The Problem Scenario
The story I am about to outline is based on real conversations with firms offering skilled services. This story exposes common cash flow problems in service-based businesses.
For simplicity, we will create a single firm and call it ‘the dealer’.
Our dealer was deeply frustrated. His pain came from chronic cash flow shortages. The harder the dealer worked the worse it got. Our dealer worked with his spouse. Over the years of hard work, with little to show, the tensions rose, at both work and home.
Selling more only aggravated the problem, so the dealer purchased the latest software to help ensure details were tracked, quotes & invoices were correct, and inventory was tracking well. Nothing seemed to be working.
The dealer had strong technical knowledge and experience, however he hadn’t learned to read financial statements, which were typically done once a year for tax purposes.
Our Dealer’s labour rates were low but not enough to explain the cash flow shortage. He believed he needed to keep his rates low because clients always push back on labour. Equipment margins were in line, because he knew he needed good margins to make a decent profit and he knew that his customers rarely pushed back on product prices.
Labour however, was a different matter. This is a common cash flow problem in skilled trade businesses. Despite strong product margins, unless labour is treated with fair margins, the firm will struggle to maintain adequate cash flow, and at minimum profits will suffer.
Firms that don’t have the luxury of product sales, or where their product is a very small percentage of overall revenue, learn very quickly that labour rates and efficiencies are critical.
Many things could have contributed to the low margin. It could be timing, meaning costs and revenues were not properly matched within the period incurred. It could be a billing or collections problem, where not everything was properly bill or clients were unwilling to pay the invoice as billed prompting a reduction in the invoiced amount. Both timing and billing seem unlikely because the equipment margins were in line.
Comparing labour costs with revenues, however, exposed the problem. Our Dealer’s labour revenue as a percentage of sales was very low. In addition, the cost of labour was very close to the labour revenue being generated, so there was close to no real margin on labour. Further, the Dealer admitted that he always discounts his work, believing that clients need to see a deal to feel good about doing business.
The primary issue was what the dealer believed was necessary to close business.
A lot of us are guilty of avoiding uncomfortable conversations. The bias towards product over labour is not new. Many salespeople (even owners) stay fixated on the product, because it is easy to point to specs, to talk about features and to feel good about exchanges that play to their knowledge. Taking the time to be knowledgeable about quality, service and what it takes to actually get the most out of the product, paves the way to talk about your firm’s value and is a great opportunity to educate and lead the conversation.
This in turn differentiates your firm by educating your prospects about your business culture, processes and experience. And this education can give clients the confidence and awareness to ask more informed questions of your competitors. In many ways, this raises the bar for everyone.
The 6 Limiting Beliefs to Overcome
Here’s a list of typical limiting ‘belief’s’ that can leave money on the table and create common cash flow problems in skilled trade businesses:
1.) Clients won’t pay what it takes:
Knowing what a good job looks like, who the right client is, is half way to profits. If the client you are speaking with won’t pay what it takes, move on. You’ll likely be surprised that the right client will indeed pay what it takes. A great phrase to take into any presentation is ‘get to either ‘know’ or ‘no’ fast’.
2.) Educating the client on labour is risky:
Your labour is your only real product; it’s at the core of who your firm is. This is your differentiator. If you think they aren’t competent enough, train them or find new guys. Help clients understand that the ‘product’ is nothing without the installation. Experience creates systems that perform; products are only a component of that system.
3.) Margins on the product will cover labour:
There is risk and overhead inherent in product, so it needs its margin, just as there is risk and overhead associated with labour. They both need margin.
4.) Clients expect discounts:
Clients don’t expect discounts, they expect value. There is a big difference. Here is a pitch if they ask: ‘Mr. Client, if I discount you, I need to add margin to cover that cost because I know you need me there to service your project. I have to be competitive to stay in business and I have to price right to ensure I meet your expectations.’
5.) Fixed contracts are necessary to close business:
This depends entirely on the complexity of the job. Managing project sizes can require different pricing strategies. Large integrated projects, that can take years, should be sold on the basis of time taken, not fixed ‘hopeful’ expectations. Better for everyone to be watching and managing progress including the Contractor, the client and the dealer. Time based contracts, in more complex situations, serve everyone.
6.) It’s better to sell below margin to keep my staff working:
There are many ways of making idle staff more productive during slower periods. Looking at the end-to-end process can reveal opportunities to work on projects at the shop, keeping labour productive and moving the project forward, in spite of site availability. Also, creating partnerships with local quality trades, to share your idle capacity can be a great option. If this is a chronic issue, it would be far better if the firm were delegating to contractors, and finding a healthy manning level, then to subsidize the client’s project.
Cash flow shortage is always a symptom not the cause. Better not to be in business, then to work hard for very little, if any return.
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Marilyn Sanford is the co-founder and CEO of LincEdge.
In the past, she had co-founded and ran a custom install firm for 23 years.
You can find Marilyn on LinkedIn.