Two key parts of a management system are a rolling budget, which points out where problems are, and key performance indicators, which identify what the solutions must be.
You hear it all the time – basic blocking and tackling can win a game. If one of the primary goals of your business is to make money while you grow, which is no easy task, you must manage money and growth together. To do this, you need to know what’s going on with your business all the time. So you need a management system. It doesn’t have to be fancy, but it must produce desired results. It’s been said coach Vince Lombardi’s Green Bay Packers used less than a dozen football plays, but they were executed effectively.
Let’s explore a basic management system by starting out with the big picture – the rolling budget – and employing key performance indicators to see what matters. Let’s start with the goal – the budget, which is a tool that, once created, is used to identify variances (the difference between the goal and the actual) and reforecast a plan (fix the variances) to ensure you make budget. Build a budget by starting with net profit and adding overhead expenses and cost of goods sold (labor, materials and subcontracts). From there, it’s simple math to calculate the revenue dollars required to achieve the gross profit dollars you need to earn the net profit dollars you want. Once the budget is created, keep the original as your standard of comparison. It’s the goal. An example of a simple budget is below. All overhead costs are condensed into one line for simplicity.
Roll the budget (reforecast)
Use the budget as part of the management system by rolling it, which simply means dropping in actual results every month where the original budget numbers once were. Now you can see variances, which are what you manage. An example of a rolling budget is below.
The actual results for the first four months tell a story. In this case, net profit is off, and it looks like revenue is running behind. Although labor might not be over budget dollarwise, it’s over as a percentage of revenue, and the average wage rate is higher than budget. Can these variances be addressed to get back in line with the original goals?
There are three important items that vary in any budget: total overhead expenses, labor expenses and revenue dollars. If you boil it down, there usually are two numbers that really matter—labor and revenue, which you can control in the short term. I’m not suggesting overhead isn’t important, only that it’s more difficult to control in the short term. These expenses—such as rent, equipment and insurance—are fixed, leaving only overhead staffing cuts to reduce overhead. Ouch!
Key performance indicators
The rolling budget provides only so much information. More detail is required, and that’s where key performance indicators play a role. They’re used to identify the sources of budget variances. There are six critical key performance indicators: overhead recovery, client management, job cost, labor efficiency, sales management and work forecast. Let’s look at each one individually.
Overhead recovery. You need to know if you’re on track to generate enough gross profit dollars to cover your fixed expenses. If you’re not, you’ll have more than a profit problem, you’ll have a cash crunch in your future. Second, if you’re covering your overhead budget, you want to know how much you can flex pricing to potentially boost sales without taking away from the net profit goal. The key performance indicator below shows overhead dollars recovered to date compared to the budgeted overhead expenses.
Client management. Losing business or missing upsell opportunites can hurt any budget. To minimize this, manage the value of contract revenue under management, contract revenue lost and gained, and upsell revenue generated on the contract revenue. It’s essential to know if what you currently have, and are budgeted to sell, is sufficient to achieve budget. The key performance indicator below can answer these questions.
Job cost. You must know where you make and lose money, job by job and client by client. Only then can you meaningfully address labor and material cost variances. Imagine having a key performance indicator like the one below that reports this information at the rolling budget level but can do it down to the job and client level. Armed with this information, you can manage labor hours and purchases much more intelligently.
Labor efficiency. There are two primary reasons for labor cost variances – hours and average wage rates. You must manage both individually and together. The key performance indicator below provides information showing this as a percentage of labor hours and rates budgeted compared to the actual labor hours and rates paid. Again, imagine having key performance indicators like this that provide this analysis at the rolling budget level, at the job, and at client and crew levels.
Sales management. It might seem obvious, but one of the central elements of the budget is revenue, which comes from retention and upsells and new sales – and new sales come from new bids. You must manage both. We don’t win everything we bid, only close a percentage of that. Therefore, to achieve the sales goals, proposal goals also must be achieved. This key performance indicator provides information essential to answering the questions: “Do we have enough in the pipeline to make the budget?” and “Are we bidding the right stuff to achieve the closing rate we predicted?”
Work forecast. The last piece of the management system is a work forecast, which can assist in answering two questions: “Is there enough work already sold but yet to be delivered (blue bar below), and is there enough in the sales pipeline at our closing rate (red bar below) to make up any revenue variance?” and “In regard to labor expenses, is the labor we have on hand today too much or too little to meet the labor forecasted, keeping in mind every dollar of revenue forecasted has labor hours and costs associated with it?”
It’s essential to make money while you grow. The two key parts of the aformentiond management system are the rolling budget (pointing out where the problems are) and the key performance indicators (identifying what the solutions must be). If blocking and tackling wins games, then allow me another cliché: A problem well defined is a problem already half solved. This is what a management system does—provides information needed to manage a million small things that add up to one big thing—winning.
Quick tip: There are three important items that vary in any budget: total overhead expenses, labor expenses and revenue dollars. If you boil it down, there usually are two numbers that really matter—labor and revenue, which you can control in the short term.
