In sports, halftime is a great time to review the first-half results and make any adjustments to the game plan to finish strong in the second half. The coaching staff pulls the first-half score and all of the statistics (numbers) that contributed to it and lays out the story of what went right and what went wrong. OK, you get it. This is a halftime talk. July is over, and there are a few months left to make or break your financial year. What do your numbers tell you and what are you doing about it?
It’s a numbers game
Lack of financial literacy is one of the leading causes of business failure. Leaders need to know not just what the numbers are, but what they mean. The numbers tell a story. Understanding the story means understanding your business.
The universal scorecard in terms of financial reporting in business is the profit and loss statement (P&L).
A well-structured P&L is a record of past financial performance over a period of time, usually a month (month to date) or several months starting at the beginning of the year (year to date). The P&L is usually broken down into four main categories: revenue, direct costs, overhead and net profit.
The first key to understanding the operational story behind the numbers is that a number by itself doesn’t mean anything. A number must be compared to another number to be meaningful.
A P&L for the current year is meaningful if the numbers (actuals) are compared to an operating budget or to the prior year’s results.
If revenue is higher than the prior year, or higher than budget, it indicates you’re growing! The story is starting to take shape. If this year’s revenues are lower than those in past years or the budget, it could indicate a problem that needs further analysis and evaluation.
The direct expenses are mostly labor and materials that can be tracked directly back to specific jobs. Rental equipment, dump fees and other miscellaneous items also may be direct expenses if they are related back to specific jobs, but usually labor and materials are the big items. Subcontractor expense is another part of the direct costs, but we’ll get to that later.
The money remaining after all direct costs are covered is called the gross profit (GP). The GP number tells the stories of estimating proficiency and/or production efficiency.
For example, if my GP goal on a job is 50 percent, then I am planning to earn 50 cents on every dollar of revenue I sell. If I sell a $10,000 job and spend $5,000 in labor and materials, I will earn a 50 percent GP. Nice job! But if I can do the same job but manage my direct cost to $4,500 by being more efficient with my labor and/or more aggressive in material buy-in, I can earn more GP (55 percent). Better job! The idea is that by examining the job numbers (job cost), I can learn how to improve performance going forward.
The P&L is a cumulative look at all jobs in a period and lays out a story of performance. Are we estimating properly? Are we purchasing in line with our estimates? Are we hitting labor hours? The P&L doesn’t always reveal the culprits behind missed numbers, but it points the experienced business person to the areas of concern for further investigation.
Gross profits earned through subcontractor-performed work are often less than profits earned through self-performed work as a percent of the revenue, so it makes sense to look at self-performed versus subcontractor-performed work separately.
The plot thickens with the overheads. Are they more than prior years’ overheads? More than the operating budget? If revenues are growing, overheads will naturally increase, but in well-run businesses, overheads tend to grow at a slower pace than revenues, which is why strategic revenue growth can lead to greater profitability. If overheads are growing faster than revenues, the story is not going to turn out well, and the P&L is telling us something is out of balance.
At the end of the day, the target is what shows up at the bottom of the page: the net profit. The ability to read the P&L and understand what is impacting the net profit either positively or negatively empowers us to take targeted action to improve results. Without that, we’re doomed to work really hard and not make money — the fate of too many businesses in our industry.
As you review your first-half numbers, take the time to understand the story behind the numbers in order to reset the second-half game plan for success. This may mean changing up the players, the plays or your leadership approach. Understanding your numbers is the first step in winning the game.