So we good

Jacob:

So.

John:

to get started on some of these or.

Jacob:

Yeah. One thing I wanna point out, plant processed versus non plant processed.

John:

Yep.

Jacob:

You maybe heard plant produced, uh, or a couple different terms. Ultimately, you know, correct me if I'm wrong, what this boils down to is the stuff that you make in your shop versus stuff that maybe you buy from your countertops. You pay another company as a subcontractor to do that, right?

John:

Yep.

Jacob:

But why that's so important for companies who maybe aren't categorizing their revenue this way or their work this way is because one, generally your drafting and engineer has to draw both, right? And, and it affects your project management, both, accounting, both,

John:

Mm-hmm.

Jacob:

but your shop not the same. Install, not the same usually. And so it's very important because no two revenue dollars in those two categories are the same. They don't affect your business the same. And, um, it's very important that if you aren't, because I've seen companies do this, say, oh man. Engineering released, you know, so much work. Why is the shop empty? Well, half that was non-plant produced work.

John:

Yep.

Jacob:

And so I think that's something that people, if you haven't been familiar with, thinking about your revenue that way, I think that's can be very important.

John:

Yeah, I think it's the key. And again, how you look at it is, is huge. So, all right, let's look at revenue costs, um, and targets. This is just kind of set the baseline, to be honest with you. If you don't have revenue, you can't do a lot of the other things. Like you can, you could do margins great. You can, you can have an indirect budget, but if it's not in alignment with revenue, like we've got problems. Right? And so just to kind of reiterate again, what indirect cost looks like, is kind of that rent, utility, sales, vehicles, again, your company needs to, to calculate what that looks like for you. Your accounting should have that separated in their profit and loss statements. this data should and could be available to you. Your, uh, your accounting team might collapse or group some things to protect people's salaries and some other things. But by all means, at our company, our team knows our indirect spend every month, every year, and we know what that means to our revenue. Last year we got those things out of balance. We had really ambitious goals to say, we got all this revenue coming at us. We're gonna, we're gonna indirect this. This aligns with our indirect and unfortunately, through slippage and revenue movement, those things got out of line and we didn't make as much money as we had hoped to. And so understanding what that is for your company is huge if you don't have that. So. Let's talk on how we do this. So the first thing that I, I need from this is a break even number. So said differently. How much revenue do we need to make at a certain margin to break even to cover all of those overhead or indirect costs, right? So, the first thing you gotta do is know your indirect number, right? I've said that a few times. If, let's use for an example that that is$1 million, just to kind of keep the math simple, and we want to do Cost of Doing Business Survey. I went down to 37 for some reason, but that's okay. We take that$1 million and divide it by 37, percent margin. That's that now equates to 2.7. I'm reading the slides for those that are listening, but so said differently if we do$2.7 million of revenue, and that margin average on that 2.7 is 37%. We will have made a million dollars in CM and just covered our indirect cost. That's super important to understand and I wanna pause, or if Jacob wants to say it differently, I'm, I'm good with that. So,

Jacob:

Yeah. Well, I think what's important here for business owners or for people that maybe aren't business owners, to know what your business owners thinking is, this is what it takes to pay the bills and for your business to make no money.

John:

yes.

Jacob:

So when we say cover your costs, we mean you, you look at that and say, oh, I made 37% margin. That means zero profit, zero net income. That means your owner, uh, when they file their taxes, they're gonna have made zero money at the end of the year. They will have just paid for all their costs.

John:

Yep.

Jacob:

And so that's why margin is a different thing than net income or profit. and so there are a lot of businesses that do this in real life for multiple years through downturns, and they keep people on and the, and the nobody in the business knows that. But this is why it's so important to know this number because this is kind of like your worst case scenario. You don't wanna do this, but

John:

Yep.

Jacob:

you have to know this to then know where to go.

John:

Totally agree. And I've been around project managers that said, man, I've even increased my margin to 39% on my jobs. Like, I'm, I'm just crushing it. If, if this relationship isn't right here and you're only a$2.7 million company, it's still not gonna net you anything. And you're, you're asking for a raise or something and you're like, why isn't my boss give it to me? I'm just crushing these jobs. Well, more than likely this relationship's outta balance. So talk about how we do it then. So what we need to then is kind of now ask our owner or ourselves, right? How much do we wanna make? Right? Do we wanna make 9%, 10%? Um, so the math equation can be easy. I would say if you're not making, if you're not trying to shoot for 10% or above. Maybe this isn't the right industry for you. Like we, our money should make us 10% as, as a, as a norm, if you will. so lets just kind of back our way into that. And the only thing we have to do now is basically take that profit percentage as part of our equation. So we got our million dollars and we divide that by our CM minus our, profit target percentage. In this case, I didn't show the math on here, but that would be 29%, right? So I'm taking$1 million divided by 29%, or to get to 3.6. Said differently, if I now sold$3.6 million at 37%, I would have$90,000 left over, which is about 9% of my$3.6 million. So it's,

Jacob:

I,

John:

it's a quick math to get back into the game and trying to say how, how big should we be?

Jacob:

And I think that that's, so just making sure I confirm on the previous slide we were looking at 2.7 million at 37%, right? So we're basically working with the same numbers and we're saying we need to increase top line revenue to 3.6 million just to make$90,000 in profit. Right. And so I think that that math is so important for, uh, people who've never thought about this or never had to think about this, because I think a lot of people would look at that and they would maybe even hear their business owner say, man, we increased from 2.7 to 3.6 this year. That's a huge jump. And they must be thinking, man, you must be rolling in the cash. You made so much. I made you so much money as a project manager.

John:

Yep.

Jacob:

They maybe went from zero to 90,000. Which if you think 90,000 is even as a salary, like that's not a huge to think of an owner making.

John:

Yeah.

Jacob:

I think that, that

John:

This is half of our revenue. This is, this is,

Jacob:

I,

John:

We said 7 million. This is about half, right?

Jacob:

yeah. Yeah.

John:

Think about that for a minute. So all good things. This is how you do that. Again, I want to point to my visual on the right hand side, until the bucket is full. To kind of complete this visual analogy for those, imagine a bucket with coins dropping into it. That bucket size is the size of our breakeven or the size of our overhead. We do not make any money until the coins overflow the bucket. so that visual says, now we're picking up the coins on the table. That's why the visual is there. That's the 90,000 that's left over because we filled that bucket and paid for it. So if that helps the visual aspect of this, I think it's, it's huge to understand is that we're just putting money, we're contributing money to this bucket, and until it's full, we're not making any money as a company. So.

Jacob:

And I also think what's important, you know, and I hate to be the, the guy who's just a show for owners here. But just to put it into context, as employees, you know, this is how you look out for yourself as well, because those, that overage, those coins on the table that are overfil, overfilling the bucket. Until you have that, there is no money to pay for new computers, to pay for raises, to pay for bonuses, to pay for new offices, whatever. Right?

John:

What already have.

Jacob:

So, right. And so until there's profit, there is no excess to then say, now we're gonna reinvest this into the business and increase our overhead, increase our direct cost, or give raises, whatever that is. That's where that money comes from. But you have to have it first to be able to commit to pay in the future.

John:

Yeah. And often owners will take it outta their own pockets to do it. So they might, their pockets might be in that overhead bucket'cause they gotta get paid too, right? So

Jacob:

Yep.

John:

sometimes salaries are there. If that bucket's not full and you're asking for a computer, guess where it's coming from? It's coming from them.

Jacob:

Yep.

John:

So something to keep in mind. So roll the dice. This is the big number I want to make sure that we're hearing we've talked contribution margin. It was a slight difference, right? There was a few percentage points. Man, look at this. This is average net profit of an AWI firm is 9%. Just like we just talked about on the previous slide.

Jacob:

Mm-hmm.

John:

That was 3.6 million. About half of the average size. A high

Jacob:

And,

John:

profit firm is 22. Like that is bonkers. What are they doing?

Jacob:

And so one, you know,'cause we started out with the difference from high profit I think was 62 to 59 or something like that, right?

John:

Yep. Yep.

Jacob:

So just from direct cost being lower, you've got maybe 3% of this 22% came from direct cost came, or maybe you could say came from the sale price. But the rest is in overhead, right?

John:

It's a hundred percent the difference. And so that's why I bring it up first in the slide is like they're doing something different. They're doing more with less. Right? And so their indirect is so small. Now that could be automation, could be some other things that are going on here that systems, softwares, uh, buyouts, you know, they're, again, I'm gonna pick on Jacob to why his business exists, right? Because it's such a rollercoaster for us in our organization to keep a drafter full time. It's hard for us to kind of keep revenue generation out of those hours all the time. Like there's just not enough, or there's way too much it seems to come in waves. We got another, got another wave coming. But that's something that we do now, we're we're shifting resources and doing some different things to make sure like we understand our bottlenecks. And I'm not gonna get into theory and constraints and bottlenecks. I think you've got previous podcasts on that, but I'm just saying like, that's what they're doing, that they're doing something different with, with less. And, and we should all be trying to dig into what that is. So it's super important. So, all right, so that's revenue. I do wanna say that, I will say that I want to just kind of plug Cost of Doing Business here because I, I, I want to kind of dive into something deeper.'Cause now that we got to a bottom line number, there's a lot of metrics in between those numbers, right? So AWI cost of doing business does give you those four bullet points of revenue, cost, margin, profit, right? But there's a ton in between. And then what I'm trying to show with this slides is that it can do all sorts of things by region. You could, you could calculate your revenue by square footage, by SG&A cost. Like you don't have to just take my total indirect cost formula that I was sharing in this slide. You can say, man, what should my size be based on SG&A? From Cost of Doing business and recalculate that out. There's a lot of interesting things. Maybe the Southwest has a different model than the all right. And so you wanna look at their data to understand how it works for you. So they give you those four categories in many, many more, along with like headcounts. Like what are, what are high profit firms doing on the headcount? So if I said they're doing something different on the indirect side. Cost of Doing Business is gonna show you that on the headcount side to say you might have five drafters over here in the average company, but the high profit might have one. I'm, I'm not saying that's on there, but now you can start to see the relationship and saying, what, I wonder what they're doing there. And, and you and your company can talk through to be like, and there's something here. Let's dig into, uh, you know, maybe it's a Duckworks thing. It may be more expensive than what our guys can do it, but man, look at this roller coaster kind of activity that's happening. In the long run it might be the right answer for us in our organization. So just throwing that out there, um, as a kind of a pitch for Cost of Doing Business Survey. So,

Jacob:

Something else while you've got this. So for those who are listening, what we've got on the screen here is a, a map of the US and by region. And, and for those that are listening that aren't from the US, US is large and there is, and I think for the people that are here, it's important to know your region and to also understand

John:

Yeah.

Jacob:

direct costs vary very significantly depending on what region you're in. They can, particularly labor, um, materials can as well. Um, but definitely labor if you're in the southeast or even in the southwest. Um, definitely the southeast. Your cost of labor is gonna be very different than west and northwest.

John:

Completely.

Jacob:

And so that's important that you understand that it's important as you're looking at this data to kind of take that into account and normalize that particularly for your labor prices. But, uh, I think it also, you know, as you start to branch out and grow in sales in different regions, it can affect how, you know, you can sell the same job for a different price in a different region, very likely.

John:

Totally agree.

Jacob:

And it's important to get into, to, to, to understand that and consider that.

John:

Yeah.

Jacob:

And that may sound strange if you're in the uk and, and it doesn't vary nearly as much as, as what it can here in the US You think we, a lot of times we think of the US as a whole, it's just everything's the same, but it varies very much based on. And even within these regions, whether you're in a metro or a, or, more rural area.

John:

So a couple caveat points to this. I was unable when I made these slides to actually pull what AWI is classifying. So please use the map as a reference only.

Jacob:

Yeah.

John:

It is in the AWI books. I just didn't have the time to scan it and put it in there. I could not find it online. So be aware of that. And the other thing is my friend Chris Wernimont, who works for us now, be careful on the data set that is there. The smaller you get, the more inaccurate it could be. So just be aware that, yeah, we got 170 companies or so, you know, in the all. We may only have a few in the Northeast as an example. So just be careful of, uh, how big your sample sizes are. So, all right, that's revenue. So I'm hoping that y'all take a look at it And get back to your owners on what you think that should be. All right. So now it's related to this, I'm saying if those things get outta line, then we've got a different, uh, problem on our hand. So, again, this is where I, I'm kind of saying like, yeah, project manager can kind of look at, Hey, I'm doing so well on my, my, my contribution margin. I'm crushing goals, I'm beating estimates all the time. Again, if these don't align, this is a problem. And we've said this over and over again in this podcast, I'm gonna kind of show you what costs of doing business says about it. So, what the difference is here is what's showing on the screen is actually a sum of their indirect values as a percentage. So now we're kind of taking that contribution margin side and dissecting it and saying. Math is math to my profit, but I'm just kinda showing you guys side by side. The average firm has 28% of their revenue to indirect cost. Right. Where a high profit firm only has 22. To Jacob's point earlier, steal my thunder a little bit. It's compounding, it's all the little things, but this is a huge, this is actually one of our bigger movements, right? In understanding where the differences are. Yeah. We saw a few points on cost, which led to contribution margin, but honestly, this metric here is showing us that they're doing something different. How do you get closer to the 22% than the 28%? Is gonna be a little bit of what I'm gonna bring up in the end of plant produced, non plant produced, and, and understanding what that is and what erodes, um, this. Um, but I won't steal any thunder for future future slides. So,

Jacob:

Well, I do think it's worth pointing out and, and one, obviously we're going through a lot in a very short period of time, but it is very important. We'll share this so that you can look through it all later. But I know, I'm sure some people, maybe if you already zoned out or you're listening to this and wondering like, why would I go through this much trouble.

John:

Mm-hmm.

Jacob:

How do I even begin to go through this much trouble to have these numbers? And I think what's important though is once you do, has to have these numbers. It snowballs very rapidly. Like once you start to track this data and collect it, you're able to do so much more with it. But this informs every decision you make going forward and makes it so much more powerful to be able to make those decisions. Because you can one price jobs and know, okay, ahead of time, am I gonna make money or not? And then you can start to make more informed decisions like we talked about earlier, like, okay, maybe I can sub out the drafting and turn what normally is a direct indirect cost to a direct cost. And I, I still have the same margin left over for contribution margin from this job. It changes the math very, it's very quickly you're able to target places to change the math of your job's budgets, and ultimately your financials for the business.

John:

Totally agree. Love that. What's on the screen now is kind of a continuation of our, our blue metric and adding now indirect cost to saying, Hey, on average this is what's happening as far as indirect cost on a normal AWI company net profiting, again around that 9% number, uh, that's shown on the screen. So, now I think it's important to kind of go side by side here to kind of understand, um, where things are at. So I, I think on the surface, what you're seeing on the screen is kind of the average firm and that same thing we just looked at, plus the high profit firm on the right to kind of. See the side by side differences and most people are gonna point to contribution margin being higher, right? So that's the normal thing. It's like, oh, they must be selling it for more than we are. Right? It is true. I see six points there. Um, but what I don't see six points is in the net profit, and that's mainly because of that math on the indirect side, like hitting that home. Like that is the thing that I feel is the most important thing to kind of have your business. Yes. Contribution you should be getting everything you are now. You know, a ghost company is pricing things at 38%. If you're not there, your competition is, right. Using that logic, if you will. But i just feel like that indirect side of things. Again, a lot of listeners on this call don't have control over, but need to understand like, I'm not getting my bonus because this is outta line. Or man, my owner's asking me to do a so much more revenue and I don't understand why I'm doing all these things. Like he's just greedy. He's just doing these things. And you mentioned that to me. But man, wouldn't we all love the 22%? Right? And if we can manage that, like let's try to figure out where that is. So,

Jacob:

And I think it's great'cause you can visualize here very quickly, and this is obviously, this is all just, this is based on real data, but these are two hypothetical examples of companies. Right. But even just here, you can see Okay. Right off the bat, yeah. High profit firms probably are able to sell their jobs for more to begin with. And here we can say they got 800,000 more right off the get go. Uh, direct cost is very comparable. If anything, high profit firms are spending a tiny bit more, looks like about$30,000 more, almost nothing.

John:

Yep.

Jacob:

Contribution margin then. And then outta that direct costs, like you said, those same high profit firms that are doing more in revenue, are spending less in indirect costs. And all that goes right down to the bottom line. So you've got$800,000 more in revenue and what,$200,000 less in indirect cost that goes right to your net profit. And what I would, let me just, you know, put some ideas out there, hy hypotheticals of what that could be. You, a lot of companies don't change their indirect cost structure when revenue goes up or down, and particularly when it goes down. Almost all of'em will lay off people in the shop or, you know, stop subbing out install and self-perform. Or, you know, maybe you let a couple people go from your engineers or PMs, right? Because those naturally scale to how much work you have. But you're probably not thinking about, well, do I still need all the people in the back of the house? Like the, a lot of people lose track of that and think, well, I, I have that infrastructure. I can't afford to let them go. And you don't think about, well, we were doing$10 million five years ago and now we're doing eight.

John:

Mm-hmm.

Jacob:

The math changes rapidly, but you're, you're not changing with headcount. And so, uh, it's, you know, when you put it into black and white objective terms, it's much easier to make informed, unemotional decisions about, you know, maybe it's not that I need to let people go, but I need to go sell more and I need to justify the cost of putting those people here. And I also need to make sure, you know, are we, maybe it's the size of your office, maybe it's, you know, things you've added before that now don't make sense anymore and you'll see it here very quickly.

John:

Yeah. I want to tease the next category'cause I feel we might be splitting this into two podcasts, looking at my recording time.

Jacob:

Yeah.

John:

I'm gonna, I'm gonna tease this to say maybe indirect cost is actually related to direct cost in a funny way. And that could be because of the plant produced, non-planned produced ideas that Jacob was talking about. We are, we are looking at top line only and we've filled revenue to the shop, but our guys are standing around doing nothing. And so the, the, sweeping the floors or dusting off the machines, that's not directly related to a cause that's going to that indirect side. Right. And so the idea around this is that money moves from direct to indirect and might just be adding to that more than they should because the companies are not managing right. That's what we're gonna get into in the next topic. Um, but wanted to tease that a little bit. So

Jacob:

Yeah, absolutely.

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