You might not think the phrase “Ponzi Scheme” applies to your remodeling company – think again!
The March 23rd issue of the New Yorker magazine has an interesting article about Ponzi schemes entitled “Madoff and his Models” in which the author discusses 2 historic schemers who turned up client’s up-front money into personal cash. Towards the end of the article he says:
“At some point the incoming money cannot keep pace withth eoutgoing claims, and the fraud must unravel.”
In a related article from the March 2008 issue of Fortune – Small Business entitled “Do the Math” author Jay Goltz says:
“My friend was running something like a Ponzi scheme, except that he was conning himself instead of clients.”
In this case the friend who sells large computer systems booked his deposits on the sale as income rather than deposits. Therefore he thought he had a LOT MORE income over the past few years than he truly had.
“For years the books said he was profitable, when his accounting methods were actually enhancing his profits or even masking operating losses. As a result, he never made the necessary adjustments that might have saved him when things got bad.”
Right now I see many remodelers in this exact situation – but they might not even know it as a situation, they might just imagine that things got really bad all of a sudden, oftentimes after months of being really good!
If your remodeling company is on any accounting method OTHER than Percent Complete (also known as WIP [for Work in Process], or Over/Under Billing) then you’re in real danger!
What happens is this: you start a new job, say in November of 2008, and take a large deposit. Many of my clients take 20 or 30% when the job starts. This invoice is booked as income. Then the job goes on and each invoice to the client becomes smaller until at the 90% completion of the job the client owes you next to nothing. And you’ve still got all those expensive finish trades to pay.
Without a new job deposit coming in the door, you’ve now got real cash problems and, to make matters worse, your profit and loss statement (also known as the income statement) looks terrible because you’ve got those expensive trade contracts and materials booked as expense without offsetting income.
This is the remodeler’s version of the Ponzi scheme – taking money upfront and then hoping to pay off the vendors and trades with new money from a new client.
It works just fine as long as your sales continue to grow – but a flattening, or worse yet a decline as we’ve experienced, forces the cash flow issue to the front.
The scenario I’ve just outlined has two potentially fatal problems:
- You don’t really know what your true gross profit is for the company or for the job at any moment; and
- Unless you keep getting new job deposits, your cash flow problems can put you out of business.
The solution is not an easy and will produce some sleepless nights, I’m afraid. But right now, more than ever, you’ve got to have really good tight financial and job profit information at your fingertips – you’ve got to know these numbers inside out and backwards. You’ve got to spend at least a couple hours every week going through them until you know you’re safe for the next week, the next month.
Call or e-mail me and I’ll help you! This is so important to the health of your company that this one change could save everything.