The Critical Drivers of Profit
Profit is the lifeblood of any business, and understanding the critical drivers of profit can help business owners to improve their cash flow. And so today, I am going to help you drive your profit results by teaching you all about the critical drivers of profit.
I know this numbers stuff can feel boring, but it is unavoidable. It is sink or swim. Successful, profitable organizations have this nailed. And I promise that today, I'm going to set you on a path to nailing your critical drivers of profit as well.
I see way too many businesses with high revenues and ZERO profits, and I want to talk to you about why that happens and how you can avoid it. You can avoid it by working out what your critical drivers of profit are. This is especially important if you've got a team of one or more, because once you go from being a solopreneur to having a team, the risk of making sales but NOT making profit increases substantially.
The thing to understand about that is that
REVENUE doesn't necessarily mean MORE PROFIT.
Gross profit is revenue less the cost of sales. And so if you get the cost of sales equation wrong, no profit is going to drop out into gross profit. Net profit is gross profit, minus all your operating costs. So if you're spending too much on the day-to-day running of your business, then again, no profit at the end. I guess the takeaway here is that just making sales revenue does not equal profit. I wish that the math equation was that easy, but it simply is not.
So now let's look at what is a CRITICAL DRIVER.
I'm sure you know what a target is. So, think of a revenue target. So let's say next month you want to generate $40,000 in sales. Now that is your target.
Your critical drivers of that target are the things that you do every day, that actually drive you to the end of the month target.
So a simple example of a critical driver around sales: let's say you've got somebody with a sales hat on or a salesperson, they might have five activities that they're doing every day that generate sales. It might be, I'm making five calls, I'm following up on all my leads, I'm following up on all my quotes. Whatever those daily tasks are, those daily activities, if they do those every day, then you are far more likely to hit your target. If they don't do those every day, then you are far less likely to hit your target. So this is just a basic example of what a critical driver is.
They've also been called NORMS. The other way to think about it is that a target or a KPI - they have lots and lots of names - is a lot like looking in the rear vision mirror. So if you get to the end of the month and you haven't achieved that target, you can only look back.
A critical driver is your ability to look forward.
An example of the power of critical drivers: my father says that he built his $100 million business on a set of critical drivers for his sales team. So when any of his team were not getting the desired results, they weren't hitting their targets, he would sit down with them, with their two pages of critical drivers, go through each and every one, and then find out which one they were dropping the ball on. And then he would just get them to focus on that critical driver, and they would achieve their targets.
He built his entire $100 million organisation on those critical drivers. So I want to impress upon you that targets are essential. You must have targets. Critical drivers are just as important. In fact, I would argue that they're almost a bit more important in order to help you get the results that you want.
So, now let's go into the critical drivers of PROFIT - these are generally trickier than the critical drivers of revenue. Let's treat this a bit like an exercise for your business. So first off, I want you to answer these questions for yourself:
What business are you in? Think about your industry, that kind of thing.
Are you a trader? Are you professional service?
What PRICING SYSTEMS do you currently use?
Do you use a mix of pricing systems that include either of these?
1. Do-and-charge work. So basically, you have an agreement with your customers or clients that you're going to do the work, and charge them a specific rate. And the rate can be hourly or it can be on measurements and things like that. So I call that, do-and-charge work.
2. Fixed price quoted work. This is where you agree with a customer or a client on a fixed price for a job that has a limited scope. So for this scope of work, I'm going to charge you X amount. So let's call that price system, but there are more pricing models.
Now that you've determined what business you're in, what industry you're in, and what pricing systems that you're using, we're going to look at the critical drivers of profit for each one of those two pricing systems.
Let's start with the critical drivers for do-and-charge work.
This one is usually a bit easier than fixed price job critical drivers, but it's not foolproof - especially when you have a team. So there are risks and they should be mitigated with critical drivers.
There are two main critical drivers that relate to do-and-charge work:
1. "Staff timesheets driving billing". I was chatting to a client about this one recently. He has an excellent business, and the approach we take with him strategically, is that the time to repair the roof is when the sun is shining. So we are not waiting for him to have profit problems. We are making sure that we nail best practices around his finances and everything else, in order to avoid problems happening, which is the best case scenario.
So, staff timesheets driving billing is about doing do-and-charge work. So basically,
when your team clocks their time each day, time-and-tasks, is that automatically flowing through to the way you bill your clients?
Because if you are in do-and-charge, even if it's by the meter, or by some kind of measurement, then the time-and-tasks that your staff are clocking for themselves to get paid should also be connected and integrated and automated into billing out the work to your client.
The reason that you need to make this a critical driver: you have to make sure that the staff are clocking time-and-tasks every day in the right way, so that you can avoid admin errors. That's why you also want it automated.
So let's say you don't have that system in place. Let's say that you're using a manual system, and that there's no connection between your team clocking their time-and-task, and your billing out of those jobs. Let's say there's no connection. So the risk there is the admin error. So if you are double handling and billing out, and it's not connected, you can easily make errors, lots of things can go wrong, and then jobs cannot get billed. Jobs can get billed incorrectly, and then the profit is adversely affected, which is why staff timesheets driving billing is one of the critical drivers for do-and-charge work.
2. "Non-billable Time". So your team is clocking time-and-tasks, can all of it be billed to clients? Is the team able to clock time-and-tasks, which is like unbillable time? So think of meetings, think of breaks. But think of other wasted time, because
anything that you're not billing to a client, that's non-billable time - it's admin time, it's operations cost.
You need to be totally in control with this do-and-charge model of non-billable time. An example of a critical driver around this, like a daily thing you do, is a report generated daily, which details unbillable time. And this is a process to performance manage any staff member that is clocking unbillable time that doesn't meet policy and procedure guidelines - the two are kind of connected. If you've got really great systems around your timesheets, around your team clocking time-and-task, then you're probably going to have better data and better entry around unbillable time or non-billable time, which means that you're going to be able to see it.
But, it's really easy to get caught up in the day-to-day. Go out, do the job, generate the revenue, everything should go smoothly. That is not the way to a really profitable business. You need just some key, nice, simple critical drivers, and in this case it's those two.
TIMESHEETS DRIVING BILLING, and are we making sure that we MONITOR NON-BILLABLE TIME and we TAKE ACTION DAILY? We don't want to wait till the end of the month and go, "Hey, Tom, why is this all this non-billable time?" "Well, I don't know, I just didn't have anything to do." Suddenly you've got all these expenses for Tom, you couldn't bill a client, and the profit's all gone.
Now let's look at the critical drivers of profit around fixed price jobs.
And before we move on to that, I'd like you to think for a moment what kind of fixed price jobs you do. So, are the fixed price jobs you do fairly simple in their scope, therefore, they're easy to work out, and the risks of the job - are they being profitable? Is the risk more limited? Or do you do more complex fixed price jobs where the scope is more broad, therefore, doing the quote is more difficult? Therefore, the risk of you forecasting the job profitability is, there's a higher risk of you making mistakes and therefore the job profits coming out zero or less than you expected.
It's really important that you take a moment to just
consider, think - rather than just do, do, do all the time.
Really, stop and consider the kind of jobs that your fixed price quoting.
There are a lot of moving parts when it comes to the critical drivers of profit for fixed price jobs. So to help you understand what some of the critical drivers for you might be, because they are going to vary business to business, I'm going to give you two examples of businesses that I've worked with or work with, and the critical drivers that they have developed to use to make sure that their businesses are profitable.
So let's call the first business, Tom's Carpentry. I'm changing the name to protect privacy. So Tom's carpentry serves the building industry. They tender for work and the scope of the jobs is broad enough that there's a fair bit of risk that when they scope, and forecast, and quote that the actual result of the job might be less profitable than they anticipated.
So they've got bigger jobs to quote - Tom's Carpentry is turning over $4 million a year. So when Tom first came to me, his profit was zero. Turnover was $4 million a year. But there was no profit coming out the bottom. So the first thing we focused on was Pillar One, we got the numbers up-to-date and accurate, because there were some issues there. After that, it took a few months, but within a few months, we had collaborated with Tom to move him from zero profit to about $80,000 a month. And I know that's a massive result. Absolutely, we were chuffed.
Let's look at how we did that. So we did narrowly focus around these critical drivers of profits - it was all about getting the business profitable. So the first thing that they did is they recognised - not in this order - but when we got the $80,000 result, it's really important that
we look at the secret sauce that they've developed that got them to the result, so that we can repeat this.
So these are the things they did. They recognised what the best pricing system for them was. And for Tom's Carpentry, they realized do-and-charge work was great for them.
They did some do-and-charge work in measurement, not always by the hour, it was by measurement, and that worked brilliantly and it resulted in really profitable jobs. They tweaked that pricing system to work for them. So, the next thing they did is they really faced up to what types of jobs were all revenue and no profit, or worse, they were actually losing money on them. So then what happened was, they had some jobs profitable, some jobs not, and the mix of the two meant zero profit. So when I talk about they faced up, they always had a gut feel, they knew early on. But when they were able to use their up-to-date accurate numbers and actually sit down and be data driven, they had the proof. So they faced up to the types of jobs that weren't profitable and they simply stopped doing that kind of work.
And sometimes it's about not doing more work.
So they thought that the answer to their profit problems was probably more revenue. Absolutely not. It was to do less. It was to stop doing work. So the next thing that they did is they absolutely made a commitment to job costing. So this was all about being data driven. So they committed to looking at the profit on every job. So they had the forecast, the quote, and they looked at the actual, and they didn't hide from it. They leaned into job costing.
They also did what I give a label of product innovation. So even if you're in the services game, you have the opportunity to product innovate. And that is to look at what you are delivering to your clients, to your customers, and to innovate the way that you're doing it, to serve them better. And to also serve your business better, to make sure that you've got the oxygen, the profit, and the cash there.
So their product innovated, in this case, it was around insurance jobs. They offered to quote on more of what was involved in the job, like rubbish removal. So it wasn't necessarily carpentry, but it was all these things that they could do, and they had a much higher profit margin, and they made a lot more profit on the job.
So what I've just outlined was really their secret sauce recipe for how to create profitable jobs in a profitable business. In terms of critical drivers, they really developed a way to monitor their work in progress to get alerts that jobs were not stacking up profit-wise. So it's not easy work, but it's essential work. They developed their own way of monitoring that, which then as with my strategic bookkeeper hat, I was able to challenge them, make sure that it was all stacking up as well. The critical driver was: let's look at the jobs daily and make sure that we can see that they are going to stack up in the end, so drive their profit result.
Let's move on to business two as an example. So let's call this one Sam's Commercial Cleaning. So Sam's turnover is about $3 million a year. This is a real life example, but I've changed a couple of details for privacy. So $3 million turnover a year and Sam is doing great. This is the one where we talk about repairing the roof while the sun is shining.
Sam's jobs can span a day, they can span two to three days, but they can also span a week or so. So like Tom's Carpentry, they came up with a way to monitor the profitability on jobs in progress. You might call it work in progress. Specifically, they personally looked at day two of each of their more significant jobs. And they compared actual productivity to forecast productivity. This included receiving daily photos from the operations team. So again, it was about looking at these jobs in progress and making sure that they could address any problems daily. Not reflect at the end and say, "Oh no, we got it all wrong." So these are the daily critical drivers.
Both these examples are of businesses with fairly high turnovers. If your business is less complex, the great news is that your critical drivers are going to be easier to develop. A key takeaway from all of this is job costing, job costing, job costing. If you are in the time for money game in any way, shape or form. So if you're white collar, like a professional services type business, if you are blue collar, if you are in any way, shape, or form, you need to lean into job costing. So definitely that is a key takeaway.
Now, I know this number stuff can feel heavy duty, but profit and cash are like oxygen for a business. They are the first thing that you must pull out of your business. So once we've got the profit and cash sorted and we can prove that we can make those consistent, then you get the privilege of pulling things like time out of your business.
Revenue is vanity, profit is sanity, and cash is king. You cannot afford to bury your head in the sand here. If you feel like you need some help in this area, we would love to help you. So you can reach out. Having a discussion costs nothing, but inaction could cost you everything.
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