470: How To Balance Profit Centers And Cost Centers In Your Construction Company

This Podcast Is Episode Number 470, And It's About How To Balance Profit Centers And Cost Centers In Your Construction Company Success in operating a profitable construction business is all about maintaining the proper balance of control over both The Profit Centers and The Cost Centers. If either one gets too powerful and is allowed to run your construction company, it can cause more damage than good.   The definition of a Non-Profit Construction Company is one that tries to fix its weaknesses and continues making the same mistakes repeatedly, expecting a different result and continues to struggle until the owner lays down and dies from over-work and exhaustion.   A Highly Profitable Construction Company builds on its strengths and core competencies and continues innovating, growing, and responding to changes in its environment.   

It's Not Rocket Science; It's A Lot Harder Than That!

Profit Centers

Most construction companies earn most of their profits from less than four different project types or Profit Centers.

Residential Remodel Contractors Have Four Main Profit Centers:

Kitchen Remodels

Bath Remodels

Additions

Whole House Remodels

Commercial Tenant Improvement Contractors Have Three Main Profit Centers:

Commercial Service Work

New Installation

Whole Space Remodel

Service And Repair Contractors Have Three Main Profit Centers:

Service Work

New Installation

Remove And Replace

New House Builders Have Two Main Profit Centers:

Spec Homes

Custom Homes

Every construction company has strengths and weaknesses, which means there are particular types of projects they consistently earn lots of money. And there are some types of projects that they always lose lots of money doing.

The answer is found in that gold mine called QuickBooks Job Costing Reports and QuickBooks Job Profitability Reports. These reports provide you with a treasure map to see which profit centers your particular construction company makes the most money in and which ones you lose the most.

Do more of the ones that make you money and fewer of the ones you lose money on. I will give you a hint; you may not like it, you may stop reading and leave angry; In most of the research we have done for our construction clients, we have discovered the concept of Leveling applies not just to whom you spend time with but to who refers jobs to you!

Cost Centers

They all share the same three Cost Centers, Marketing - Accounting - Production (MAP)

Marketing Is The Number One Cost Center

One current client or customer is worth more than all of your prospects combined.

All contractors need existing customers and new ones to survive and thrive.

The 80-20 Rule for contractors can guide your marketing dollars where they will do the most good.

Understand and document your target market demographic and psychographic profile.

Focus 100% of your marketing on your target market and forget everyone else.

Identify the top 20% of your customers that generally generate 80% of your net profit. 

Identify the top 20% of the goods or services you sell 80% of your revenue.

A good rule of thumb to grow sales is to budget 5% to 10% of gross sales on marketing.

Anything less is like winking at a pretty girl without her knowing you are doing it.

Relying 100% on word of mouth and referrals keeps contractors poor and broke.

Accounting Is The Number Two Cost Center

Successful, highly paid contractors understand and use reliable QuickBooks Financial Reports and Job Costing Reports to know:

Which jobs they are equipped to do and make a handsome profit on because it is one of their primary to bid on and pursue

Usually, contractors who understand this concept earn the bulk of the profits in the construction industry. For what it is worth, "There is a Hall of Justice; however, there is no Hall of Fairness."

Production is the number three Cost Center

This is where all your hard work pays off. At this point, you have some basic operation manuals in place for your field and office employees. It is the document that answers the same questions you will be asked hundreds of times. It is the Wikipedia of your company. "This is Who We Are, and How Things Are Done Here."

Now you have a road map to success, and all you have left is to assemble the tools, equipment, and employees, set up your trucks or vans, and work!

The reason is simple. A contractor focusing on finding and optimizing profit centers will have a much more difficult job than someone overseeing a division that is not classified as a profit center. A profit center manager will have to increase sales by generating additional revenue and decreasing costs (as a percentage of income), much like an entrepreneur would have to do in their own independent business.

On the other hand, a cost center manager only has to worry about staying within budget. (A cost center is a department that is important to the overall success of a company, but its contribution to revenues and profits can be only incrementally measured. A cost center is an area that typically runs red ink in upfront losses but will result in a much richer company if managed correctly; think of the research division of a major pharmaceutical corporation that spends billions developing new drug treatments without selling a single pill for years).

If the pipeline were to dry up and the cost center shut down, the company would soon find a shadow of its former self. Yet, it is a cost center and not a profit center that is likely to find itself at the top of a list for recessionary layoffs.

Many businesses are tempted to treat all divisions as cost centers instead of profit centers. This can be a horrible mistake because if managers are rewarded simply for cutting costs, they will not make sufficient reinvestment in a business to grow profitably in the future. Hence, you eventually end up with outdated equipment, facilities, and staff and your customers are likely to go elsewhere because their needs aren't being met. On the other hand, a profit center approach blends the need for current cash with the desire to grow earnings in the future, making a manager accountable for the long-term health of a business.

The legendary management consultant and thinker Peter Drucker created the term profit center in the 1940s. He subsequently asserted that the term profit center is a misnomer that leads managers to focus on the wrong overall priorities, insisting that everything is a cost center. By focusing only on the absolute profit of a division, factors such as return on capital, opportunity cost, efficient use of resources, and relative returns are ignored to the detriment of the stockholder or owner.

Final thoughts

A holistic Business Process Management Strategy (BPM) is the only way to optimize profit and cost centers. Outsource your accounting services to a firm specializing in Construction Bookkeeping And Accounting because it is a chore for you. In most cases, we can do the job for much less than an in-house bookkeeper because we have a system. Above all, learn to read your financial reports; we can guide you on which reports to pay attention to and why specific reports can make you more money than the other ones.

About The Author:

Sharie DeHart, QPA is the co-founder of Business Consulting And Accounting in Lynnwood, Washington. She is the leading expert in managing outsourced construction bookkeeping and accounting services companies and cash management accounting for small construction companies across the USA. She encourages Contractors and Construction Company Owners to stay current on their tax obligations and offers insights on how to manage the remaining cash flow to operate and grow their construction company sales and profits so they can put more money in the bank. Call 1-800-361-1770 or sharie@fasteasyaccounting.com