The path to 12% profit via the overhead key performance indicator

If you’ve followed my last two columns, I’ve outlined the productivity key performance indicators (KPIs) that drive the net profit percentage. (Editor’s Note: Read column one here, “The path to 12 percent net profit,” and column two here, “The path to 12% profit: The labor KPI.”)

Net profit is driven by three productivity KPIs: labor/crews, overhead and equipment. You can’t drive up net profit without managing these KPIs. That’s because you have to make informed decisions about 1) How much more labor, overhead and equipment to buy and 2) Knowing that information in relation to a best-in-class benchmark. This column addresses the overhead KPI.

Chart: Kevin Kehoe

Why is this KPI important? The greatest challenge to generating higher net profit is overhead expense. Not that it exists, but that it can grow at a faster or the same rate as revenue when it should be growing slower. You don’t want sales growth offset by overhead growth.

Why does that happen? The simple answer is 1) We typically hire staff before the revenue happens, 2) We have a hard time getting rid of staff once they’re hired, regardless of revenue swings, and 3) We have inefficient systems requiring more bodies to get the work done.

You must grow overhead at a slower rate than your revenue. You invest in overhead to optimize crew production — period. To do that, you buy facilities, staff, software and other operating items. For more information on these items, see Frank Ross’ chart of accounts.

Chart: Kevin Kehoe

His is the one I employ to make the benchmark calculation.

Overhead KPI = Revenue/overhead

It is best to calculate this KPI on a 12-month rolling basis because overhead spending varies by month.

In my example, one dollar spent on overhead generates $2.40 in revenue for this company. Is that good? It’s not when compared to the benchmark of $2.60 for this commercial maintenance business. Keep in mind, construction contractors should see ratios closer to $4.00.

What’s the solution to get the ratio higher? Mathematically, 1) Revenue should be $3,250,000 or 2) Overhead should be $100,000 less: $1,153,846.

Now that we know what the numbers should be, what’s the solution in the real world?

Chart: Kevin Kehoe

Since most of your overhead is truly fixed, you have to focus on the part that is not — staffing. You must assess if people are pulling their weight, role by role. For example, are your account managers managing $1.7 million of work or are they managing $2 million? You, of course, want the second scenario.

You can and should cut costs for a while to get there, but ultimately, nobody makes money in the long term just cutting costs. You make money by growing your revenue at a faster rate than overhead. This means raising revenue per person. The details of doing this warrant another column by itself.

But we know that increasing revenue per person is a function of personal productivity that is driven by their experience, your training and your systems. While it would be nice to recruit all the most experienced talent for every job, that is unlikely. And, since any training must be based on teaching a system, the place to invest is systems —systems that provide your staff with the best tools to do the work at a high level consistently. That means an investment in technology, both hardware and software, is essential.