Painting Profits Unveiled: Know Your Margins

Welcome to the Profitable Painter Podcast. The mission of this podcast is simple: to help you navigate the financial and tax aspects of starting, running, and scaling a professional painting business. From the brushes and ladders to the spreadsheets and balance sheets, we've got you covered. But before we dive in, a quick word of caution: while we strive to provide accurate and up-to-date financial and tax information, nothing you hear on this podcast should be considered as financial advice specifically for you or your business. We're here to share general knowledge and experiences, not to replace the tailored advice you get from a professional financial advisor or tax consultant. We strongly recommend you seeking individualized advice before making any significant financial decision.

This is Daniel, the founder of Bookkeeping for Painters.

This is Richard, tax director. How's it going, Daniel?

Going well. It's been a while since we've recorded together was getting through tax season.

It has been. In case folks don't know, I took a little hiatus from the podcast for the first few months of the year to get through tax season. But I'm back. I know. I'm sure nobody missed me, and that's okay. But it is nice to be back.

Yeah. A few more gray hairs. I've noticed. Since before tax season?

Yeah, you know, every tax season has its own challenges. This one is no different. They keep making changes to the tax code. And so you really have to kind of stay up on things.

Yeah, job security.

Job security, man. I tell you, there's nothing— there's nothing more assured in life than death and taxes. So it's either mortician or tax planner. And, uh, I, I don't know if I picked the right one, but, uh, at least I got job security.

Yeah. Yep. Cool. Well, today we are going to discuss knowing your margins, trying to help folks understand their numbers. A big part of what we do. And so hopefully this podcast will help you understand, uh, when you're looking at your profit and loss, what it is, what is you're looking at, and also what numbers should you be hitting So we're going to go through some basic definition of terms because a lot of times it can get confusing with a lot of different, a lot of different terms and people say them in a different way. And, you know, there's like a lot of jargon associated with this stuff like COGS and EBITDA to make things more confusing. So we're going to go through definition of terms, make sure everyone's on the same page, and then we'll go through what should you aim for in your margins? We're going to give you basically what we've seen the best painting businesses, what kind of margins are they hitting, what their numbers look like for different stages of a painting business. So hopefully this will be a good reference episode for you in your journey.

Yeah, you mentioned that, uh, it makes it more difficult because these things have different names, and I thought just off the top, you know, We're going to go over a profit and loss statement. Don't you mean income statement? No, because the statement itself literally has different names. So, yeah, you know, us crusty accountants, we tend to stick with the traditional income statement, but profit and loss, P&L, it's all the same thing.

Yeah, technically it's under GAAP. It's the only— if you're using GAAP, then it's an income statement, but everything else is a profit or loss. So there's actually the, um, AICPA has like rules on if you can call it an income statement or not. So, uh, yeah, so unless you're following GAAP strictly, it's going to be a profit and loss is the, uh, is the right— but yeah, you're right, it's all these different terms. And so we're going to be talking about those definition of terms. So if you're looking at your profit and loss, or which you might hear other folks refer to as an income statement, the, the first thing you see at the very top is revenue, or even some, depending on your software, might even say something else like, uh, total income or, uh, gross sales. So there's even, you know, that, that term revenue might be substituted for a few different things, but it's basically the thing on the top. That's revenue, total sales, gross sales. Total income. That's, that's the money coming in from your customers without anything taken out.

So when they talk about growing your top line, that's what they're talking about, right? The— you're increasing the total amount of money that comes into your business without regard to expenses and things like that, right?

Yeah. And just this first one, I mean, there's so many different ways to say revenue. Uh, I think in QuickBooks Online it doesn't say total income. I want to say it does.

Now, like, I was taught that the term revenue refers to like gross revenue, money coming in without regard to expenses, and income is more of what you have after you factor out all of your expenses. I don't think that's a hard and fast rule. I still kind of stick with that. But tax returns will say total income when they're talking about top line. QuickBooks will say income. So yeah, I mean, again, it's, it's, it's whatever you feel comfortable calling it as long as we understand, right? It's the top line there, the gross sales or the gross income.

Yeah, and then right below that section, that top line, is the cost of goods sold section, or sometimes referred to the cost of sales, cost of services. So it's basically the section where your direct costs are supposed to be in there. So this is like your direct materials, your paint and supplies, and then your direct labor employees or subcontractor crews working on the job site. That's the cost of goods sold section. And so that's the next section there. And then right below that, it should be gross profit margin or gross profit. And so gross profit is what's left over after you take your revenue and subtract out your cost of goods sold or COGS. Some people refer to it as COGS. That's another piece of jargon. Someone says, what's your COGS? The cost of goods sold. But anyway, so gross profit margin is revenue minus your cost of goods sold equals your gross profit margin. And that's a key number for painting businesses. And, you know, the average gross profit margin is 40%, and that's kind of the average across the industry that we see. And again, that's your revenue minus your direct materials, job site materials, and you minus your direct labor, job site labor, equals your gross profit.

And we want that gross profit to be, you said, 45%? This kind of the goal?

Well, the average is 40%, uh, so you typically want to shoot for better than average, so I typically recommend 50% gross profit margin. And again, the percentage is what's left over divided by the revenue. So, you know, if you're— you have a house that you painted, you charge the client $10,000, you paid $3,000 for the labor and then $2,000 for the paint and supplies, that your cost of goods sold is $5,000, $3,000 plus $2,000. What's left over is, you know, $10,000 minus the $5,000 cost of goods sold equals $5,000 of gross profit. And so if we take $5,000 divided by what we charge the client, that's of $10,000, we equal— that equals 0.5, which is 50%. So again, the percentages, you're— whenever we say percentages, we're basically talking about taking that number and dividing it by their top line revenue.

All right, so a nice rule of thumb is when you go to bid a job you debit it twice as much as it's going to cost you in paint, supplies, and labor.

Yeah, exactly. As a general rule of thumb, for sure. Yeah. Um, so that's gross profit margin. And then there's another similar one, which is contribution margin, or some people might just say margin. And so this is where it kind of, kind of gets confusing when people are talking about what's your margin percentage or what's your, what's your contribution margin, what's your gross profit margin. People are usually using different words to mean different things and it can kind of get confusing. So gross profit, like I said, is what's left over after you pay for direct cost, materials and labor. Contribution margin is what's left over after the same thing, but also some other variable costs. So variable costs are usually things related to production, job site production. So these could be things like auto expenses, because a lot of times you're, you know, driving from— making trips to the paint store, going out to the job. Those types of things are variable. Based off of how much production you're doing. And so that's a variable cost that you can include up above the line, which we'll come back to that phrase above the line in a second. But you can include that in your calculation for contribution margin. And then payment processing fees might be another one. It's a variable cost because your payment processing fees are gonna go up as you charge your clients more more money, you know, because Stripe or Square, they're charging you a percentage of, of, uh, whatever you're processing through them. And then, then another one might be production managers. You might pay them, uh, bonuses or commission based off what they produce in, in, in, in the amount of jobs or the, the value of jobs that they're doing. So that might be another variable cost that you have. That you would include in the calculation of your, your contribution margin. And some people even include salespeople up in the contribution margin to basically, uh, use all those variable costs to subtract from revenue to get your contribution margin. So that is another, uh, um, term that folks use. So it's similar to gross profit margin, just adding a few more of those variable costs in there.

Sounds like the big difference between like direct costs and figuring gross margin and then these other variable costs is the fact that they're variable. Is that right? So like if I have to go down to Sherwin-Williams and buy paint, I have to pay whatever Sherwin-Williams is charging for that paint. You know, my, my guys, they, they get paid a certain amount per hour. I have to pay them to do the job. These other expenses like vehicle expenses and bank processing fees and things like that, they are tied directly to the job because we wouldn't have these expenses if we weren't doing the work. But maybe there's more flexibility in controlling them. Like maybe I can, you know, choose to drive less or drive less expensive vehicles or maybe find a better payment processor with cheaper fees. Is that, is that kind of the big difference between the contribution margin costs and the direct costs, or am I just thinking about it kind of weird?

Contribution margin and gross profit margin. Like you're in your— so like, yeah, gross profit margin is just like simple. Try to keep it, it's simple, simple and comparable across different companies pretty well because you can easily identify these are supplies and materials that we purchased for the job and this is what we paid our folks. So those are direct costs and that subtracts out to get a gross profit margin. Straightforward. And then contribution margin, it's very subjective. What can you include in contribution margin? Basically anything that's variable. So, you know, like you said, auto costs, paying your production manager, paying your salesperson potentially. And people have a different definition of what they would include in contribution margin. It's somewhat based off preferences, whereas gross profit margin is more— it's pretty much materials and labor for the most part. When, uh, that's what most people mean when they say that. But, uh, you know, even then it can be a little subjective, but it's a little bit more straightforward than contribution margin.

Gotcha.

Um, and the other thing that you might hear is above the line or below the line. So above the line, the, uh, so this is a different line than the top line. So the, the top line refers to revenue or total income, total money coming in. When someone says above the line or below the line, this is actually a different line that we're referring to. This is the line that is below the cost of goods sold. It's basically, um, the line between your cost of goods sold and your gross profit margin. Or your, uh, your cost of goods sold and variable costs and your contribution margin. So depending on who you're talking to and, and how they're tracking this portion of their P&L, uh, that's where the line is. It's either basically where contribution margin is or where gross profit margin is. And so when they say above the line, they're talking about the cost, like the variable or direct cost involved. If they say below the line, they're talking about overhead costs. And, um, and so overhead costs are basically anything that's not job site related. So that's another piece of jargon that you'll hear a lot, is, uh, above the line or below the line. And so this next— oh yeah, go ahead.

I was gonna say, as far as overhead goes, So now we're talking about expenses that are necessary for the business, but they're things you're going to pay each month whether you sell work or not. Right? So like if you've got a shop that you're renting, you've got utilities, rent, maybe you have an office manager, whether you sell $10 million that month or $10,000, those overhead costs are going to be there. And that's kind of what puts them below the line in that they're, they're necessary, but they're not directly tied to the work that you or the, the services that you sell.

Exactly. Yeah. They're not tied to the— they're not tied to a job or they're— if you're using contribution margin, they might be more fixed costs. Or semi-fixed, where like, for example, your insurance, there's a little bit of— it might be semi-fixed. It's somewhat dependent on how big of a— depending on how big of a company you have. But for the most part, throughout the year, that a single year, it's not going to, you know, change substantially. Or accounting cost is semi-fixed. You, you know, have an agreement with whoever you're working with. They're probably charging you about the same if your services don't change, you know, about the same amount throughout the year. But obviously as you grow a lot larger, that will change the amount you charge. So it's like semi-fixed. But yeah, those type of costs not associated with a job or somewhat fixed are going to be in overhead. And also positions that are not applicable, not have to do with not any specific job. Like obviously your crews that are working on the job site are not going to be an overhead. They should be up in cost of goods sold. And then your, your office worker would be an overhead salary. Your, uh, some, like we said before, production managers and salespeople, they can be an overhead, but but some people do track them up in contribution margin to derive that. So those are dependent on, you know, who's setting up your chart of accounts. You can do it either way. I think for comparability purposes, if you want to compare your numbers to other painting businesses, gross profit margin is like the safe way to go because it's for ease of comparability. If you know your margins really well, and you know exactly how much you should be paying, maybe contribution margin would be a good option. Um, but, uh, so overhead, not job-specific and usually fixed or semi-fixed.

And would this also include like your advertising and marketing costs in overhead?

Typically, yes. Typically sales and marketing is in overhead. Occasionally you'll see somebody put it up in contribution margin. With the idea like, oh, these are variable. Uh, it's not necessarily wrong, but most of the time you're gonna see sales and marketing and overhead cost. Um, and then that leads us into net operating income. So net operating income, also some people say EBITDA, is a very similar concept here. Basically what's left over after paying for your direct costs and your overhead, what's left over before any kind of interest, or depreciation. That's your net operating income. Some people say EBITDA, which is earnings before interest, taxes, and amortization depreciation. Um, so that's the net operating income. So then we get into the last couple ones, which is other income and expenses. Other income might be like credit card rewards, uh, or Other expense might be interest, depreciation, those, those type of things.

If you have any investments for the company or even just like the interest off your savings accounts and things like that, that would be in other income. You know, it's not directly related to your operations but is on your profit and loss.

Yeah, exactly. And then finally we get to the bottom line, or net profit, net income. Uh, what are some other words that people use?

Uh, my pocket money.

Yeah. Yeah.

Um, no, the bottom line, that's, that's the really important one, the net profit. Yeah, because that, that tells you how much you actually made, right?

Um, in, in some cases. Uh, we'll get to another term here in a second, but net profit's your bottom line, net income, what's left over after you pay for all the costs of the business, what's left over for the owners. Now sometimes as an owner, you're not just the owner of the business. You— a lot of folks that are listening to this are working in the business, and if you're an S corp, you're required to, to run a reasonable officer salary, and so you're probably running, or hopefully running, a reasonable officer salary, and your salary is on the income statement, probably in overhead, you know, as officer salary. So to really calculate what you're making in the business, you would take your net profit and then add your salary together to get your discretionary earnings, or cash flow to owner is another way to say it. Basically, what do you make in the business as a business owner? So discretionary earnings, you'll hear that. You'll hear cash flow to owner, um, and that's basically what your net profit is plus any salary that you're taking.

Gotcha.

Cool. So hopefully that— those are some definition of terms. Hopefully that makes things a little bit more clear, as can be confusing even for me on talking to people, what they're saying and what they mean by what they say. So hopefully that clears things up a little bit. The next piece we're going to go into is what should you actually aim for in your margins? And so I'm going to do a screen share. So if you're listening to this, you can go watch the, the YouTube version of this and actually see the screen, but we'll try to explain it for the folks that are just listening. So we have a growth model that kind of gives a recommendation for what you should be hitting in your margins for each stage of your painting business. We have 4 different stages. We're going to cover probably the first 3 just, uh, for this episode. And the different stages is basically foundation, which is $0 to $500K in revenue, growth, which is $500K to $1.5 million, and then expansion is $1.5 million to $5 million. So those are 3 different, uh, revenue levels. And underneath each one of these, we have recommended margins that you should hit and recommended percentages that you should be paying out for a particular expense category. So for example, for direct labor, your direct labor should typically run between around 35% of revenue. So to use an example again, if you have a $10,000 project, you should be paying around $3,500 to your, your painters that are painting that house, um, with fully, fully loaded with a payroll and workers' comp. So $3,500 should go to that direct labor. And that's 35%. That's typically where you would want to shoot for. So we'll go through 3 different models. So we'll stick with the first one, which is foundation first, which is the $0 for $500K. So this is typically a painting business owner that is doing— wearing a lot of the hats. And so we'll say that this painting business owner is the salesperson, the production manager, the, um, office worker, and also the business owner. So if— so with those different roles, their discretionary earnings, what their cash flow to themselves, is going to be a lot higher of a percentage then as the business grows. So let's start with what, what should this person make? To kind of illustrate what we're talking about here. So if the painting business owner is, you know, the salesperson, production manager, office person, and also the business owner, what should they be making? So if we take the net profit of this business, recommended percent to hit is 11.5%, then we add in salesperson, 8.5%, we add in office worker, because oftentimes, you know, with the smaller businesses, you're also doing the office work too, along with everything else, and you're also the production manager. So with those 4 different roles, production manager is 7.5%, salesperson 8.5%, office workers 4.5%, and then net profit is 11.5%. The discretionary earnings for this painting business owner would be 32% should be going to them in the form of net profit and any salary that they're running, if they're running that. Another key number to know, so that's what you should be making, but what should your gross profit margin be? Like we said before, the average is around 40%, but you should be shooting for around 50%. So we have 47.5% gross profit margin for this, this level. It's a little bit lower than the other levels because it's, it's when you're getting started, it's usually harder to— you, you don't have as much, um, authority to charge as much. It's a little bit harder getting started, maybe newer in the, in the industry, so you're not as well known. Maybe don't have as many Google reviews, so it's harder to charge as much as someone that's been around for you know, a decade plus. So that's why the gross profit margin is a little bit lower, but you should still shoot for 50%, and then maybe you'll end up somewhere around 47%.

Yeah, I imagine you still have some efficiencies to work out too with your crew. When you're just starting out, maybe you take a little bit longer than, than you should, or maybe, maybe you're not quite as, um, efficient with the materials. And as you As you grow and you learn these things, then the costs of your direct labor and direct materials will start to shrink as you become more efficient.

Exactly. So that's the foundation phase, $0 to $500K in revenue. Bottom line is if you're the production manager, salesperson, office worker, and the business owner, you should be shooting for about 32% in discretionary earnings. Cash flow to yourself, um, and a 47.5% gross profit target. Those are your kind of your key numbers for that. Um, now there's some other key numbers here on, on for this level, uh, which I'll— we'll cover here at the end. We'll go to the next one, uh, which is the growth the growth stage, which is the $500K to $1.5 million. And so typically painting business owners at this level, they are doing the, they're doing the sales, uh, and they're often at this point, they've most, or a lot of them have a production manager at this point. Not all of them, but many, many, you know, end up getting a production manager in place. And they often also have an office worker helping them as well. And so they're doing sales still and they're making a profit as the business owner. Now, of course, this might be slightly different depending on your situation. Obviously, someone closer to $500K in this stage will likely be doing production management as well and maybe even the office work. And then if you're close to $1.5 million, you're probably doing maybe less things, maybe just the salesperson role and the business owner. So let's say they're the salesperson, the business owner. At this stage, you should be getting 8.5% for your sales role and then about 14% in profit, bottom line profit. We add those together, that's 22.5% in discretionary earnings going to you, cash flow to owner, 22.5%. 5%. And then you're paying your production manager around 7%. You're paying an office worker somewhere around 4% of revenue. And then your margin, your gross profit margin, you should be shooting for 50% at this stage as a recommendation. And so that is the growth stage. Then the third one we'll cover here is the expansion. This is $1.5 to $5 million. So at this point, you know, a lot of painting business owners actually get out of sales as well. They have a salesperson or even teams of salespeople, and they have production managers. And so really there's a new line item that pops up here, which is the C-suite. This is your CEO, COO, CFO, CMO. So chief executive officers, chief operating officer, chief financial officers, chief marketing officer, your C-suite. And so we have the ones who have the nice—

they're the ones who have the nice offices on the top of the building with the corner windows and the leather chairs. Exactly.

Okay, so, uh, 3.5% is allocated to that. So if you're at this level, you're probably, uh, if you're you know, doing around $2 million, you're probably doing all those roles. You're probably the full C-suite, you know, so you might have 5 offices with great views. And so that 3.5% is probably all going to you and you, you know, you likely have a salesperson, production manager covered, at least a lot of folks do at this point. And then you are the business owner, so you get that 15%. Profit, and so that's 18.5%. So you'll notice that the percentages are going down as you're growing, uh, but that's okay because you're getting, um, you're— the, the overall pie is growing, so you're getting a smaller percentage of that pie, but pie is growing, so you're getting more overall in terms of dollars in your pocket. So, uh, 18.5% discretionary earnings, which is 3.5% for the C-suite, uh, roles that you're playing, and then your bottom line profit. And at this point, your gross profit margin target, we, we recommend to shoot for— try to improve a little bit over 50%. You know, at this point you've probably been around a while, you probably have a strong sales process that you can command higher prices, so you can start getting getting a little bit over 50%, and so we recommend 53% gross profit margin. And, uh, so those are the 3 scenarios to kind of give you an idea of what you should be shooting for in your numbers. There's other key numbers here that are kind of the same across the different, uh, stages, which, um, we talked about direct labor for the most part is somewhere around 35%. Direct materials somewhere between 12% and 15%. Obviously, as you get more experienced and bigger, you can usually start— you have better negotiating powers with your vendors, that sort of thing. So you should be able to drive those costs down as a smaller percentage of revenue. Auto expenses, somewhere around 2% to 3%. For the most part across all levels. Marketing, marketing includes the cost to do marketing, either pay someone to do it or hire an outside firm to do it. Somewhere around 7% is what you should aim for, or at least we recommend somewhere around 7% of revenue. Your accounting, somewhere, you know, your accounting, you might hire this out or you might have someone in-house doing it or a combination of that. So, you know, you probably to do all the things that you need done, which is your bookkeeping and your taxes and your invoicing and your accounts payable, all that stuff, somewhere around 3%. And then we have a couple of smaller items there. So those are some recommendations on what you should be hitting for your numbers and the margins you should be seeing as you move through your journey as a paint business owner.

That's a great graphic you have, Daniel. Definitely very informative, and I love how it kind of breaks up the journey of a business into stages. You know, we take things one step at a time, and as we grow and mature, our numbers adjust slightly to reflect that growth. So I appreciate you sharing that.

Glad I could help. All right, cool. So hopefully that this podcast was helpful for you to know, understand your margins so you can grow your business to the next level. We'd love to hear your thoughts or comments on this episode. If you want to join the conversation, go to Grow Your Painting Business. You type that into Facebook, uh, ask for an invite to the group, and we will let you in. Definitely let us know what your thoughts are on, on margin, what you shoot for. Love to hear your thoughts. And with that, we will see you next week.

All right, thanks for listening.