Have you ever been in a meet­ing and half way through felt like you were going to be sick? You learned that some­thing you have been doing for a very long time wasn’t accu­rate and was caus­ing you to make deci­sions on mis­in­for­ma­tion. We recent­ly had this very con­ver­sa­tion with a client, how­ev­er by the time the meet­ing was over, that sick feel­ing had van­ished, and the busi­ness was mov­ing for­ward with accu­rate infor­ma­tion that will dri­ve bet­ter busi­ness deci­sions. So, what exact­ly hap­pened?

Dur­ing this meet­ing with our client, we were dis­cussing the esti­ma­tion process and how the busi­ness came up with their esti­mates and the rates used in the esti­mates. For the past cou­ple of months in meet­ing with this client, we were strug­gling rec­on­cil­ing the finan­cial results of the busi­ness with the net income mar­gins the busi­ness own­er was say­ing their projects gen­er­at­ed. The finan­cial state­ments showed a net income mar­gin of between 7–10% con­sis­tent­ly month after month, how­ev­er the projects esti­mat­ed a net mar­gin of around 22%.

Was there an effi­cien­cy prob­lem and the hours worked on a project exceed­ed the esti­mate on a con­sis­tent basis? Was there an issue with the esti­mate and not all the work that was required to be done being cap­tured in the esti­mate? As we con­tin­ued to ask ques­tions and dive deep­er, it was deter­mined the main cause of the dif­fer­ence was due to the fact the busi­ness didn’t under­stand what their ful­ly loaded cost rate was.

The busi­ness thought the rate they were using of $50 per hour was the ful­ly loaded cost rate to cov­er the cost of their oper­a­tions labor along with all the over­head of the busi­ness. The actu­al ful­ly loaded cost rate was $62 per hour. There were costs not being account­ed for by the busi­ness in their rate. This explained every­thing and now the finan­cial results made sense. Some­thing as sim­ple as the cost rate was caus­ing the vari­ance between what the finan­cial state­ments were telling us and what the pro­ject­ed net income mar­gins were show­ing.

At first, there was a look of shock on the busi­ness own­ers face when learn­ing what was hap­pen­ing. Instead of think­ing they were mak­ing 22% net income mar­gins on a project they were real­ly only mak­ing a 7% net income mar­gin. After pro­cess­ing the infor­ma­tion, it did make sense to him and fur­ther explained why he didn’t think the busi­ness ever had enough cash in their accounts or as much as he thought there should be.

Although this was not the answer the busi­ness own­er was look­ing for, the busi­ness own­er now had a clear under­stand­ing of how the busi­ness was per­form­ing and the sick­ness in his stom­ach start­ed to ease. There might be projects that before the busi­ness would take on, but now may steer away from because they know they will lose mon­ey on the project or only take them on if there is excess labor capac­i­ty. They now also have a plan in place to look at oppor­tu­ni­ties to increase their billing rate or cut excess over­head cost to improve their net mar­gin.

This exam­ple shows how impor­tant it is to have accu­rate infor­ma­tion when mak­ing busi­ness deci­sions. This small busi­ness isn’t alone, we see many busi­ness­es that make deci­sions based on infor­ma­tion that isn’t accu­rate or some­times no infor­ma­tion at all. This leads many busi­ness­es won­der­ing why the actu­al results of the busi­ness do not line up with what they think should be hap­pen­ing and cause frus­tra­tion and a feel­ing of con­stant defeat.

If you feel like you or your busi­ness is in a sim­i­lar place and you would like to dis­cuss, feel free to reach out to any of us at Mack­ey Advi­sors (859) 331‑7755.