Archive for August, 2008

Company triage? Use the 80/20 rule!

Over the years of working with remodeling contractors, some simple patterns have become apparent. One remodeler’s strong interest in people leads to success in sales. Another’s love for design produces award-winning projects. Still another with a fondness for systems can produce a company which produces predictable and repeatable customer experiences, time after time.

Each company can enjoy a certain level of success and stability.

But to develop a larger company complete with beautiful office space, internal staff and consistent profitability sufficient to develop a nest egg for retirement demands an owner with another attribute – a love of numbers.

Only by digging through job cost reports, understanding financial statements and developing trend-lines for current concerns can an owner truly understand and protect and forecast company profitability. This is not a task for the faint-hearted; neither can it be delegated in the early stages of company development. The owner must understand certain vital components of the business and measure them continually.

To many whose interests lie elsewhere, the task seems overwhelming. But long-term success rests on determining not just what to measure, but when. Some indicators, such as cash flow, merit weekly tracking, others, such as gross profit margin, are job dependent. Monthly and quarterly tracking suffice for still others, such as accounts receivable and payable turnover ratios.

Use Pareto’s Principle, otherwise known as the 80/20 rule, to establish the current highest priority. The 80/20 rule predicts that 80% of the result is determined by 20% of the effort. Using this rule, 80% of company profits derives from 20% of the jobs, or 20% of the job types – such as kitchens and baths. Additionally it says that 20% of your employees cause 80% of company losses and problems. Conversely, 20% of that same pool of employees produces 80% of your profits. The key to using the 80/20 rule is to determine where to first apply it.

Certain problems are immediately apparent: if vendors and subs continue to hound you for payment, then cash flow should be your number one priority. If your produced gross profit margin is always more than 2 or 3 points different from what was bid (either way), then estimating jumps to the top. When sales are erratic and you complete one job only to wait for the next, marketing data, including lead and close numbers bear scrutiny.

Just as the emergency room crew determines which patient to handle first, you must use Pareto’s Principle to perform ‘triage’ on your company. Triage looks at the current situation, establishes relative importance and operates ‘first on the worst’, then moves on to the next. This process continues the life of your business – just as one variable is stabilized, another takes on greater importance.

As the company moves through various stages of growth (as discussed in my JLC article “Evolution & Revolution: 3 Stages of Growth for Construction Companies”, July 1996, page 45) some indicators will be more critical than others. Build a stable foundation at each stage using the 80/20 rule, then build on it to reach the peaks of business performance. The business model which best fits an individual personality will have in it the same critical indicators at each stage.

At stage 1 the owner does everything and cash flow and customer satisfaction are key. At stage 2 the owner begins to delegate, gross profit margin and overhead control become vital. Stage 3 the owner handles only sales and employee productivity and pipeline capacity develop greater importance. In stage 4 the owner manages the company and develops exit strategies, employee satisfaction and development together with metric predictability is paramount. Metrics for each stage build on previous: at stage 4 cash flow and customer satisfaction are as important as ever.

Extracting predictable and accurate metrics requires patience and clarity. First establish your current greatest need using the 80/20 rule. Then develop the tracking tools and procedures. Monitor your results closely for a quarter or 2, then move on to the next most pressing issue.

Remember, that although you might delegate the process of metric extraction to others, it is your responsibility as owner to understand and control the direction of the company over time.

The IRS & Independent Contractors – BEWARE!

No doubt you’re fully aware of the need to hire only certain types of companies as Independent Contractors for tax reporting purposes rather than employees.

You might also be aware that if the IRS reviews the facts regarding the worker’s status, the employer can be held liability for all Federal employee taxes including: federal income tax which should have been withheld, FICA and Medicare, both employee and employer portion.

However, the most recent newsletter from the AIPB (American Institute of Professional Bookkeepers) says that “if the employer failed to send a 1099 to a worker it used as an IC (independent contractor) its liability for the employee’s taxes double.”

If in the past you have been somewhat cavalier about capturing every trade contractors W-9 information, DON’T BE. Clean up your act this year and produce 1099s for EVERYONE who is not an employee or incorporated.

Don’t put it off till January 30th – do it now!

Who’s a pessimist? Economic modeling & the future.

After failing physics and thereby failing to become an undergraduate in the school of architecture, I studied economics. This was before economic modeling gained the enormous advantage of computers to extract data from multiple sources and thereby build future assumptions. This ability is now called ‘econometrics’ and adds to the art of economics a scientific and statistical filter which wasn’t available to me as an college student.

Now statistical modeling is the foundation upon which current economic predictions are based. However, they’re based on the probability of any given event occurring in the future. And typically they’re based on the probability of a few of the many possible events occurring simultaneously.

Nouriel Roubini is one of the few strong voices in economic research who “get into everything”. According to the article in the NY Times Magazine 08/17/08 he predicted the current collapse. Now he predicts even an even further deepening of economic woes.

“America’s economic problems are deeper than a housing crisis, Roubini argues. ‘We have a subprime financial system,’ he says, ‘not a subprime mortgage market.’

Read the entire article:

http://www.nytimes.com/2008/08/17/magazine/17pessimist-t.html

Individualist mentality vs. collectivist mentality

David Brooks in the NY Time Op-Ed section on Tuesday August 12th comments from China that:

“The world can be divided in many ways – rich and poor. democratic and authoritarian – but one of the most striking is the divide between the societies with an individualistic mentality and the ones with a collectivist mentality”

Commenting on the opening ceremonies in Beijing, he says “if Asia’s success reopens the debate between individualism and collectivism …, then it’s unlikely that the forces of individualism will sweep the field or even gain an edge.”

“The rise of China isn’t only an economic event. It’s a cultural one. The ideal of a harmonious collective may turn out to be as attractive as the ideal of the American Dream.”

Read more to gain a better understanding of what this might mean to us in the future.

http://www.nytimes.com/2008/08/12/opinion/12brooks.html?_r=1&scp=1&sq=david%20brooks%2008/12/08&st=cse&oref=slogin

Visit to the Seattle Public Library 08/11/08

Last week I took friends of mine to visit the world-famous Seattle Public Library, Central Branch, designed by Rem Koolhaus. See other Posts on this site plus the link to this incredible piece of sculpture – Leeds certified sculpture.

My architect friend was astonished at the building, and he’s been around the world a number of times being astonished by many buildings.

Aside from the building itself, however, we made an incredible discovery that day in the Seattle Room: the original “Concept Book” which laid out for the public the results of years of analysis and dialogue between the two principle firms – OMA in the Netherlands and LMN in Seattle.

The first page blew me away. It reads:

“Seattle Public Library

The Library represents, maybe with the prison, the last of the uncontested moral universes: communal accommodations for ‘good’ (or necessary) activities… The moral goodness of the Library is intimately connected to the value of the book: the Library is its fortress, librarians are its guardians… As other mediums of information emerge and become plausible, the Library seems threatened, a fortification ready to be ‘taken’ by potential enemies. In this scheme, the Electronic is identified with the Barbaric. Its ubiquity and its uncontrollable accessibility seem to represent a loss of control, depth, tradition, civilization. In response, the language of the Library has become moralistic and defensive: its rhetoric proclaims – implicity and explicitly – a sense of superiority in mission, in social responsibility, in value… The Library’ s insistence on one kind of literacy has blinded it to other emerging forms that increasingly dominate our culture, especially the huge efficiencies (and pleasures) of visual intelligence. New libraries don’t reinvent or even modernize the traditional institution; they merely package it in a new way.

Look at it yourself and be amazed.

http://www.spl.org/cen_conceptbook/page2.htm

QBP – build a perfect Account list for the Profit/Loss

Developing a perfect chart of accounts combines art and science.

Science because it is expected to follow GAAP (Generally Accepted Accounting Principles) and Art because there must be a good balance between sufficient detail and elegant simple presentation.

So I suggest using the sub-set ability in QBP to produce both. So, for example, in the profit/loss which is the area of the Chart of Accounts most burdensome, I suggest the following:

Main heading: COST OF GOODS

Sub-headings:

Material

Subcontract

Equipment

Other

Labor:

Gross field wages

Field Burden:

PR Taxes

Insurances – WC and General Liability

Benefits

Indirect allocation

Main Heading: OVERHEAD

Sub-headings:

1 – Indirect Allocation: this account holds detail of ALL expenses which relate to field labor but are difficult to attach directly to individual jobs:

Field small tools and supplies

Field vehicle expenses

Field education

Field uniforms

Field cell phones;

2 – Marketing and Sales: this account holds detail of expense relating to marketing and sales;

3 – General and Administrative: this account hold detail of expense relating to running and maintaining and office whether in your house or out;

4 – Overhead Payroll: this account holds detail of expense related to office payroll including the owner;

5 – Education & Training: this account holds detail of expense related to all education and training not field related.

In this way you get good detail (imagine that all the standard accounts for overhead are truly sub-sets of these 5 headings) and when you hit collapse the report shows only the summary information as follows together with a % of income.

Income

COGS

Overhead:

Indirect

Marketing & Sales

G&A

Overhead PR

Education & Training

Education and training is shown as a separate heading because this is a very big expense for companies trying to grow to a successful stage. You need to know what % of income you’re spending on education and set some expectation regarding payoff down the line.

So build your chart of accounts for the profit/loss in this way and reap the rewards of both sufficient detail (using the expanded version of the Profit/Loss report) and simplicity (using the collapsed).


Tax increase inevitable?

Ben Stein, a moderate man and an economic conservative, said in the NY Sunday Times on August 10th, that he supports raising taxes on “all upper income Americans.” He goes on to say “I do wish, however, that “upper income” started just a dollar above me”. I’m sure we all feel that way.

Read the complete article about “the problem with tax cuts as an economic premise.”

http://www.nytimes.com/2008/08/10/business/10every.html?scp=1&sq=Ben%20Stein%2008/10/08&st=cse