I was asked recently by a subcontractor how they could increase their bottom line. They had fallen into the trap of believing increasing revenue would increase profit. In fact by increasing revenue they were going broke quicker.
Whether it is the overall business or an individual project the principle is the same. Revenue is usually determined on a fixed price contract and costs are controlled by the business and on projects, the on-site team.
The table below set out the difference in increasing revenue or reducing cost:
| Current | Required | Difference | % | |
| Increase Revenue | ||||
| Revenue | 10,000,000 | 13,636,364 | 3,636,364 | 36.4% |
| Costs | 9,500,000 | 12,886,364 | 3,386,364 | 35.6% |
| Gross profit | 500,000 | 750,000 | 250,000 | 50.0% |
| Margin % | 5.0% | 5.5% | 0.5% | |
| Reduce Costs | ||||
| Revenue | 10,000,000 | 10,000,000 | 0 | 0.0% |
| Costs | 9,500,000 | 9,250,000 | (250,000) | (2.6%) |
| Gross profit | 500,000 | 750,000 | 250,000 | 50.0% |
| Margin % | 5.0% | 5.5% | 0.5% | |
My subcontractor friend is not an accountant. COGS, EBIT, work in progress, accruals etc are a foreign language to him. He simply wants to make more money.
In this example I demonstrated how to increase his annual gross profit by $250K. So I explained based on the above if he reduces his costs by 2.6% he will increase his gross profit by $250K. To achieve the same by increasing his revenue he needs a 36.4% increase ie another $3.636M, along with more risks on variations not being approved, more clients who may pay slowly and this does not allow for maybe more overheads to handle the increased turnover.
This sounds simplistic because it is. Costs are variable and under our control, but we have to fight for every cent of revenue not included in the contract.
PREMDALE CONSULTING 