Running a trade contracting business isn’t easy. Beyond managing the details of every project is managing the operations of the business itself. Doing so comes with its own set of challenges that can be difficult to overcome, including staffing, asset acquisition, financial management and marketing efforts.
One particular challenge that all business owners contend with is what to do with the profits their business makes. It’s a problem that’s good to have, but it isn’t always easy to solve.
Essentially, there are two basic options: Hold on to the profits or reinvest the money back into the business. But which approach is best? The short answer is neither. Experts advise you should be doing both.
It’s Good Business Sense to Hold On to Some Profit
While your entrepreneurial instincts may scream at you to reinvest every dollar of profit to grow the business, this can be counterproductive. Here’s why.
Every Business Needs Cash Reserves
“One of the primary reasons construction companies fail is inadequate cash reserves,” writes Andrew Venzke, a tax supervisor with Thompson Greenspon. These cash reserves are critical to trade contractors in a few different ways.
For starters, you never know when you might need cash fast. Maybe there’s a lag between jobs or a project is costing more than was budgeted. You would need to have access to money to fund operating expenses during those times.
Also, trade contractors often have to front the labor and material costs for projects and there is usually a long wait for repayment, sometimes up to a year. “If a construction company doesn’t have the cash reserves to handle this, they may end up having to take out unnecessary loans or delay important payments,” notes Bradford Pack, CFO at ecommerce platform Ocavu. That can be a risk to the business’ sustainability.
A general rule of thumb is to have enough cash reserves to cover at least six months of operating expenses.
Reinvestment Can Quickly Lead to Overextension
Expanding your business too rapidly without building up a cash reserve can also lead to overextension. It makes sense that you want to scale your business as much as possible, but you can’t feasibly take on every project opportunity that presents itself.
“The construction industry has a high rate of failure,” explains Tim Holicky, senior executive underwriter for The Hartford’s construction central bond team. “And more often than not, it’s because of too much work, rather than too little of it.”
In an effort to get more work, construction business owners reinvest by hiring more people and buying more assets to broaden their scope of capabilities. Too often, though, that leads to the company taking on more work than it can handle and spreading itself thin. Jobs get backlogged, working capital shrinks, and debts tend to grow at this time as the company tries to keep up.
You Deserve to Be Paid a Salary
As the business owner, you worked hard to get the business up and running. But, as is often the case for owners, you feel bad about paying yourself when there are a number of ways you could reinvest that money to expand the company. This guilt often results in business owners not collecting a salary at all even though the profit is there for them to be paid.
The truth is you, like every other employee, deserve to be paid for the work you do. If the margin is there for you to collect a check, you should. But it’s a tough decision for so many owners because it requires striking a balance between personal needs and business needs. “It’s difficult to pay yourself based on an informed decision that is right for both you and your business,” says Melanie Hopkins, founder of business financial consultancy Finance Friend.
However, it’s a critical decision to make as you plan what to do with your profits. “You may not pay yourself in the beginning, but ideally, your compensation should be part of your business plan,” writes Amrita Jayakumar at NerdWallet. “Your financial projections should include the amount of your salary or owner’s draw to help you understand what your business needs to grow.”
While these are all justifications for holding on to some of your business profits, it also makes good business sense to reinvest to grow the business.
Your Business Needs Capital to Grow
If you do have plans to expand your business, reinvesting profits is a great way to increase efficiencies and capabilities. Deciding how much to reinvest is the challenge. Industry experts’ advice about how much you should reinvest varies drastically from 10 percent to 50 percent, so you’ll have to decide what’s right for your business.
“To understand exactly how much you should dedicate to reinvestment, start by crafting your near- and long-term goals,” suggests the team at Fifth Third Bank. “Determine the cost of achieving these goals and how reinvesting your profits can help achieve them faster.”
It’s important to have explicit plans in place for the money you reinvest. The money should be used very specifically in pursuit of definitive goals. “When spent strategically, reinvested profits can help you further grow your bottom line,” writes Ryan Lasker, senior technical writer at the Association of International Certified Professional Accountants. Such planning is critical to keep you from overextending as you expand.
Where you reinvest the profits matters, and your strategy will dictate where the money goes. Some of the most common areas for reinvestment are:
- Employees. If you are planning to expand, one of the first things you will likely need to do is hire more workers. Because this is often done before the growth actually begins, the reinvested profits can help you cover the expenses of new employees until you bring in more projects. The funds can also be used to recognize the hard work of current employees to keep them motivated to give their best when more work comes in.
- Assets for new capabilities. If you identify a particular service gap you can fill in your market or a new market you can enter, you may need to purchase new equipment to meet those demands.
- Marketing. If you are going to grow your business, potential customers need to know about your new capabilities. Expanding your sales and marketing efforts, particularly your digital assets, is a good way to garner interest and bring in new clients. “Your target audience is looking for your services online,” writes Charlotte Smith for Contractor Training Center. “If you don’t have a website and don’t utilize a marketing strategy to nurture leads and make sales, you’re already behind.”
- Technology. Are you using the latest technologies (software and applications) to maximize productivity and efficiency in your business? If not, you may want to consider reinvesting profits to upgrade your tech. This may be particularly critical to your company’s success as you try to manage expansion. The team at World Construction Today says technologies such as drones, wearables, and RFID tags are becoming increasingly common in the construction industry. What tech do you need to do your work better or increase your capabilities?
If reinvested wisely, your profits can help you expand your business or improve upon your current capabilities, but you don’t want to overextend yourself. You need to hold on to some profits. The decision of what to do with the profits from your business is too important to leave up to hunches, gut feelings and best guesses. You need data to help you find the right balance for your company.
Use Data to Drive Your Decisions
The right data mitigates risk of not only your projects but also your overall business; it helps you make informed and calculated decisions. Construction reporting software with analytics capabilities, like eSUB, gives you the data-driven insights you need to decide how best to use your business’ profits. Some of the information you can glean from the software includes:
- The projected outcome of projects. This information helps you plan your time and resources if you maintain the current project plan. You can then decide if you are going to meet deadlines and budget projections and if you have the space to expand services for more projects.
- Where profit margins may be shrinking. You need profits before you can decide what to do with them. Reporting analytics gives you real-time information about where your projects may be losing money so you can find ways to stop the losses..
By being able to fix inefficiencies to increase profit margins and look ahead to future project bandwidth, you can set new goals for your trade contracting company and create a plan for how to best use your profits to achieve those goals. It may be building up a cash reserve or paying off current debts or it may be reinvesting in some part of the business. Whatever that combination is for your company, data will help you find it.
To see how eSUB Cloud can help guide your decisions about what to do with profits, schedule a demo today.
Images used under license from Shutterstock.com.