BlogAsk an Industry Pro Episode 5: Know Your Numbers: How Do I Know If I’m Profitable?
By Construct-Ed Inc.
Welcome back to our “Ask an Industry Pro” series! In episode 5, Chris answers your questions regarding understanding your numbers and the performance and profitability of your projects by understanding ratios. You can also find a full transcript of the video below.
Got a question you would like Chris to answer? Just visit this page and submit your question in the form and keep an eye out to see if your question is chosen. And check out our previous episodes at the bottom of this blog.
Welcome to this next episode of Ask an industry pro my name is Chris Jurin and I’m here with Construct-Ed and we’re going to walk through our topic today in episode #5 here, focused on knowing your numbers.
So, what are your numbers? Well, first off before we jump into that, one thing I just want to remind you of is that I’m not your financial advisor. What I’m offering here is purely educational and we strongly recommend that you work with an accountant. Somebody that is familiar with your business and your industry that you work in to help you put these numbers together.
So, the questions that we’re going to look at within this episode are first off, why do you need to know your numbers? What purpose is it? You want to get out, you want to get work done. Why do you need to be worried about your numbers? Number 2, why are ratios important?
So, we’re going to learn how ratios help you compare. And then we’re going to look real quick at what are some of the different ratios that you’re going to need to know.
So, the first question that we want to explore is the question “what are your numbers?” What are the numbers that are part of your business? And the first point that I want to make here is that they are unique to your business. You operate your business uniquely from how your competitor does and from how the industry is established. It is not uniform, so you have to know the numbers that are important to you.
Next point is these numbers are how you judge the performance of your business. So, the points below here, certain numbers are your profit, both your gross profit and your net profit. Learn what they are. Learn what the targets are that you’re shooting for. What’s your overhead? And the point here is what’s your monthly burn rate? Your business burns cash to pay for its overhead. That overhead will continue to run regardless of whether you’re doing projects or not. So, you know what that burn rate is, you know the type of business you have to operate to support the overhead.
And then what are your direct costs? Know your numbers there. That includes your material costs, labor costs, there can be sub cost, could be equipment rental costs. There are lots of different cost factors there so know your numbers from top to bottom. Understand what they are.
So, all right, you know what your numbers are. But why should you know those numbers? OK, first point here. They help you know how your projects are performing. So, you work hard to put an estimate together. That estimate becomes your budget that you operate the job by. Is it sufficient, are your numbers there sufficient to cover all of your expenses, or do you have cost overruns? So you need to know your numbers based upon your projects.
Number 2, know how your staff is performing. If you have overhead staff, if you have a bookkeeper, if you have a sales representative, how are they operating? So, is your overhead efficient, or are you overpaying for staff that you just don’t need?
And the last point here is what is your return on your investment? You paid out money to get your company started. Are you making the returns that you expect to make? So, you have to know where that’s at so that you understand am I being effective, or would my assets be better off used in another location? You’ve got to know your numbers to be able to make good judgment calls to move your business forward.
OK so let’s take a look at ratios. And you know your numbers, we’ve discussed that quickly in the prior slides. Now you want to understand ratios. So why do we transition from numbers to ratios?
Well, first is that it allows you to compare year-over-year performance for your business. So, let’s just say your business volume changes significantly. You go from $1,000,000 to $1,500,000 in a year. That’s a 50% increase. But it’s a lot of business that you tack on in one calendar year. How do you know if you’re as successful at the 1.5 million as you were at the million? And that’s when you use ratios for. The ratios allow you to compare year-over-year.
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Number 2 – it allows for the comparison of the business performance versus your overall industry. Now you can look at yourself against your competitors if they if you can get access to any type of financial ratios that they have. But in general, you can look across the industry as a whole and understand how your ratios compare from what you’re operating to the industry that you’re working in.
And finally, financial institutions have a tendency to focus on ratios when they’re determining your financial rating and the risk associated with your business when they determine your lines of credit, if you pull one, or if you’re going for a business loan or anything along those lines. So, your ratios are important for you to be able to maintain.
OK so what we want to do here is just quickly discuss a few critical ratios. What are some ratios that you want to keep an eye on? Well, the first one that you want to take a look at, which you might want to consider using, is the current ratio. And that formula is current assets divided by current liabilities. So, it indicates your ability, or the business’s ability to service current debts. Can you pay what is currently due?
Next ratio would be a debt-to-equity ratio. So, it’s your total liabilities, both short term and long term or current and long term, however you want to term it, divided by the total equity. How much equity do you have in your business? And what they want to see is If the business is too highly leveraged. Are you extending yourself too far? Is there too much debt? That includes your long-term debt, so you could have a lot of capital equipment that you purchased, you’ve got loans on. You need to make sure that that type of debt is building your equity up at an acceptable ratio.
Last one we’ll take a quick look at here is the quick ratio. That’s your quick assets divided by your current liability. It indicates the ability to service current debts with assets that can be or are quickly liquidated.
So, in your current ratio you may include inventory whereas in your quick ratio, you take your inventory out. So, it depends what type of business you have. Again, if you’re holding inventory these two indicate two different things. Whereas if you don’t hold any inventory, you might be able to just use the current ratio. Again, talk to an accountant, talk to whoever is your advisor and they’ll help you pick the best ratios to keep an eye on.
OK so in closing, in business, business is about constant improvement. So, you always want to be asking yourself, and my better today than I was yesterday. Am I better this week than I was last week or even this year than I was last year. It’s about constant improvement.
So, ratios allow you to understand that performance and the trends of your business. Without comparison, you’re not sure if you’re ever improving, you’re not sure where you’re at. It gives you a way to be able to put a stake in the ground and say “am I improving, am I status quo or am I deteriorating, am I dropping off?”
So, the earlier you can detect the problem, the quicker it can be corrected and probably with a little bit less pain. And remember, bad news does not get better with time.
So, as we close out here, we are still working on putting together our accounting course just on basic introduction accounting for small business contractors. So, if you have any questions on that, please make a comment below and we will continue to track and let you know when that’s going to be ready. We’re hoping for a launch here in the fall of 2022.
Thank you very much! Have a great day.