MANAGING YOUR COMPANY BY THE NUMBERS

1. MANAGING YOUR COMPANY BY THE NUMBERS Sponsored by: Presented by Judith Miller, J. Miller & Company

2. I - INTRODUCTIONS • My goals: • To define, simplify and track the numbers essential to the operation of a successful construction company • I hope that you will be able to: • To identify major components of success at each stage and for every function; • To determine which measurements of success are appropriate for your company; • To understand how to develop the processes for obtaining reliable and timely measurements; • To balance simplicity with completeness in your measurements.

3. FIRST, SOME GUIDELINES • We’re going to look only at what is vitally important to the discussion; we won’t become mired in minutia; • We’ll work from the point of view that simple is better – “KISS” in action; • We’ll use the 80/20 rule to separate the vital from the “noise.”

4. UNIQUE QUALITIES - • Construction companies share some unique qualities: • Each project is unique; • A project works against schedules & budgets to produce specific results; • A construction team cuts across many organizational & functional lines involving every department in the company; • Projects come in various shapes, sizes & complexities.

5. SOME DEFINITIONS: • WHAT IS A SYSTEM? • A system is a series of instructions which, when followed by employees suitable for the job, produce the same desired result every time • The “desired result” for good financial management consists of accurate and timely reports, both company and job • The appropriate level of reporting detail depends on the company’s stage of growth

6. DEFINITIONS, AGAIN • WHAT IS MANAGEMENT? • To manage: to control the course of affairs by actions (1609)* • Manager: one skilled at handling the affairs of a business (1705)* • “If you hire, fire or spend money in your job, your job is one of management.” (1) • “Accounting and other related financial control disciplines are the most neglected control functions in contracting firms. The result … is a wide variety of operational problems.” * Oxford English Dictionary

7. WHY NUMBERS MATTER ? • The Best case: used before the fact to predict and plan and thereby control; • The Worst case: never done, the company runs from crisis to crisis; • Better than nothing: done after the fact as historical analysis thus providing some benchmarks against which to relate the future. • “Every time a number is calculated and understood, thinking takes place. Thinking leads to action.” (101 Business Ratios)

8. NUMBERS DRIVE RESULTS - • Owner & managers’ job is to understand how to use the financial/job cost information to better manage the business • We need not only the information from the financial and job cost reports themselves, but also information correlated across multiple reports at one time. • From this information we establish goals, put into place strategies and tactics to meet those goals and then measure our progress toward them.

9. RATIOS, BENCHMARKS & TRENDS - • Ratios compare one number to another: • Typically expressed as a percentage (such as gross and net profit); • Sometimes expressed as a single number (such as AR turnover). • They allow us to discuss complex financial terms in simple language. • When we say our slippage is 25%, we know we’re completing our jobs 25% less efficiently that we bid them – that is we’re over budget. • Solve this problem to increase our gross profit dollars and therefore, given good overhead control, our bottom line. • Combine with another ratio to form an index • For example - the success equation • Customer satisfaction + net profit: by itself, net profit does not predict future success. A flash-in-the-pan start-up company can produce high net profits, only to fail the next year. Happy customers, on the other hand, drive repeat business. • Combine these two metrics to form the Customer Satisfaction Net Profit Index — CSNPI or “Snippy.”

10. BUILD YOUR OWN “SNIPPY”- • Set a net profit goal (something between 5% and 12% is right for most construction companies). Use your past history as a guide, but set a goal one or two percentage points higher than previously attained. • Measure customer satisfaction. This requires writing a simple customer-satisfaction survey that scores answers on a 1-to-5 scale. A good target score is 4. • Add the two together. If net profit for the first half of 2011 averaged 6%. Set a new net profit goal of 7.5%. Add that to the Customer Satisfaction target of 4, and the Snippy benchmark for the second half of 2012 is 11.5 (7.5 + 4).” [From the Benchmark Column in Remodeling Magazine, September 2005

11. OTHER CRITICAL RATIOS/INDEXES • Slippage – measures the inefficiency (or increased efficiency) of production • Bid gross profit – produced gross profit / bid gross profit  • 38% - 34.3% / 38% = 9.7% ( NOT 3.7%, a huge difference) • Labor burden – measuring the total costs to the company of maintaining employees provides a good measure of the company’s ability to develop a strong culture where all employees • Total labor costs (per hour or annualized) – gross wages / gross wages  • $39 - $20 / $20 = 95% • Owner pay - correlating total costs for owner compensation to total volume provides a good reflection of not only owner success but allows the owner to compare his/her earnings to others. • Total owner pay / total volume •  $100,000 / $1,000,000 = 10%

12. CRITICAL RATIOS/INDEXES - 2 • Back log - this ratio relates the total amount of work to be produced to the annual volume budget projection and reflects how quickly the company might run out of work. • $ in backlog / annual budget volume x 12 months •  $450,000 / $1,500,000 x 12 = 3.6 months • Current ratio - this ratio tells you whether or not you have enough working capital in current assets (those to be converted into cash within the next rolling 12 months) to cover your current liabilities (those to be paid within the same period). • Current assets / current liabilities •  $250,000 / $125,000 = 2

13. CRITICAL RATIOS/INDEXES - 3 • Debt to equity - Debt to equity – tells you who really owns the business, creditors (total liabilities) or you as owner (equity). • Total liabilities / Total Equity • $350,000 / $350,000 = 1 to 1 • Return on equity – this number tells you how much money your current investment in the company is generating. • Net Income / Total Equity • $150,000 / $350,000 = 42.8%

14. CRITICAL RATIOS/INDEXES - 4 • AR/AP turnover net – as companies grow, they lose focus on the time in which outstanding client invoices are paid, thus reducing the effective cash flow. This measurement tells you whether or not you’re borrowing to pay current liabilities or you’re receiving your accounts receivable collections rapidly enough to pay. •  AR / annualized volume x 260 – AP / annualized COGS x 260 •  $250,000 / $4,000,000 x 260 = 16.25 average days to collect your receivable invoices • $125,000 / $2,400,000 x 260 = 13.5 average days to pay COGS payable invoices •  16.25 – 13.5 = 2.75 days borrowing to fund our AP

15. BENCHMARKS - • A benchmark provides a goal against which we measure our performance. • Standard benchmarks should be defined by each company for the ratios critical to your performance above. • One of the most important benchmarks for any owner should be focused on meeting the owner’s retirement goals • It is impossible to predict how much any one individual needs for retirement, however if you’ve not established a benchmark for yours, in both lump sum and as an annual contribution, do so today – use the tools on the web, consult with a financial advisor or read up on the subject in your local library: whatever you do, DO IT NOW!

16. BENCHMARKS FOR YOU - • Other benchmarks relate to departmental efficiencies. Below are some of the most important. • Marketing - % of annual volume spent on marketing for companies > $3,000,000 = 4-5%: roofers might be significantly higher • Sales – visits to sales 70% • Production – slippage < 2% • Finance – net profit between 7 and 10% • Owner – hours worked per week < 50 • Customer satisfaction – 4 on a scale of 5

17. TRENDLINES - • A benchmark is line in the sand against which we measure ourselves. But comparing actual performance with a benchmark is a static measurement. Unless we've reached the goal, we have no idea whether we're moving closer to it or further away. • To find where we’re headed, we need trend analysis. A trend line is dynamic; it indicates which direction we have been moving and predicts which direction we will move in the future. • Use a rolling 12 month average to indicate trends, not just positions on the graph. • Source: “CEO Tools” by Kraig Kramers

18. II - THE HEART OF THE MATTER • At each stage of company development, different metrics illustrate company progress • The goal should be reliable, consistent, timely and vital numbers appropriate to each stage • No more than 7 indicators should be tracked per function or department • Work towards the development of a company dashboard – the earlier you start to develop a dashboard the more useful it becomes

19. MEASUREMENT BY FUNCTION - Regardless of the stage of growth and regardless of the product sold, each company must control 5 primary functions: • Leadership & ownership • Marketing, sales & estimating • Production • Finance & administration • Resource development

20. LEADERSHIP & OWNERSHIP • In many remodeling companies, the owner also provides leadership; they are, however, distinctly different: • Ownership provides vision, strategy and direction • Leadership turns that vision, strategy and direction into measurable actions • As companies move through stages 1 through 5, ownership and leadership functions become more complex & diverge

21. MARKETING, SALES & ESTIMATING - • Marketing, sales & estimating are all part of the primary business function of bringing appropriate work to the company and selling it to the client’s budget • Marketing: develops the company image in the eyes of the community • Sales: turns potential contracts into actual • Estimating: quantifies expectations derived from the sales process

22. BASIC #s -M/S/E - • MARKETING & SALES: • Leads/visits/sales % • Most profitable job type • Average job size • Close ratio % • $ per lead

23. PRODUCTION - • Production makes reality of the sales concept: • Primary goal: to finish the project safely • On time • On budget • As specified • Primary components: • Construction execution plan • Field schedules – time plan • Construction budget - money plans • Resources plan – people, materials & money • Primary method: plan, organize & control

24. BASIC #s – Production • Average labor burden % • Slippage in % • Bid gross profit % • # FTE (full time equivalents) • Productivity / FTE • Company current capacity • Customer satisfaction

25. FINANCE & ADMINISTRATION - • Finance & administration measure and assist all other components of company processing • Determine and compile measurement standards • Evaluate and develop process and procedure standards • Monitor and control departmental communications

26. BASIC #s - Finance • Break-even $ • Working capital $ • Produced GPM % • Net profit % • AR/AP turnover

27. RESOURCES - • Resources -projects and protects the company’s ability to produce to the promised level of quality • Resource development determines how best to apply company resources, including cash, equipment, employees and subs • Resource development controls career paths, job descriptions & evaluations and employee motivation

28. BASIC #s - Resources • # employee reviews scheduled/held • # W-9s missing when preparing 1099s • Insurance costs as % of annual volume • # employees participating in 401(k), HSA, etc. • Workers’ comp mod rate

29. MEASUREMENT BY STAGE - 1 • Owner does it all and manages finances simply: • Looks at the past – only at tax time • Cash based income statement • Overhead mixed with COGS • Sole proprietor business type • Uses mark-up to calculate bid price • NEEDS to understand job costs and to learn basic bookkeeping principles

30. #s AT STAGE 1 • Marketing: customer satisfaction • Sales: most and least profitable job types • Estimating: # hours per contract $ • Finance: start up equity & net profit • Resource development: # hours worked • Ownership: personal annual budget

31. MEASUREMENT BY STAGE - 2 • Owner begins to delegate and develops greater need for financial management: • Moves to computer-based registers • Separates overhead and COGS • Changes in company structure require better financial organization: • Hiring employees • Purchase of tools and vehicles • NEEDS to understand overhead and to learn to read monthly profit/loss

32. #s AT STAGE 2 • Sales: visit to sale ratio; average job size • Production: bid & produced gpm • Finance: overhead % and $; annual profit plan • Resource development: employee productivity • Ownership: retirement funding needs

33. MEASUREMENT BY STAGE - 3 • Owner delegates everything EXCEPT sales: • Considers incorporation • Moves into out-of-home office space • Quantity and complexity of information increases • Employees become important part of company structure – require accurate costing information to assist estimating • Job costing becomes imperative • NEEDS to understand the Balance Sheet and to learn ratio analysis

34. #s AT STAGE 3: • Marketing: numeric lead sheet • Sales: job probability matrix • Production: job type profitability • Finance: break even analysis; simple ratios • Resource Development: company capacity

35. MEASUREMENT BY STAGE - 4 • Owner delegates everything • Financial management is now dispersed among company departments • Simple, accurate and timely benchmarks used by the owner, prepared by others • Planning becomes more important • NEEDS to understand trend analysis and cash flow projections

36. #s AT STAGE 4: • Marketing: cost per lead; cost per sale • Sales: sales person productivity • Estimating: unit and assembly costing • Production: partial incentive based compensation • Finance: ROE; cash flow projections • Resource development: training budget • Ownership: board of directors

37. MEASUREMENT BY STAGE - 5 • Owner positions company to operate without him/her • Effects of previous financial management decisions are now apparent: • Does the company have value independent from the owner? • How is that value measured? • Can it be reproduced? • At what cost?

38. #s AT STAGE 5: • Marketing & sales: predictable lead sources • Production: slippage <2% both for job as a whole as well as by line item • Finance: 3 year budgets for P&L, balance sheet and cash flow • Resource development: employee productivity increases • Ownership: exit strategy goals

39. WHY BUILD A DASHBOARD - • A dashboard looks at company performance from a macro view • A dashboard turns data into information • Information can be more easily understood by more people • Graphic information tells a story • The more complex the organization the more useful a dashboard.

41. HOW TO BUILD A DASHBOARD - • Identify the most critical metrics • Establish benchmarks for each annually – determine how often to update: all the time vs. one time • Develop a visual presentation method • Engage the entire company • Test for 3 months, then finalize • Establish reporting protocols – have different people report on various metrics to engage them in the analysis

43. WHAT’S THE POINT ? • Running a business consists of: • Selling a product • Producing it • Managing the organization • Running by the numbers in every department at every stage is critical to the success of any company • If this type of management is not your interest, sub it out as you do board up!

44. QUESTIONS & ANSWERS - • Thank you for your attention! • Thank you to Business Mentors for inviting me to speak with you today. • Contact me at: • jfmiller@remodelservices.com • www.remodelservices.com