How Much Money Do I Need? - Part 2
A hard look at the financial end of starting your own woodworking business - June 18, 2000
Excerpted from Chapter 7 of Profitable Woodworking: Turning Your Hobby into a Profession
By Martin Edic
How Much to Pay Yourself
You'll notice that I picked a number as salary for the example of $15 per hour. Your choice of what to pay yourself, aside from profit, should be based on what you would have to pay a comparably skilled worker in your marketplace. If your competitors are paying their workers $5 an hour and you pay yourself $15, your bids won't be competitive. You must be realistic.
Cash Flow and Profits
I've mentioned cash flow and profits several times. I waited to provide definitions of these key money concepts because I knew they would be clearer after I walked you through some of the money considerations. Cash flow has been described as the lifeblood of any business. It is the flow of money through a business that pays the bills, buys the improvements and keeps things running. A business can be successful and still have cash-flow problems because of late payments from customers or the necessity to provide up-front funding for a big project. For this reason and others, cash flow is one of the main things that a bank looks at when considering a loan application. A business that is only marginally profitable but has a steady cash flow is more likely to pay its bills regularly and stay afloat than a business that makes big money erratically.
Keeping your cash flow steady can be hard when you're waiting 90 days for a final payment on a big commercial project. For this reason, many woodworkers will be willing to take work that isn't particularly profitable in order to pay the bills. Often, developing a product line on the side can help with cash-flow problems even if the products aren't very profitable.
As an entrepreneur you'll receive profits as your reward for owning your business (or you'll have to absorb losses). Profits come from marking up your prices to reflect your value-added expertise and skill. These profits may be reinvested in your business to help ensure its growth, to update tools or equipment or to increase your marketing effectiveness. Or you may pocket them, or do a little of everything. If you have a good year, you'll want to consult your accountant and/or a financial planner to determine the best action to take.
Building a profitable business is the most common route to wealth in our society. A recent survey of the thousands of millionaires in the United States revealed that the average millionaire owns a comfortable but unpretentious home, has normal spending habits and is the owner of a small to midsize manufacturing company. If you ever decide to sell your woodworking business, your profits may well be the major determinant of the sale price.
Estimates and Quotes
Pricing your work is one of the most daunting tasks facing the newly professional woodworker. This is particularly true when you are bidding competitively against other woodworkers. The only way to handle these situations is to estimate the job at the price you can afford and take your chances. There will always be companies that will drastically underbid work, and getting into a price war with them is a waste of time. Once you get a reputation for being the cheapest guy in town, your customers will always expect rock-bottom prices, and the customers interested in good quality will go elsewhere. Stick to your price and don't spend a lot of energy worrying about jobs that got away. The work you lowball always tends to be the biggest headache. (This could be called the Murphy's law of self-employment.)
You'll be faced with the decision to quote a price or an hourly rate. In general, I recommend an hourly rate for repair jobs or situations where you won't know what you're getting into until you're there. For very small jobs, most shops have a minimum, usually two hours at shop rate. Doing $20 jobs is not worth the effort unless you have nothing else to do. If you're working hourly, you can quote your shop rate. Try to stick to it.
In general, it is always preferable to give a total quote for a project. Large projects are a challenge, but eventually you'll know when you're in the ballpark. Until you've made enough bids to do them with confidence, you can use the following list to develop a method that will work for you.
- Using your shop rate, divide the job into tasks and calculate how long it will take you to do each task. Don't forget to include time spent in meetings, on the phone, tracking down materials end suppliers and something extra for unexpected problems. Total the hours and multiply by your shop rate.
- Calculate your total materials cost and add 15% to 20% for a markup to cover your resourcefulness. Remember you can get better prices than a walk-in consumer and have access to more suppliers. Give yourself a profit on the items you resell to a customer. Shop supplies such as glue and sandpaper are built into the shop rate, unless you will be using an unusually large amount, in which case you may want to add them to your materials cost. When you order materials, be sure to account for the large amount of waste resulting from the work. Anyone who has milled rough lumber knows that at least as 50% or more of what you buy ends up as scrap or sawdust. Also there will be a certain amount of unusable material caused by checking, discoloration, warp, etc.
- Total your shop time and materials and consider the number. This is where experience and your personal assessment of the situation come in. If you are much higher than the range the customer wanted, you must either cut your price or scale down some phase of the job. In general, it is always a good idea to stick to your price if customers balk and show them places where they can cut corners by reducing the amount of work or features put into the project. Lowering your price without changing the project will undermine your credibility.
- Type out a professional-looking quote that is straightforward, clearly written and has all the information the customer wants. Potential problem areas should be clearly spelled out with a method for dealing with them. These include change orders, mistakes in design that are not your fault and any other unexpected problems. The quote can be on a form that becomes a contract when signed by the customer and you. It should clearly spell out a completion time, terms for payment and what is included. Use your letterhead and be professional. These forms are available as two part Quote/Contract forms at any office-supply store. You can use the format and boilerplate language from these forms for your customized estimate or use the generic ones. Type, stamp or write your business information on them.
- Present the quote to your customers and make sure it is clear to them. Don't apologize or start explaining your prices. In this situation, the first person to make an excuse or concession is the loser. If they are happy make sure they sign the quote. Usually your terms will be to start the job upon receiving the signed quote and a deposit.
Although it is hard to say no to work, there are situations when it is more professional to stick to your guns. If you feel that your price will be too high for a particular customer, you must decide if you want to do the work for less before you present your price. Don't start any job without a signed contract and deposit, if required.
Preparing and presenting bids is part of the overall sales and marketing operation. You'll learn a great deal by listening carefully to the customer's desires and needs during your initial meeting. Take some notes, defining any "hot"-button topics your customers emphasize. Make sure you address those concerns in the bid. If your bid proposes solutions to their specific problems you have a far better chance to win the job than you would with a cheap price and superficial bid that didn't address their concerns. Good salesmanship can mean more money on each job.
Product lines have a different set of criteria when it comes to pricing. We'll look at pricing a product in detail in Chapter 10.
At some point you may need help to run your business profitably. The decision to hire an employee or employees is a big one because of the responsibility it entails. When you hire someone you are agreeing to provide him or her with work and pay, whether you have that work or not, unless they are temp workers or subcontractors. If they are subcontractors, you cannot, by law, ask them to show up at certain hours or work for an hourly wage. Before you work with a subcontractor, be sure to review the laws with your accountant and lawyer. If you violate the legal description of a subcontractor relationship you may be liable for back taxes, withholding, worker's compensation and other deductions you should have taken.
Temporary employees work for an agency that takes care of all their payroll and insurance needs. You contract with the agency for their workers. While it sounds ideal, it is expensive and you will discover that it's difficult to obtain skilled workers.
Permanent employees are people in whom you invest a considerable sum with the hope that the work they do will more than justify the cost of having them. Your expense is not just monetary. You must train them and provide a safe environment and various perks, including medical insurance, vacations, etc. Because they are an investment, the decision to take on employees is based on need. If a helper can save you more time and money than it costs you to hire him, then you may be making a justifiable business decision. If you are a loner who likes to make your own hours without being beholden to anyone, an employee may be too much of a burden.
The wage you pay a worker is based on the prevailing rates in your area, his or her skill level and the availability of good-quality people. You'll have to try out a wage and see if you can attract the skill level you need. You can use part-timers, college students or even an intern from a local trade school. Using part-timers is a way to try out an employee before making a commitment to bring on someone full time.
Payroll also includes Social Security withholding, worker's compensation insurance and other withholding required by state and federal laws. You must withhold taxes and document your actions. For a small-business owner, the paperwork can be overwhelming. Fortunately there are payroll companies that will handle all the paperwork for a small monthly fee. For most small businesses, the expense is more than worth it, since payroll companies save you time and help you avoid legal and taxation hassles. Look under Payroll in the Yellow Pages.
Return on Investment
Throughout our discussion about the role of money in your woodworking business, I've emphasized return on investment. Your money should always be earning interest in one form or another. If it sits still, inflation eats away at it, reducing your net worth and the value of your labor. The money you invest in your business helps you earn a living, builds an asset that you can sell or pass on to others, and provides jobs and other benefits for society. It's important to keep an eye on how well your investment is performing, whether it is invested in a piece of machinery, a brochure or training an employee. You should realize a gain form all of your dollars. Your accounting system and your accountant can help you to track both the tangible and intangible gains (or losses) you are realizing.
At times you may have substantial sums of cash on hand. Good money management means making sure that these short-term cash hoards earn money while you have them whether you sweep them into a money-market account or use a cash-management account that automatically does this for you. Make sure it is a "no-load" account (without excess fees). You may also want to talk to a certified financial planner to arrange to put a portion of your profits to work for your retirement. As a business owner you are entitled to various tax-deferred investment strategies that can make a difference in your economic situation for years to come. Be sure to start taking advantage of them early in the life of your business. Every year of investment has an impact on your overall return later.
Money is of major importance in being a profitable, professional woodworker. It is a significant measure of your success and can mean the difference between long-term comfort and mere survival. Become knowledgeable members and keep up-to-date with your books and you'll succeed. Ignore money matters and you may find yourself wondering what happened to your once-pleasurable business.
Excerpted with permission from Profitable Woodworking Copyright 1996 By the Taunton Press Inc. - All rights reserved. For information on ordering a copy of this book, call 1-800-888-8286.
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