The path to 12 percent net profit

I recently conducted a benchmarking webinar with Greg Herring sponsored by my company, The Aspire Software Co. The results were interesting and distressingly familiar. Less than 20 percent of the respondents (52 companies) had net profit greater than 10 percent. The benchmark for excellence is 12 percent. Therefore, this first of several columns is about how to get started on the path to 12 percent.

Warning: you cannot simply look at an income statement line by cost line to figure out how to get there. To do that, you must understand the critical key productivity indicators (KPIs). These show you where to improve and how much an improvement will add to net profit. That’s because net profit is a function of productivity. Productivity is a simple input-output investment ratio. The ratio tells you how good you are at turning an input into an output — and determining whether you’re getting a max return on that investment.

There are three KPIs that matter because they are where you make your biggest investments: labor, overhead and equipment. I would add a fourth — technology. The level of technology investment industrywide is so low that any investment can potentially achieve an enormous return. Think about it. From a cost-of-sale perspective, you spend +/-35 percent on labor, +/-14 percent on equipment and +/-40 percent on overhead of which the vast majority is people (management, sales and administrative related). You have to understand if each of these is paying off for you and where you must improve to drive the bottom line.

Chart: Kevin Kehoe

Definitions

Let’s define the calculation of these KPIs so you can evaluate them tonight in your office and compare them to the benchmarks.

Labor KPI: Realize rate divided by wage rate.

Realize rate = Revenue minus materials and subcontractor expense divided by the labor hours.

Wage rate = Payroll dollars divided by payroll hours; includes the payroll taxes.

Overhead KPI: Revenue divided by overhead dollars.

Overhead = everything that is not cost of goods sold.

Equipment KPI: Revenue divided by net equipment dollars.

Net Equipment = cost of equipment minus straight-line depreciation.

Please note there are service line and regional differences in these numbers. That is why I am dedicating my next three columns to the details of the calculation, comparisons and benchmarks for each KPI. What will not be different is how to achieve the higher KPI score.

Why does all this matter? Simply because this Trump good-time economy will not last forever — these things never do. In my 30 years in the industry, I have lived through three significant pullbacks. So now is the time to focus and invest wisely and make the tough decisions that will carry you through the bad times and have you emerge strong for the next run-up.

In my next column, I’ll cover the labor KPI and how to maximize it.