Rick Phelps

Synchronous Solutions

Just like a professional baseball team, your fabrication business has a salary cap. And like in baseball, the league sets your salary cap!

That’s right, the league you want to play in sets your salary cap. If you want to play in the minor leagues, then ignore the salary cap and earn single digit returns – there are lots of players in the minors…

If you want to play in the big leagues and earn 15%, 20%, or even more fabricating countertops, then read on!

The math is simple, but to calculate your salary cap you will need to understand Throughput Accounting and how to calculate Throughput Dollars ($T) and your $T Ratio – the percentage of revenue that your $T represent.

You will also need to understand your Income Statement (P&L) and Balance Sheet.

From your Income Statements, calculate the percentage of Revenue that you spend on materials with your suppliers. The industry average is around 35%... Take that percentage and subtract it from 100% and you have your $T Ratio - the percentage of your revenue that stays in the business to pay your bills. Across the industry the $T Ratio averages about 65%.

Next, calculate how much money you spend each month NOT COUNTING material costs. We call this your Operating Expense, or $OE for short. You can get this number from your P&L, but you will need to check your Balance Sheet to make sure you don’t have monthly payments on capital that only show up only on the Balance Sheet. Add all your monthly payments to calculate your average monthly $OE.

As you are calculating your $OE, break your expenses into two categories: 1) LABOR: Anything to do with Labor (direct, indirect, contracted out…), and 2) FIXED: everything else.

You now have all the ingredients you need to calculate your salary cap, so let’s work an example.

To keep the math simple, our fabricating business does $1,000,000 in Revenue a month. Materials are 35% or $350,000 per month leaving $650,000 $T. Our total $OE are $550,000 per month, so our business makes $100,000 per month in Net Profit ($NP) for a 10% Return on Sales.

$NP = $T - $OE

$650,000 $T - $550,000 $OE = $100,000 $NP

Of our $550,000 $OE, $400,000 is Labor, which means $150,000 is Fixed.

Example: Next year we plan to grow our Revenue by 15% to $1,150,000 per month and achieve an average 15% Return on Sales. What is our Salary Cap, assuming our Fixed expenses stay the same?

Revenue: $1,150,000

Net Profit: $172,500 (15% of Revenue)

$T $747,500 (65% of Revenue)

$OE Fixed $150,000

$NP = $T – $OE Fixed - $OE Labor

$OE Labor = $T - $NP - $OE Fixed 

$OE Labor = $747,500 - $172,500 - $150,000 

= $425,000

To achieve our objectives, we will need to hold our Labor costs to $425,000 per month, an increase of just $25,000.

With a little bit of math and a lot of discipline, and you can improve your bottom line and achieve your objectives.

Yet so few actually do…

Knowing things like your Salary Cap are critical for your success in business. If you weren’t aware before now of how to do this basic analysis, don’t sweat it! You could have invested in an MBA and STILL not know these basics!

We help business owners create amazing businesses. It’s not rocket science, but it is logic and scientific thinking!

If you need help with your strategic planning, reach out to us at Synchronous Solutions! Contact us though our website www.synchronous-solutions.com/contact-us/.