The Quick Consultant

Dare We Explain the ABCs of Profits to Employees?

By John Stewart

So you want to get back at a neighbor? While they are away, secretly drive a 10 penny nail into the side of the house. Ideally, the house will be wood-framed. Fasten a thin, almost invisible piano wire to the nail and pull it tightly through a small hole in the fence and fasten it to a stake. Apply as much tension as possible. Then, late at night, take a music wand or bow (cat gut works best) and start stroking the wire. The results are nothing short of spectacular. The house will act like a speaker cabinet and the vibrations set up through the wire are amplified throughout the house. The windows will rattle and the wood will hum. “My work made enough eerie, low frequency noise to wake up the mark and his family that night. They were terrified.” 

The above devilish prank is only one of more than 370 tricks described in a book sent to me by a reader of my column who obviously thinks he has a handle on my disturbed sense of humor and fair play. Titled, “Spite, Malice and Revenge – The Complete Guide to Getting Even,” this 523-page book by Nelson Chunder and George Hayduke is an A-Z collection of every possible dirty trick you could ever wish to pull on someone who had done you wrong. 

My friend, knowing that I see myself as a caped crusader out to right the wrongs I see around me, told me he knew I would love this book and I do. As a printer, this book can come in exceptionally handy, since we are often forced to deal with all types of low life’s and other unsavory business characters who like to take advantage of us. Whether your “mark,” as the author refers to them, is a swindling auto dealer, a malicious banker or a politician who has stuck you with an unpaid invoice, there is an A-Z listing of ideas guaranteed to help make your victim’s life miserable. 

Some customers just need to be taught a lesson. Here’s another idea from the book. Purchase a small bottle of “animal scent” or “musk” from a hunting goods store. “If applied anywhere,” says the author, “the smell lingers a very long time.” Fill a syringe with the scent, and insert the needle through the weather stripping of your “mark’s” car door and squirt away. Not only would the smell make the car almost uninhabitable, but my devious imagination wonders if it might not attract many of the same animals that the musk scent was intended to mimic, and they would be found gathering around the car the next morning. 

Giving Employees the Facts

Speaking of teaching folks a lesson, I think it is time for some owners to explain the facts of life, especially when it deals with profits, to their employees. As many know, I am currently working on the upcoming Operating Ratio Study for PrintImage International. I am diligently analyzing more than 300 financial statements provided by participants in this survey. Although I only have preliminary data available at this point, I can tell you one thing for sure – owner’s compensation in this industry hasn’t changed much and it continues to hover around 12% of sales. 

Since the term “owner’s compensation” includes both corporate net profit and the salary and perks paid to a single owner, real net profitability, as taught in textbooks, is somewhat less.  

Unfortunately, many owners don’t understand either term (owner’s compensation or net profit), and thus many think they are earning or withdrawing from the business far more than they really are. Only when it comes time to sell the business and explain to a potential buyer do they begin to understand that the salary paid to the owner and profits or “excess earnings” are really two separate items.  

In any event, if owners don’t always understand profits, it shouldn’t come as any great surprise why employees take on a glazed look in their eyes when profits or the lack thereof is explained to them.  

Trying to impress upon a DTP employee the importance of properly charging for all time spent on a job, or trying to convince a press operator or bindery operator how disastrous it can be to re-run a job due to a mistake that slipped by is a constant challenge in this industry. Most employees don’t understand, and because they don’t it can cost your company dearly.  

So here is my challenge. Call a company meeting outside of normal work hours. Yes, you will pay them for their time. It should take no more than 30 minutes but you will have to be the judge. Before you have the meeting, you have to do two things. First, go to the bank and get 100 single $1 bills. Put the bills away for later. Second, set up a dry erase board or a flip chart so that everyone can see the examples you are going to use. Now, let’s have the meeting. 

An Employee Profit Test 

Tell the group of employees this is just for fun and no grades are being given. Tell them to pretend they are in the construction business and they have just finished building a small shed. Tell them to assume that they had to hire employees, buy lumber, paint and nails as well as some bags of concrete for the footings. They also had to pay for permits. Conclude your listing by telling them that after all invoices were totaled, the costs came to $1,000. These are the facts they have to work with. Write that down on your board. 

To make it even more interesting, tell them there are no tricks to the question that follows, but tell them to imagine that their life hangs in the balance depending upon whether they give the correct answer. 

Now ask them if all the costs indeed totaled $1,000, and they were required to produce a modest profit of 12%, what must they charge the customer? I guarantee you that 90% of employees and at least 50% of owners will tell you that you that you need to mark the costs up by 12% (or multiply by 1.12). Most will add $120 to the $1,000 in costs and sell the job for $1,120 in order to make a profit of 12%. Right? WRONG! 

First and foremost, this little example and the wrong answers it will elicit simply demonstrates how poorly our children are being educated these days. Then again, this simple business example has been fooling folks for years. Tell owners something costs $500 and it sells for $1,000 and many will tell you they are making 100% profit. Hogwash! 

Remember, we did not ask the employees to “markup” $1,000 by 12%, we asked specifically what did we need to sell the job for in order to make a 12% profit? There is a big difference. In this case, those who chose to sell it for $1,120 actually produced a profit of 10.7%, not the 12% they were assigned. 

This is the example you need to write down on the flip chart:  

                        Selling Price…              $1,120.            100%

                        Total Costs…               $1,000.              89.3%

                        NET PROFIT…        $   120.              10.7%

This example can be further clarified by demonstrating that $120 divided by $1,120 equals 10.7%. 

The employees thought they would be making 12% profit, but instead, ended up making 10.7% instead. What should the employees (and some owners) actually do in this scenario to solve the problem? If you know all of your costs, and you want to make a specific profit percent, you divide the total costs by 1 minus the desired profit percent. In this case, you would divide $1,000 by .88 (1-.12), and thus arrive at $1,136 as a required selling price.

Selling Price…              $1,136.            100%

                        Total Costs…               $1,000.              88%

                        NET PROFIT…        $   136.              12% 

By the way, I can’t tell you how many times owners have taken the cost of an outsourced item like business cards and marked it up by 50% or multiplied it by 1.5 thinking this would result in a profit of 50%. Never, never confuse or substitute marking up a price by a percent with achieving a desired profit margin. They are different! Thus, in the earlier example above, multiplying costs by 1.5 or using a markup of 50% will produce a profit margin of only 33%. Once again, with these types of errors being made, it is no wonder that some owners make as little money as they do in this industry.

Ok, we’re finished with employee lesson #1. Now let’s move on to lesson #2. We’ve still got a few minutes left. 

Bringing It Closer to Home    

Ok, now let’s get the employees to look at your own company for a few minutes. Since most employees don’t understand profits, I think it is important for owners to sit down with their employees and explain it in some detail, without necessarily “giving away the farm” when it comes to confidential data. 

Tell the employees we are going to start off with simple statement of fact. Tell them,“We just received $100 in cash for a job we produced in back. It involved a minimum typesetting charge and some basic printing and cutting.” Now ask them, “Does anyone want to venture a guess, remember there are no tricks here, as to how much money we will make on that job after all the bills are paid? Any guesses?” If you do get some guesses, write them down on the chalk board or flip chart. 

Continuing, you tell them, “Now, I’m going to tell you exactly what happens to this $100 in real life, not only in the industry at large, but in this company in particular.” 

Pulling Out the Stack of Bills 

Now you pull out the stack of $100 bills and put it on the table, or better yet, push it over to one of the employees and tell her she is in charge of paying all the bills.  In the simplest terms possible, using accurate industry statistics, you need to explain to employees exactly how that $100 is spent in your company.

First, they need to know that the average job in the shop involves paper, ink, plate material and or copier clicks. Tell them these are called “cost of goods” and that they typically run about $30 on a $100 job. Sometimes a bit more and sometimes a bit less, but it averages $30 or 30%! Let’s say $30 for right now, so ask Cathy, the employee you’ve assigned to keep the money, to count out 30 $1 bills and hand them over.  

Next, tell the group what all the payroll and benefit costs run in your company, excluding your own. Tell them that wages, salaries, workman’s comp, health insurance, unemployment taxes and employer FICA contributions total another $31 or about 31%. (Sadly, some employers don’t even have a handle on this number.) Ask Cathy to fork over another $31 in singles. Remind them that when you talk about payroll expenses it doesn’t include a basic salary for you. That is an additional expense you will deal with later.  

Last but not least, list for them all of the typical costs and expenses listed under “Overhead” expenses. Mention building rent, accounting fees, advertising and phone expenses, heat, AC and other utility expenses. Tell them about the auto insurance, interest expenses for all of the company loans, leasing costs to rent the copiers (or whatever), along with repairs and maintenance costs. Ask them to mention some expenses they might know. Go down your own list of expenses. Tell them about building and liability insurance. Don’t forget auto insurance. Make it as real world as possible. 

Conclude by telling them that the average company in this industry will end up with at least $27 worth of expenses for each $100 in sales, and then ask Cathy to fork over another $27. Note that this stack represents 27% of sales. Each time you receive a disbursement, write the amount and the percentage on your chalk board or flip chart. 

Your flip chart should look like this:  

Cost of Goods…          30%

Payroll…                      31%

Overhead Expenses      27%

Total…                       88% 

Breaking the Profits Down 

Ask Cathy to slowly count out the remaining currency. Hopefully, assuming she hasn’t pulled a fast one, she will have $12 left. Ask your employees if it would be Ok with them if you could have, as owner of the company, say 4% or $4 of what is left from of each sale for a small salary for yourself. Remind them you never received any money on this job like they did. Surely that isn’t too much to ask for, you might note. Now, you have $8 left.  

Ask them if they think the company needs any new equipment and ask them to list it for you. Then tell them, as owner, that you believe the company should put aside at least another $5 or 5% to help pay for this new equipment. Now we’re down to $3. Ask them if they remember the last time business was really slow and note that everyone still got paid, even though the company lost money that month. Ask for another dollar to be put in a “rainy day” account or reserve and note how much is left. Ask them, if in addition to a modest salary, they think you are entitled to take out at least $1 dollar as a bonus. Remind them of the risks you have taken. Most will agree. 

We’re now have $1 left in the pot. Ask them if any of them think they deserve a raise and hopefully most will raise their hands. Ask Cathy to hold up what is left – She will be holding in the air a single $1 bill. Then tell them you agree, and ask anyone if they have change for that dollar so you can all divide it up.  

At the end of this demonstration, your flip chart or chalk board should look something like this:           

            Distributing our $12 in Profits:

            What’s left… (Profit)                            $12.00

            Basic Salary for owner                          -$  4.00           

Put aside for new equip.                        -$  5.00

Contingency (slow months)                   -$  1.00

            Add’l payment for owner’s risk -$  1.00

Left over for employee raises                -$   1.00

Left over from $100 job?                      $   -0- 

This may be too simplistic for a few employees, but for others it will be a real eye-opener!

Conclusion 

If you want, you can conclude your meeting with a demonstration that explains exactly what happens when you company makes a mistake in either typesetting, press or bindery and you are forced to rerun that $100 job.

What happens? Gather up the $100 in bills and dramatically throw them in the trash can. Now explain what is involved to recoup that $100. Explain that we didn’t just lose the $12 we would have made in profit on that job, but rather we just lost $100. We threw it away, remember? Ask them to calculate how much in new, additional sales would be required to generate the $100 lost because of a mistake.

How much new work do we have to generate? In order to recapture the $100 we just threw away, we will have to generate $833 in additional sales at 12% profit to generate that $100! ($100 divided by .12) You should also note that the lower the profit margin, the greater the “replacement sales” need to be. As an example, at an 8% profit margin, you would have to sell $1,250 in order to make up for that little $100 job we threw away in the trash can. 

Well, at least this is food for thought.