2020 was a tough year for almost everyone. Only God knows what a new year will bring and that’s good. If we’d known what 2020 would be like we’d have given up. Every year has its blessings and its challenges.
That year taught us that we can’t control everything. If you thought you were the captain of your ship, you learned otherwise. When many businesses were ordered to stop operating, it put a lot of business owners in a tough spot.
With an operating capital reserve account it’s easier to not be distracted by a financial crisis. I’d like to share a few notes we received from clients when the pandemic began. We received this note March 17 from a renovation contractor in Toronto:
We are starting to shut down up here in Toronto. We closed the business down on Monday. All gov’t is pretty much closed, restaurants, and public places. The majority are at home.
I know I’ve thanked you many times for many things over the years, but I wanted to thank-you again for your blogs and seminar info on emergency funds.
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I’ve doubled the business the last few years, and though I’m not a millionaire, I did save $250,000 in operating/emergency funds for a recession, or rainy day. So now I sit back and I am glad I did. I have your article in my business manual – better to pay the corporate tax…don’t spend your money on things you don’t need.
Stay safe and healthy.
This note came in a week later from a specialty contractor in Oregon:
I wanted to let you know what is going on with our business.
We took your advice and began setting aside up to 3-4% of our weekly receipts for our ‘rainy day fund’. I can’t tell you what this means to us today. We were able to give our employees assurance that our company is solvent, does not operate in debt, and that they will keep their jobs. We, at this time, are giving them all an extra week of sick leave and will evaluate week to week as time goes on. Since we work with water, we are considered essential and can continue working, although it will be at a reduced volume. The past three years have been the best in our 21-year history with over 20% growth.
Your advice when we met with you a few years ago has been invaluable and we thank you. Those words seem so simple in light of the impact you have had on us. You do a great service to the construction industry.
We didn’t share these notes back then because if you weren’t prepared for that rainy day it might have been salt in the wound. Those were tough, unsettling days. Since then business has picked up for many of you and some are very busy.
So here goes: no more excuses. If you haven’t already, start preparing for that rainy day. Start your operating capital reserve account now.
An operating capital reserve account is a savings account, or if you prefer, a CYA account. It keeps you out of financial trouble when bad things happen. It eliminates the need for a line of credit, loans against your home, or borrowing from friends, relatives, loan sharks, or the government. It stops you from having to sell tools or equipment you need to make payroll. It gives you the freedom to walk away from bad jobs. Most importantly, it keeps your family free from financial worries, and that helps you sleep better.
Once you’ve set one up and are regularly contributing, you’ll appreciate the freedom of knowing you can pay your bills if a job goes south, or the government shuts down business.
Chapter 5 of Markup and Profit Revisited is titled “Avoid Financial Pitfalls”. That’s where we outline how much you should set aside, and how to go about doing it. Begin by taking 1% right off the top of every check you receive. Once you can set aside 1% without feeling too much pain, increase the amount. Make it 1.5%, then 2%, all the way up to 4% of every check. You’re slowly building your own line of credit to tide you over when times get tough.
Your goal is to have enough funds in your account to at least pay your overhead expenses at least one entire job cycle. A job cycle is the time from the first day you advertise until the day you cash the last check from a job that came in from that advertising. A specialty contractor may have a cycle of two to three months. A typical remodeling contractor will have a cycle of five to seven months. A new home building contractor will have a cycle of nine to twelve months or even longer.
So, if your monthly overhead averages $11,675 and you’re a remodeling contractor with a five-month job cycle, your account goal is at least $58,375. If your annual sales are about $500,000, setting aside 2% will put $10,000 in your account each year. If you can set aside 4%, you’ll have $20,000 in your account and reach your goal even sooner.
Setting up and maintaining an operating capital reserve account requires discipline. You’ll be tempted to spend the money on equipment you don’t really need, or on a vacation that might be soon forgotten. You’ll probably have to pay taxes on the funds the year they’re first set aside; that’s part of the cost of doing business. After the taxes are paid, the funds are yours to use when needed.
We contacted both contractors a year later and they are busy and thriving. One was getting ready to expand their business and can do so without borrowing funds and going in debt because of their reserve account.
One step in the year-end planning process is to review and recalculate your markup. Include an operating capital reserve account in your overhead so you’re able to set aside funds without too much pain. Using the correct markup allows you to calculate the right sales price for your work. The right price is the price that covers your job costs, your overhead expenses including a reserve fund, and allows you to set aside a reasonable profit.
Take time to work on and improve your sales game. Read, or re-read, Profitable Sales, A Contractor’s Guide. It’s also available on audio if you spend time driving. Remember, nothing happens in this business until someone sells something, at a profit. Go make it happen.
The knowledge and experience Michael Stone gained in his 60+ years in construction has helped thousands of contractors improve their businesses and their lives. He is the author of the books Markup & Profit Revisited, Profitable Sales, and Estimating Construction Profitably, and is available for one-on-one consultations.
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