If you are like most professionals in the industry who are operating a small pool/spa business, then there is a good chance you got involved in the trade because it was a fun summer job or way to help out with the family business. However, what you may not have realized until after starting the business and stopped working as an employee, is the work is not all about ‘fun’ anymore.
Instead of being outside and involved in the construction process, you are in an office behind the scenes performing tasks such as negotiating prices, selling, collecting money, hiring/firing, purchasing product—the list goes on. Eventually, you need to realize that operating a business is a lot different than simply selling, installing and servicing swimming pools and spas/hot tubs.
In order to survive and prosper, you need to look at your business in a different light. Small business management, and in particular financial management, becomes essential. This article will focus on the elements of financial management as it relates to operating a small pool/spa business.
The importance of a business plan
If you are fortunate enough to have a degree in business, or related experience in operating a pool/spa company prior to starting your own, it is quite possible a proper business plan was put together. It would have considered things such as marketing plans, budgets, sources of financing, etc. If this is the case, then some of the unnecessary growing pains or ‘learn-as-you-go’ education was likely avoided.
Having a proper business plan in place will significantly increase the odds of your business surviving its first year. It will likely also lead to easier management and growth in the future.
If your business survived its first year without such a plan, it is essential to review your financial information to try to get a thorough understanding of what took place over the last 12 months as far as money is concerned.
A bookkeeper or accountant can help simplify this daunting task. Simply using the financial statements, which are prepared by your accountant for yearend purposes, is not good enough. These statements more or less only benefit banks and the government. The statements you require for managing and controlling your business need to be much more detailed.
For that matter, it is a worthwhile exercise to work with your bookkeeper to review all the paperwork from the previous 12 months and reorganize it into a manner you will understand. This makes it easier to use the information when strategizing and planning for the next business year. Once your financial information is organized into a detailed profit-and-loss statement (the way you want to see it, not the accountant or the bookkeeper), you can use this template to set up your chart of accounts for the upcoming year.
Going forward, however, you should ensure every piece of paper going through your office is coded and filed to the right account. This is a meticulous and costly process; however, the benefits far outweigh the costs. The more accurately the information is organized, the more useful the numbers become in monitoring and controlling your business on a weekly, bi-weekly, monthly or quarterly basis. Further, the more often your business financials are monitored, the quicker you can identify problems and take corrective action.
In the pool and spa business, weekly is the best scenario due to the duration of individual projects and working season. Keep in mind, this is not a small undertaking; it requires commitment from several team players—from the business owner and bookkeeper to the office and operation managers. Everyone has to make sure the financial information is provided weekly to the bookkeeper, and you, as the owner/manager, should review it each week in order to take corrective actions where necessary.
The basis for good financial dataThe basis for good financial information starts at the job level. Every piece of paper, receipt, packing slip and time card, etc., generated from the field must be properly coded to the right job, piece of equipment and overhead account. Likewise, paperwork coming into the office must be properly coded to the appropriate overhead accounts (i.e. phone bills, advertising, insurance, etc.).
As a minimum, costs must be separated and tracked into either ‘cost of goods sold’ (COGS) or ‘expenses.’ However, individual job costing is ideal. If you track job costs separately, you can not only track your company’s overall profitability, but also see which jobs are making and losing money. If you are able to get down to the job level, then you have time to identify problems on project sites before they get out of hand.
For instance, if you are halfway through a two-month project, which was estimated at 2,000 labour hours and 1,500 have already been exhausted, you will know there is a problem and there still might be time to take corrective measures and/or determine where the problem lies and why it is happening. If you are not tracking individual jobs, then you can only compare the performance of the overall company to the budget.
This still allows you to manage and control your overall business; however, you will not have any decisive information as to which projects are doing well and which are not.
For this to work, it is critical for every document concerning company finances be processed and entered into your accounting system. Many businesses make the mistake of holding onto certain paperwork because they believe there is an error, e.g. an amount owing on an invoice. However, even if an invoice is wrong, you should still enter it into the system and then deal with it afterwards as an adjustment or credit. If the invoice is not entered, then the accounting data on that specific invoice will not be accounted for in your regular financial statements (i.e. profit and loss [P&L] statement). If the amount is significant, and/or several invoices were not entered, then your P&L statement will show an inaccurate profit. This can be extremely dangerous, especially in larger companies, where different people compile and review the financial information and statements.
For instance, if you are not aware $50,000 worth of invoices are being held back, and therefore do not show on the P&L, then you may think the company is more profitable than it really is. It is far better to be on the conservative side and input an invoice owing, which shows more than what is truly owed. Chances are the invoice is not out by much and once the adjustment/credit is applied, it will provide a positive boost to your P&L statement.
Creating a realistic budgetCreating a realistic budget is probably the most important thing you will do in your business on an annual basis. Many new/inexperienced business owners are hesitant or afraid to put together a budget, mainly because it is new to them and they are not fully aware of how important it is.
In some cases, a company can be in business for more than 10 years before realizing the importance of budgeting. It is possible for a company to operate without doing a formal budget; however, besides being very lucky, it is quite possible they are following some type of informal budget. More than likely, they are also working harder than necessary with the need to react to various issues each day, rather than proactively pointing the business in the right direction.
Due to the seasonality of the pool and spa industry, and the extremely tight profit margins, a budget is essential. In other industries, which operate at much higher gross and net profits, it is quite plausible for them to succeed without a formal budget since there is enough extra profit in the business to absorb unexpected problems that can erode profits.
Many people put budgets together because it is something they have to do as part of their job responsibilities. Even though this is better than not putting one together at all, it is not the right reason to compile a budget. A budget serves many purposes, for example:
- It forces you to sit down and actually think about how you are going to embrace the upcoming season;
- It is a roadmap or plan for your company to follow in its attempt to achieve business goals in the upcoming year;
- It is a plan for profit; and
- It is a tool to help steer your company.
Using the budget
One purpose the annual budget serves, which many people are unaware, is the assistance it provides when creating your pricing structures for the upcoming year.
The concept of pricing is a complicated subject. There are countless books written on it and many different theories on pricing strategies. For example, if you asked a dozen accountants for tips on how to determine appropriate pricing for your business, you would likely get several different answers. Often, the most dangerous advice you will get is to model your pricing strategy based on ‘whatever the market will bear.’ This is probably the single most surefire way to quickly put your company out of business.
Pricing your work ‘at the market rate’ will not work, at least not in the long run. Every individual company has its own internal cost structure, and in using someone else’s prices you cannot expect them to allow your business to turn a profit. It may result in you getting work, but there is no guarantee you will make money. You will more than likely lose money.
By using your annual budget, you will be able to calculate three important numbers, which are the lifeline of any business:
- Overhead recovery rate.
- Net profit or profit margin.
Watch your overheads
Overheads are large expenses for many businesses. They comprise everything from office wages, insurance, phones and utilities to advertising, meals, entertainment and other miscellaneous costs. These overheads are also referred to as fixed or recurring costs. Job costs, COGS, are not considered an overhead expense.
Overheads get paid regularly by a business regardless if work is performed or not. For instance, during a slow period, even though COGS are minimized or non-existent, overheads still need to be paid. Sometimes, overheads actually increase (at least temporarily) during these slow periods because the business is trying harder to find new work, resulting in increased marketing and advertising expenses.
Overheads must be recovered by the job costs. Several methods are available for recovering overheads in the pool and spa industry. Some of the most successful include:
- Single overhead recovery (i.e. on labour)
- Dual overhead recovery (i.e. on labour and materials)
- Multiple overhead recovery (i.e. on labour, material, equipment and subcontractors)
At the end of the day, you should determine which overhead recovery method works best for your business and then use it consistently. As long as you are recovering (paying back) your company overheads, that is all that matters. Some methods may be more effective and even more advantageous from a pricing strategy; however, this would be beyond the scope of this article and would be an entirely separate subject of its own.
With your overhead recovery rate calculated (usually expressed as a percentage of the COGS), you know how much you need to charge for each product or service as a percentage of your job costs to recover the proportionate amount of overheads. In doing so, you should recover your total overhead amount by yearend.
Your breakeven sales point, where your total sales cover your COGS and overheads exactly, can also be calculated from your budget.
For example, if your COGS are $500,000 and your overhead costs are $500,000, your breakeven sales point is $1,000,000. However, at this point, you will earn zero profit. Once you sell more than $1,000,000 you will start to earn a profit that is proportionate to your COGS, overheads and net profit margin.
Setting net profit margins
The net profit margin is the one variable you, as the business owner/manager, must set; it is not determined by your internal cost structure. A good target is 10 to 15 per cent. In all likelihood, if you plan a net profit margin between 10 and 15 per cent, you will perhaps make less due to uncontrollable variables such as weather and/or mistakes. Even though basing your pricing on ‘what the market will bear’ is strongly discouraged (as previously discussed), you may need to consider this method when determining your company’s profit margins. However, you cannot do this until your internal cost structure, COGS, overheads and breakeven sales point have been determined.
Job costing tools
Assuming you are consistent year-over-year in terms of your percentage markup for each type of service/work your company offers (i.e. retail, service, new installations, etc.), you can use the exact ratios calculated from your budget to do job costing.
The easiest part of pricing is usually material take off (the materials required to do the job such as concrete, re-bar, pumps, filters, etc.) Most business owners are consistently within plus/minus of one per cent on the required job materials calculation. The challenge is actually determining the amount of labour hours required to complete the job.
If job costing (tracking) is performed properly, after a year or so, you will start to get a feel for the amount of labour hours required to complete a project. Costs for equipment (both owned and rented) and subcontractors are relatively easy to estimate. These constitute the job costs or COGS.
To this value, calculate your overhead recovery amount as a percentage of COGS, and then calculate your breakeven point (the point at which you earn a zero profit). Once this amount is known, you can apply the net profit margin you would like to earn on the project based on factors such as time of year, current workload and/or a competing bid on the job.
To determine the final selling price, use the following formula:
Sell price ($) = Breakeven ($)
(1 – Profit Margin*)
(*the profit margin is expressed as a decimal [e.g. 10 per cent would be expressed as 0.1]).
Each year at budget time (January or February for the pool and spa industry), you can determine what is needed to achieve your sales goals for the current year. For instance, this may include an increased labour force, new equipment (to replace older equipment or expensive labour) and any new overheads needed to manage and control these new changes (e.g. new sales person, increased insurance on new equipment or a new supervisor to manage the additional workers).
After determining these costs, your budget is fine-tuned until it is manageable and you feel it is achievable and necessary for the profitable growth or existence of your company.
It is your responsibility to review the internal financials of the company—either weekly, bi-weekly, monthly or quarterly—and compare them to your budget to see if your business is financially on track at that point in time.
Regular review and comparison to the budget, and even to prior statements from the previous week, month or even year, will allow you to take any necessary actions in a timely manner as opposed to waiting six months after the end of your fiscal year when your accountant returns your financial statements. By this time, everything is history and the statements have little to no value except to the banks, shareholders and government to assess how much tax you will pay.
This article was written by John Petrocelli and originally appeared on Pool & Spa Marketing [link].