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May 24, 2000 2:32 PM CDT

Managing Growth

Grow your masonry operation and remain profitable

By

Growing a masonry business too quickly can be a dangerous proposition. A masonry business that lacks realistic goals, lacks manpower, time or other resources needed to manage growth will either lose customers or forfeit opportunity, if not both. In other words, growth has to be managed.

Imagine investing in a successful advertising campaign only to find that your operation lacks the raw materials or the staff required to service potential customers. Similarly, imagine acquiring a new forklift only to find that the operation's bottom-line income is not sufficient to cover its costs.

Many masonry contractors know that it is essential to build a masonry business on a solid foundation. Although it might be tempting to expand the masonry operation or increase sales, it is important to first put money back into the masonry operation and to remain profitable.

Putting the Business in Order
Before committing any resources or funds to growth, a masonry contractor should put the masonry operation in order, to make it as efficient and profitable as possible. Then, working from that strong foundation, it is time to see what can be accomplished without making massive changes.

For example, instead of relocating to larger or more expensive offices, garage or storage space, see if the current space can be used more efficiently. If large numbers of new customers are knocking down your door, reducing advertising expenses will increase bottom-line profits. Similarly, if a customer can be encouraged to purchase more, total sales will increase with those same or reduced advertising costs.

An Unexpected Tax Bite
How many masonry contractors and related businesses salt away reserves to be used for growth? Reserves are obviously a worthy cause, but can be dangerous. First, the money being placed in that growth reserve is money on which taxes have already been paid. There is no tax deduction for reserves. Even worse, putting too much of the masonry operation's earnings and profits away, can trigger a substantial tax penalty.

Any incorporated masonry business that accumulates earnings and profits for the purpose of preventing the imposition of income tax on its shareholders is subject to an annual accumulated earnings tax (in the nature of a penalty). The tax, which is in addition to the regular corporate income tax, equals 39.6 percent of the corporation's "accumulated taxable income" for the year.

That's not to say that all money kept in the business will be subjected to the accumulated earnings tax. The accumulated earnings tax applies only to those funds retained beyond the reasonable needs of the business. Acceptable purposes for retaining earnings and profits include business expansion, acquisition of a business, debt retirement, etc. Plus, all incorporated businesses may legitimately accumulate a minimum amount of $250,000. But, it is the taxpayer who must have a formal plan for those funds - and be able to present that plan to the ever-vigilant Internal Revenue Service to justify the accumulation of funds.

Maximizing Profits
Quite a few masonry contractors try to maximize profits by increasing their prices to the point where a disproportionate decrease appears in the number of construction jobs sold. A ten percent price hike that results in only an eight percent volume decrease increases profitability. Remember, however, a five percent price increase that reduces the number of jobs/sales by six percent is unprofitable. The basic accounting equation for profits appears as:

Profit = Revenue - Expenses

That revenue is a result of the selling price of a job or service, times the quantity sold:

Total Revenue = Price x Quantity Sold FUNDING GROWTH

Putting the masonry operation's house in order, making the most of existing business assets and increasing profits, all the while keeping an eye out that growth funds are not accumulated to the point where the tax penalty will kick in, is a good start to managing the growth of your masonry business. But outside funding will usually also be required.

Raising the cash needed for growth by borrowing allows the masonry contractor to benefit from the principle of leverage - a technique of increasing the rate of return on investment through the use of borrowed funds. As long as the earnings exceed interest payments on borrowed funds, the application of leverage allows the masonry operation to increase the rate of return on owner's equity or shareholder investment. Remember, however, that leverage also works in reverse.

In other words, the masonry contractor who borrows $1 in order to "grow" his or her business, must expect a return from that investment far in excess of that $1 borrowed.

After all, a dollar of increased sales may only represent ten cents in actual cash return after overhead, inventory cost and selling expenses are subtracted.

One financial ratio that can be utilized in this area is the ratio of net income to sales. The ratio of net income to sales measures the masonry operation's profitability by comparing net income and sales. The ratio is computed as:

Ratio of Net Income To Sales = Net Income/Sales

This profitability ratio is a critical indicator for any profit-seeking masonry business. The ratio of net income to sales does give the average contractor some idea of how much the operation's revenues must be increased to repay every dollar borrowed.

Managing the "Stroking"
Cash-strapped masonry contractors and business owners are typically forced to raise their growth funds a little bit at a time from a variety of people and institutions. At first, funds usually come from relatives and friends, then business associates, customers or suppliers may get involved. As masonry businesses establish records of growth and profitability, owners gain access to banks, professional investors and other sources of capital. Most successful masonry contractors usually end up with a patchwork quilt made up of different financing pieces. Coordinating those capital relationships isn't simple, given all the other demands on the owner's time, but it is essential. That's because only those masonry contractors that figure out how to keep their investors satisfied, well informed and committed to a teamwork approach will be able to rely on them for support when unexpected crises and opportunities arise - as they always do.

The addition of a banking relationship adds a new wrinkle to the masonry operation's communications challenge. Banks have very specific things that they care about, such as on-time payments, remaining within the financial covenants they have established and sending them the specific financial reports that they want. In contrast, communications with family and private investors are often more flexible and often focus on whatever information the masonry operation's owner feels is significant.

Relations with those who supply the capital for your masonry business can become complicated. This is a fact of life for many entrepreneurial masonry businesses as they broaden their reach into the capital markets. But as the business grows, the advantage of communicating effectively is simply one more challenge of managing that growth.

Measuring Growth to Manage Growth
The financial information of every masonry contractor and business is - or should be - summarized in three key accounting statements: the balance sheet, the income statement and the statement of changes in financial positions.

The balance sheet can be thought of as a photograph showing the assets, liabilities and owners' equity of a masonry business at one point in time. The income statement is a motion picture designed to show the profitability of a masonry business over a period of time such as a quarter or a year.

By subtracting expenses from income, the income statement reveals the amount of profit (or loss) for that accounting period.

The statement of changes in financial position explains the financial changes that occur from one accounting period to the next. It focuses on the sources and use of funds in the masonry operation.

The Growth Rate of the Masonry Business
The rate of growth for your masonry business is simply the amount of change in some financial characteristics of your operation. That growth can occur in total sales, net profits, total assets or merely inventory turnovers. Managing that growth of course will ensure that growth in total sales is accompanied by growth in bottom-line profits. Abraham Lincoln once said: "I claim not to have controlled events, but confess plainly that events have controlled me."

Managing the growth of your masonry business means taking control of that growth and managing it. Growth for growth's sake may appear impressive. However, unless that growth is built on a solid base and accomplished economically, the end result may be disaster.

Thus, the need for a formal plan of growth, a business plan if you will, that shows the masonry operation's present position, the goals you think feasible and, most importantly, a chart showing the path to those goals that will enable you to manage that growth for maximum profits - for many years to come.


About the Author

Mark E. Battersby is a tax and financial advisor, freelance writer and columnist.

 

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