January 2020

Rated 1 of the Top 10 Most Read Articles in 2019

Are Poor Pricing Methods Destroying Your Bottom Line?

No single factor creates as much havoc for home improvement contractors as the
price. The first complication is how to factor it; then, the issue becomes how to sell
it against competition, which often seems to have a lower quote.

In a previous article on this subject, I stated that a well-run specialty home improvement
company, which sells a single product line such as replacement windows, roofing, siding or a
combination of these (or similar products) should target to earn no less than 10% pretax net
profit. Many of our clients earn 15% to 20% pretax.

While a general, remodeling company should plan to earn no less than 5% to 6% pretax net
profit. Many claim to do this; in fact – most do not.

Now examine Exhibit (A) (see last page), which breaks down how to analyze profitability
using your operating statement (also referred to as your P&L).

Despite what you may have heard, or believe, a proposal estimate and contract price has to
be figured based on the individual circumstances of your specific business. Most contractors
start in the right place -- with the cost of labor and material necessary to produce the
finished job, but many soon lose their way. Standard formulas, such as multiplying your
direct costs by 1.5 or even doubling your labor and material, may not be a valid formula for
your company. And it’s too late, once you’ve sold and installed the work, to find out that you
have made little or no profit on a contract.

Pricing formulas have to be based on actual and specific costs within your particular
business. You need to know (not guess) what your overhead costs actually are.
1
Start by separating your sales and marketing costs from your general overhead expenses.
Every ad, promo, job site sign, yellow page cost, display piece, home show participation and
similar is a marketing cost. All costs related to hiring, training and managing salespeople
should be classified as sales costs.

In the case of very small companies, you have a sales cost even if you do all the selling. Not
to allocate something for your preparation, prospect visits, sales follow up, and phone time
is to deny your value in this part of the process. At the very least, allocate the percentage
that you would or did pay your salesperson or what companies similar to yours pay their
salespeople.

Separating Expenses

Once you have these costs separated, factor them against your total sales to achieve a
percentage for each. Then project the net profit, which you desire.

EXHIBIT (B)
A MODERN (FACTUAL) PRICING FORMULA LOOKS LIKE THIS:
(Percentages are “for example only”)
Marketing 10 % (Accountants often classify these
Sales 10 % under gross margins)
(G & A) Overhead 18 % - - - - - - - - - - - - -

Projected Net Profit 10 %

The total percentage above (48%) when subtracted from 100% (selling price), represents all
other costs (plus 10% profit allocation) other than labor and material often called direct costs
or cost of goods sold.

This is a basic formula. It may require modification depending on the size and style of the
project. Major remodeling jobs, smaller remodeling jobs and purely specialty contracts such
as windows or siding all require several additional steps. However, nothing changes the fact
that if these classifications above listed were to total 48%, the cost of labor and material to
complete the job cannot exceed 52% of the selling price or you are eating into your profit.

2
 Most contractors don’t get the price that they are entitled to, and it’s not
because the finished product isn’t worth the money. The problem often lies in
the inability to sell the value when presenting to their prospects.

At this point, you are able to assess profitability on each contract sold prior to starting the
job. It’s pretty simple – on any job sold (if your percentages match the above example)
and the cost of your labor and material exceeds 52% you are sacrificing a portion of your
profit.

Such circumstances may require an adjustment to the commission on this job (contract)
prior to accepting it. This may also be true of a completed job exceeding 52% based on
additional promises to the customer or mis-measures occur.

Establish Revised Chart of Accounts

Each category such as (a) fully loaded marketing costs (b) fully loaded sales costs,
commissions paid to salespeople, project managers, sales managers, etc. (c) general and
administrative costs (d) allocation for profitability should be listed separately in your
operating statement. Any percentage increase in an account should appear on your
internal (prior to the year-end) operating statement.

If you analyze your actual revenue (installed contracts) monthly, against what
you spend to acquire and install your work, this can/will enable you to examine
whether your collective installed contracts were or were not profitable to the
degree you intended with your pricing plan.

By further explanation, the operating (P&L) statement reports a company’s revenues and
expenses over a period of time. If revenues exceed expenses, the company has a net
profit. If not, the company has a net loss. Revenues (installed sales) in the Home
Improvement Industry are defined as “inflows” mostly resulting from the completion of
contracts requiring the installation of products (a combination of Goods and Services).

Expenses are defined as “outflows” resulting from the purchase of goods, rendered
services and attendant expenses to support the advertising, sale and installation of home
improvement contracts.

3
 Operating (P&L) statement accounts are temporary and reset at the beginning of a new
period. For example, at the end of the year, revenues are closed and the accounts are
usually set back to zero.

The operating (P&L) statement “accounts” become part of the retained earnings. When
all operating statements accounts are closed at the end of the year, the net addition to
retained earnings will be the net income or net loss that resulted during the period. As
the account title indicates, retained earnings are earnings that are kept and reinvested in
the company, or distributed to the owners.

As a reminder (See Exhibit (A) on the last page), in the home improvement business the
proper way to do a Profitability Analysis is:

1) Gross Margin
2) Operating Profit
3) Pre Tax Profit
 Adjustments such as owner(s) draws
 Misc. Income and/or one time charges or write offs
 Reserve or allowance for taxes and/or uncollectible “receivables”
4) Net Profit

CAUTION: Profitable operations do not necessarily create positive cash flow. This
comes from getting the proper price to begin with, then working within the
projection of all expenses to effect a projected profitability.

To make your company more efficient and profitable, start by examining your pricing
methods, then correcting them to ensure you are earning the profit to which you are
entitled.

Dave Yoho is president of the oldest and largest consulting group serving the home improvement industry.
He is the producer of a recorded series entitled “How To Run A Profitable (Or More Profitable) Home
Improvement Business”. Visit his company website www.daveyoho.com – view free information on
YouTube – “Dave Yoho Associates”. For more information on his business call: 703-591-2490 or e-mail
him at [email protected].

4
 EXHIBIT A

ANALYZING PROFITABILITY WITH YOUR

I. GROSS MARGIN

 Net Contract Price Less Labor, Material and Miscellaneous Installation Costs such as trims,
underlays, caulking and similar.

II. OPERATING PROFIT

 Revenues Derived from the Installation of Products/Services Specified In Contracts, Less Sales,
Marketing and G&A (overhead).

III. MISCELLANEOUS INCOME AND EXPENSES (added to or subtracted from net operating profit)

 These can be listed as misc. income or expenses:

 Income from Other than the Sale and Installation of Products/Services. Examples:
Manufacturers Bonuses, Prompt Payment Discounts, Processing Fees, Profit (Loss) from Sales of
Equipment, Settlements from Litigation and Similar Income – Less Expenses, and “One Time”
Charges (Inventory, Write-Offs, Non-Collectable Receivables)

 NET (PRE TAX) PROFIT

 Prior to Allocation for Taxes, Inventory Write-Offs, Non-Collectable Receivables Owners salary
(base compensation) should be allocated as operating expense.

 NET PROFIT (Pass through income for S Corp – LLC)

 ASSESS E.B.I.T.D.A. (Earnings Before Interest, Taxes, Depreciation and Amortization) Note: Do
Not Otherwise Use as Formula for Taxation, or Reporting

*Nothing contained herein is offered as financial advice. Nor is it intended to conflict with or
contradict GAAP (Generally Accepted Accounting Principles). Review with your accountant, lawyer
or tax advisor.

© Dave Yoho Associates