Advice sought for a small fraction of the profits both businesses now enjoy
Recently, Worrells Consulting gave advice to two businesses that had positive and consistent growth in revenue and size but concurrently had a substantial decline in profit.
Both businesses' accountants/advisors were:
- trying to (unsuccessfully) convince their client to change their costing models (which were developed but the client wasn't taking them seriously); or
- unfamiliar/uncomfortable with the process of developing a costing model. And were inundated with formal tax and other business service requirements for their client that even if they could develop a costing model, they didn't have the time to do so.
Their clients consented to Worrells Consulting conducting a preliminary review. It quickly became apparent the business owners had insufficient information available to establish their overall costs per productive hour.
The problem was broken down into two issues.
Issue 1: How many productive hours are contributed per employee and what are their respective operating costs?
We focused most of our attention on lost time i.e., how many productive hours each employee losses due to inefficiency, unexpected delays, and downtime. For example:
- The services business's employees had to visit multiple sites per day, which resulted in several hours of productive time being lost in travel. As it wasn't recorded, that lost time couldn't be built into their costings.
- The construction business's employees who worked on large-scale buildings were not recording time spent on induction, site and health & safety meetings, or the time spent moving around the site. Again, this lost time wasn't factored into their quoting, which resulted in (unintentionally) underquoting.
Issue 2: What is the expected overhead cost/hour?
We focused on how much overhead cost should be included in each productive hour.
As with most businesses, both owners were busy running their businesses and didn't pay much attention to their advisor's guidance on budgeting and forward planning (where provided). This left them without a clear understanding of the projected costs to run their business for the coming year.
As a fallback position, largely driven by their industry's competition, they based their margins on an estimate of what competitors were charging. Ultimately, this resulted in consistently failing to recover the operating costs and/or severely depleted their profit margins.
Over a relatively short 6-week period, the business owners, their accountants/advisors and Worrells Consulting worked together to review and improve how the businesses operated.
This was achieved through the following steps.
Step 1: Modelling the business labour and overhead costs and working out true productive hours. We identified between 15%-20% of lost productive time. By building in the correct unproductive time, hourly rates were calculated that truly reflected the businesses running costs and set profit margins that produce sustainable profits.
Step 2: An operations review identified potential changes (easily assessed using the modelling in Step 1) to determine which operations were profitable and which should be ceased. It also enabled an overhead costs review with changes in cost structure to be analysed and changes made.
Step 3: Developed monthly dashboard reports to allow the owners to easily assess their business without the need for high-level financial skills. The dashboards cover the life cycle of work through each business and flag when issues occur at each stage. This provides the owners with a fast and reliable business analysis.
Both businesses have since significantly improved their profits, having eliminated unprofitable work and reduced their overhead expenses. More importantly, they now have systems in place to maintain profitability into the future.
Worrells Consulting is on hand to assist these businesses if/when needed. However, in both scenarios, their accountants/advisors are now:
- holding regular management meetings with the owners
- producing the budgets used in the costing and performance management
- helping the businesses maintain the models used in the costing of their services.
Through all of the above, the knowledge required to run the business successfully is integrated into their daily operations for a small fraction of the profits both businesses now enjoy.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.