Episode 71 Podcast Transcript

Speaker 1 (00:00):

The numbers is the language of your business. You’ve got to know how to speak it and how to interpret it and how to make decisions based on information rather than by gut feel. Hi everyone. Rob Kropp and Dan Stones from Pravar Group and welcome back to another episode of The Trade Den. Welcome back, Dan. How are you?

Speaker 2 (00:23):

Good, thanks Rob. How are you? I am very well and looking forward to getting into today’s episode. Another Matters episode, A Money Matters episode. Actually, we haven’t done a Money Matters for a while, so looking forward to ripping apart some numbers and seeing what we can uncover. So before we dive in though today about these four key numbers that you talked about in the intro, let’s just set the scene. These four numbers, where do they come from? It’s from your profit and loss statement, and the profit and loss is one of the key documents in what we’d call a triple bottom line. We’re not going to go into that today, but the P&L should be one of your home bases. You should be looking at this, you should know it. And today the four numbers we’re going to talk about are in your profit and loss statement.

(01:04):

So if you want to follow along or do some homework after this and go and dive in, that’s where you’ll find these numbers. So the profit and loss, as you said, it’s like the scoreboard. It shows how your business is actually performing over a period of time. You stack up the periods, it tells you a story, so it tells you not just what’s in your bank account, it tells you way more than that. It tells you what you’ve earned, what’s been spent, and what you’ve got left over. So really important that you understand this document and the four key numbers that we’re exploring today. So without any further ado, let’s just jump straight in. Let’s talk about number one and that number is revenue or what we call the top line.

Speaker 1 (01:40):

Yeah, the revenue line is the top line within your profit loss and it tells you how much sales your business has made over that period of time, whether it’s one month for the quarter, for the financial year or whatever it is. It’ll say revenue and that dollar figure. And you’ve got to remember this is the amount of money that you have invoiced out within your business. We don’t want to get too technical versus accrual versus cash accounting, but really in the end of the day, it’s an accumulation of all the work that you’ve done over that period of time for all the invoices you’ve gone out of the door and it might say revenue or sales on your profit loss and it might say $1.5 million or whatever it is, but it’s the top line. It’s the revenue, it’s the work that’s gone out the door of invoices that have gone out of door over a period of time.

Speaker 2 (02:29):

Yeah, you’re right, it’s how much work you’re doing, but it’s important to stress though it’s not how much you’re keeping. Let’s make that upfront. Revenue is not how much you get to keep, it’s how much you’ve done and without the rest of the three numbers, if all you do is look at your revenue number and think, how good am I going? You are starting to run into some dangerous ground.

Speaker 1 (02:48):

Yeah, revenue can be a little bit of a vanity number and some people can get way caught up in this top line number. And obviously yes, the profitability, the line net profit percentage is always a percentage over revenue. So do you need to be able to grow your revenue over a period of time to be able to make more profit? Absolutely. But it’s somewhat a vanity number because more revenue does not always equal more profit if you don’t manage your costs accordingly. So it doesn’t always drop to the bottom line and that’s why it’s somewhat of a vanity number.

Speaker 2 (03:23):

Yes. So let’s get into number two, which is gross profit. And what we’re going to do when we talk about gross profit, there’s a little distinction here. There’s two sorts of gross profit we talk about. One is the dollar amount of gross profit and the other is your gross profit percentage. So one’s expressed in a full dollar amount and the other one you can calculate using a formula which you can then express as a percentage. So gross profit if you want that formula. Gross profit equals your revenue, the number we just spoke about minus your cost of sales, which is your materials, your chargeable ground crew, those sort of things that are going into actually generating that income, that revenue and what’s left over once you take cost of sales away from the revenue is your gross profit.

Speaker 1 (04:07):

And this is a really important number, but more importantly, it’s a really important percentage number within your business because what your gross profit is really telling you is how efficient and profitable your business is before you pay any overheads. Now, every business has got a range of GP or gross profit that they work towards when you work in terms of the builders for example, they run with lower margin. They might work on anywhere between 15% to 20% gross profit. Then you work in trades businesses, which are more project style businesses, which might be ranging anywhere from 20% to 35%. Then you’re working more or up to 40%, and then you’re working more in service-based businesses, which are more like 40% to 60% gross profit. So every business and every industry has a different range and a different gross profit target percentage depending on the nature of the business. But it’s really important that you know your gross profit percentage because if it’s too low, it’s very hard to scale that style of business when you’ve got a low GP because all you’re going to do is scale problems on a low profit margin business.

Speaker 2 (05:28):

Yeah, absolutely. You’re using the word margin there, just explain what you mean by margin and how we use that interchangeably.

Speaker 1 (05:34):

Yeah, it’s the gross profit margin. So if you hear that word margin, that’s what it is. It’s really what’s left over in the end of the day. Once you’ve taken your revenue and you’ve got your revenue and you take it away, the direct costs which are associated with delivering that revenue, so equipment, higher chargeable, labour materials, consumables, all those types of things, and that margin number and margin percentage is one of the most important numbers and percentages every business owner needs to know because that really helps them drive profitable outcomes in the end of the day.

Speaker 2 (06:15):

Yeah, it also lets you know what you’ve got left over to pay the third number, which is overheads.

Speaker 1 (06:22):

Yeah, these are your fixed costs. Your overheads are your fixed costs within your business. Now you’ve got to remember, these are things like your phone built, phone bills, your insurances, your the running costs of your motor vehicles, your admin, marketing expenses, accounting fees, professional services and all those types of things, rent. These are the costs which are really to keep the doors open. They’re fixed in nature because your landlords are not going to say, that’s okay, mate, you shut down over for three weeks over Christmas, we’ll just discount your fees. It’s fixed in nature because they are fixed costs of keeping the doors open. So yeah, these are the expenses of what it takes to run your business in the end of the day.

Speaker 2 (07:06):

And a lot of business owners can tend to take these for granted or they neglect this number. It’s definitely not a sexy number. It means you’re spending money, but at the same time, if you don’t keep an eye on it, you end up really running into trouble. And these overheads can grow over time, especially if you’re not on top of it. You look at it one month, you give it six months, you don’t look at it again. All of a sudden we’ve seen guys absolutely blow out their business because they just haven’t kept an eye on overhead. So as important as margin and gross profit is, overheads are just equally as important to keep an eye on. You can’t neglect it.

Speaker 1 (07:40):

Yeah, correct. And we did an episode number 58, which was another money matters episode where we spoke around sloppy spending, killing your profits, and we spoke around there around the a hundred thousand dollars reality check where we did talk a bit about overheads. And if you increase your overheads by a hundred thousand dollars and you are running at a 30% GP or gross profit, it’s not that you’ve got to make a hundred thousand dollars in revenue to be able to cover that a hundred thousand dollars in overhead. You’ve got to do north of $300,000 in revenue because you’ve got to be able to pay for your cost of sales out of that to be able to break even on that increase in overheads. And that’s why you can’t just look at all these numbers in isolation. You’ve got to be able to see, understand the formula of how the profit and loss works, and you’ve got to be able to understand what revenue, how it relates to cost of sales, your gross profit at the end of the day, what it’s going to take to be able to cover your overheads to make sure your profitable.

Speaker 2 (08:42):

Yeah, it’s a good point. I think knowing these numbers is absolutely important, how they’re defined, how you get them, but knowing how your numbers relate to them, and what I mean by that is what’s going from your business that comes into, it spoke about general margin numbers before, but if you are trying to baseline your business against someone else’s numbers, that’s fraught with danger.

Speaker 1 (09:03):

Yeah, correct. And I was having a strategy call with someone the other day and I’m like, mate, tell me a bit about how your pricing your work. And he’s the age old story, Rob, when I got into business, I grabbed a Excel spreadsheet off one of my mates and that’s how I’ve priced ever since. I’m like, well mate, how do you know if you’re even charging enough to cover your direct costs of labour and materials? How do you even know that if you’ve got enough margin to cover your overheads to make it enough profit in the end of the day? And he goes, Rob, I don’t. I don’t, and that’s why I’m here and that’s why I need your help. And that’s why you’ve got to know these numbers so that you’ve got the ability to be able to price correctly and manage your jobs correctly and have a financial model that stacks up to be able to ensure that in the end of the day you do have a viable business. Because if you don’t know these numbers like the back of your hand, you are literally running blind day in, day out and it’s a very dangerous position to be in.

Speaker 2 (10:15):

And you use it for where do we need to go and what do we need to do? It’s both ends of the equation. It’s not just a backward looking thing on performance. It’s also a decision making tool as well.

Speaker 1 (10:25):

Correct. And we’ll get to net profit in a second, but if you looking at your profit loss over a period of time, understanding what your revenue profile is doing is really important because you’ve got to understand the trajectory that you’re on. If it’s on an upward trajectory, great. That’s telling you that you can match your revenue to resourcing. It’s telling you who to hire and when to hire and all those types of things. If it’s a downward trajectory, that’s a leading indicator that your pipeline’s drying up and you’ve potentially got to lay blokes off. So that’s what that tells you when you’re looking at your margin. If your margin is getting better, that’s a good thing. It tells you that you’re managing your margin better and more is dropping to your bottom line. But if your margin is deteriorating, then that’s a bad thing because you’re going to have to do more revenue to make more money. And so understanding these numbers and the relationship to each other and why certain things are going in certain directions, it helps you become an empowered business owner to make strategic decision based on fact, not by gut feel. And that’s the position that you want to be in as a trades business owner.

Speaker 2 (11:33):

Yep, 100%. Let’s keep moving. Let’s go into number four, and that is net profit or what we call the bottom line.

Speaker 1 (11:42):

In the end of the day, this is the most important number in business and it’s the most important number on your profit loss statement, which is your bottom line left over in the of revenue minus cost of sales, gives you gross profit minus your overheads, gives you your net profit. And that’s the bottom line. And if you are breaking even or worse yet going backwards, you’ve got brackets around your NP, that’s a sign of an unhealthy business that’s got no viable future, but by having a business that’s got a positive, healthy net profit number and percentage within their business that demonstrates profitability and demonstrates viability and demonstrates sustainability for that business moving forward.

Speaker 2 (12:34):

Without knowing that number, you might think you know what you’re making. If you know this number, you look at it, you understand the trends and how these numbers relate, you’ll know what you’re making. You know what it actually is that’s left over at the end of the day as opposed to, like we said in the intro, that sort of casual glance at a bank statement and have I got money in the bank? That’s probably the most terrible metric followed by have I made money or have I invoiced money? But yet that’s what most businesses do.

Speaker 1 (13:00):

Yeah, correct. And when you think about a trades businesses, most trades business owners, range trades businesses range from anywhere from 10% to 15% to 20% net profit after the owner pays themselves. And that’s a healthy range. Anything in double digit is a healthy business. It’s very rare for a trades business to be making more than that from an NP net profit point of view, but that’s what you want to be aiming for. And anything less than that, to be honest, it’s not worth your while. You’ve literally got a business that’s covering your wage with stuff all left over, in the end of the day, you’ve got a business that’s making wages. So in the end of the day, you want to have a business that maximises the amount of profits that you’re making to reward you and your family for the risk that you’re carrying and the pressure that you’re under of running a business.

Speaker 2 (13:51):

Yeah, absolutely. Thinking profit is a reward, is a great way to, I think it’s a great mindset to have. That’s the reward. That’s what you get. That’s the output of all of it. Rob, before we wrap up, I think there’s another thing that comes to mind, and I think it’s Jim Rowan quote about profit. I know you love it. I can’t remember what it is, but I’m sure you can.

Speaker 1 (14:10):

Yeah. Jim Rowan is famous for saying that profits are better than wages. Wages will make you a living, but profits will make you a fortune. And I love that. I love that quote because what it’s saying is, is that in the end of the day in business, you should get paid a wage for the role that you do, and that wage covers your living costs as a family to live on for all your everyday expenses. But you don’t want, you’re not going to get financially free from that when you run a business in the end of the day, you live off that, but the whole name of the game is to maximise the amount of profits because then you take that profit from the business in the most strategic and tax effective manner extracted out of the business when the time is right. And that’s where you start building assets and wealth creation outside of the business, and that’s where you build your fortune. So I love that quote. It’s profits better than wages. Wages will make you a living, profits will make you a fortune. It’s just a great reminder for business owners.

Speaker 2 (15:09):

It really is. Yep. I love that. What about in terms of, I think wrapping this up, I’d say it’s really about these numbers is you’ve got to get on top of them or they will crush you eventually they will catch up, they keep going, even if you don’t look at them, they are moving, they’re changing. They’re telling you a story. They’re either, they’re asking to be looked at to be considered and for decisions to be made based on them. If you ignore them, you’re really ignoring them at your own peril.

Speaker 1 (15:37):

Yeah, correct. And if you don’t know these four key numbers, it’s like driving down the highway at 120km an hour with a blindfold on, and the bigger that your business gets, and without knowing your numbers, the more dangerous it becomes. It’s a very dangerous position for you to be in.

Speaker 2 (15:57):

Yeah. You end up being like most businesses in the trades and construction space, no matter how big they are, how small they are, they’re busy, but they’re broke and they go broke, not because the work’s not there. It all dries up and things are tight and tough, but because they just don’t understand their numbers or the numbers don’t work, you can see it. If you look at a lot of the statements, even when the bigger companies go bust, you look at their balance sheets or their profit and loss statements, the stories there in the numbers. You don’t need to be a bookkeeper or an accountant, but you really do have to understand those numbers like a business owner, not just a tradesman who’s got a glancing pass at a bank balance or something like that, or speaks to the accountant once a year to just see, well, how did we go?

Speaker 1 (16:38):

Yeah, correct. And like we’ve said on previous episodes around when we’ve talk, spoken around numbers on these episodes is the numbers is the language of your business. You’ve got to know how to speak it, how to interpret it, and how to make decisions based on information rather than by gut feel. And yes, sometimes your accountant might talk to you like they’re talking in another language, or you might shy away from your numbers because they don’t make sense. You don’t know what they mean or they may not look healthy. That’s the worst thing that you can do. You’ve got to lean into it. You’ve got to embrace it. You’ve got to ask the dumb questions and get to fall in love with understanding your numbers for your business because that’s what’s going to make you a more empowered business owner who in the end of the day is going to make better decisions and make more money once you know your numbers better.

Speaker 2 (17:30):

Yeah, absolutely. Rob, why don’t you remind us, where could we go? If you want to break down your numbers, fix your margins, set, targets that matter, and you can start to track.

Speaker 1 (17:39):

Yeah, jump across to strategysession.com.au book in a free discovery call. Let’s get to know you a little bit more. Let’s see where you’re at in business, and if we feel like we can help you, we’ll get a strategy session booked in from there and map out your path forward and let’s see if we can help you have your most profitable year yet in the year ahead.

Speaker 2 (17:58):

Brilliant. I love it.

Speaker 1 (18:00):

Thanks for tuning into another Money Matters episode. Hopefully you took a lot away from it. Lean into those numbers. Looking forward to coming back to you next week with another episode on The Trade Den. Until then, be safe.

Speaker 2 (18:11):

See you soon.