Avoiding the Roofing Contractor “October Surprise”

You may or may not know the term “October Surprise” from American political jargon. I will leave that version of the definition to the political commentators.

In roofing, I use the term differently. It describes the unpleasant surprise a contractor gets late in the year when the company discovers it is not making the money everyone thought it was making during the first three quarters.

Expected profits begin to disappear. Jobs that looked healthy are suddenly producing far less margin than anticipated, and in some cases the company can move into the red very quickly.

I have seen this happen to good roofing companies over the years. Some corrected the problem. Others repeated the same cycle until the financial damage became much more serious.

The good news is that the roofing contractor October Surprise is usually avoidable. The first step is understanding where profit erosion is coming from before year-end exposes it.

Six common causes of profit erosion

There are many reasons a roofing company can miss its financial expectations, but six issues show up repeatedly:

• Not knowing true overhead, break-even point or gross profit requirements
• Poor estimating practices
• Loading the company with low-margin work just to keep crews busy
• Severe or repeated overbilling without an accurate monthly work-in-progress review
• Underbilling and weak collections
• Poor or nonexistent job cost tracking

Any one of these can hurt profitability. When several occur at the same time, the financial picture can change quickly.

Know your overhead and break-even point

A roofing contractor cannot price work intelligently without understanding what it costs to operate the business.

Overhead includes the costs required to operate the company that are not direct labor, direct materials or other direct job costs. Office salaries, insurance, facilities, vehicles, technology and other operating expenses all have to be recovered through the work the company sells.

The break-even point is where revenue equals cost. If a project is sold at break-even, the company may cover its operating costs, but it has not earned a profit for taking on the work and risk.

A qualified accountant or business consultant can help calculate these numbers correctly, but ownership and management still need to understand what they mean. Pricing decisions should not depend entirely on someone else explaining the financial condition of the company after the fact.

Gross profit margin is not markup

This is one of the most common financial misunderstandings I see.

Markup and gross profit margin are not the same calculation.

If a contractor needs a 25% gross profit margin to cover overhead and produce the desired net profit, simply multiplying cost by 25% will not produce a 25% margin.

For example, if your required gross profit is 25%, the break-even sell price must be divided by .75 to arrive at the required selling price.

Confusing markup with margin can leave a contractor short of the gross profit needed to support the business before the project ever begins.

Profitable projects start with estimating

A successful project starts with the estimate.

That means giving estimators enough time to understand what it will actually take to perform the work. The job is not simply to complete a takeoff and attach a price.

A strong estimator understands which projects fit the company and pays attention to the details that can affect labor, material, equipment, access, scheduling and risk.

Guessing, assuming or throwing money at an unknown condition is not estimating.

The estimate establishes the financial starting point for the project. If that starting point is weak, operations will spend the rest of the job trying to recover.

Be careful with the “feed the machine” mentality

Roofing contractors can get into trouble when keeping crews busy becomes more important than protecting margin.

High volume and low margins may work in certain retail models, but roofing carries labor, weather, safety, material and execution risk that makes that approach dangerous.

Work should contribute enough gross profit to support the company.

Selling more work does not automatically make the company more profitable. In fact, low-margin volume can consume labor and management capacity while producing very little financial return.

Contractors should pay as much attention to the quality of the backlog as they do to the size of it.

Overbilling can hide the real picture

Overbilling can be helpful to cash flow, but it can also create a false sense of financial strength.

If a project has billed ahead of actual progress, some of the cash sitting in the bank is still needed to complete the work. Treating that money as earned profit can create a serious problem later.

That is why monthly work-in-progress review matters.

Management needs an accurate picture of the remaining cost to complete each project, how much has been billed, what has actually been earned and whether the projected margin is changing.

Without that review, the company can appear profitable while future costs are quietly waiting to catch up.

Underbilling and poor collections create a different problem

If overbilling can disguise profitability, underbilling and weak collections can create an immediate cash problem.

A profitable company can still fail if it runs out of cash.

Billing needs to occur accurately and on time. Someone also needs clear responsibility for following up on receivables and collecting what has already been earned.

This should not become a year-end cleanup exercise. Billing and collections need consistent attention throughout the year.

The longer money remains outstanding, the more financial pressure the contractor absorbs while continuing to fund payroll, materials and overhead.

Job costing gives you time to react

Job costing allows management to compare actual costs against estimated or budgeted costs while the project is still underway.

That timing is critical.

Labor hours, material usage and other direct costs should be monitored against the original plan. Field reporting should help management understand how much work remains, while job cost information shows how much has already been spent and what the final cost is beginning to look like.

That gives contractors time to act.

If labor is running over budget, the project manager can investigate why. If production is falling behind, the superintendent can determine whether manpower, staging, sequencing or site conditions are contributing to the problem.

Waiting until the job is complete only tells you how much money you lost. Good job costing gives you a chance to protect the remaining margin.

The October Surprise is usually built months earlier

The financial surprise may appear in October, but the causes usually started much earlier.

Weak estimates were sold months before. Labor overruns accumulated gradually. Billing problems developed over several pay applications. Job cost information was ignored. Low-margin work filled the backlog.

By the time the financial statements finally make the problem obvious, the company may have very little time left in the year to correct it.

That is why contractors need regular financial and operational review throughout the year, not just when the accountant begins talking about year-end results.

Being a good roofer is not enough to build a profitable roofing company. Contractors also need to understand the operating and financial mechanics of the business. That includes estimating, overhead, gross profit, cash flow, work in progress and job costing.

The roofing contractor October Surprise is not inevitable. With accurate information and disciplined financial controls, management should know where the company stands long before October arrives.