Throw Out the Fish Bowl!

by Vaughn Burbidge

In my 42 years of experience in the concrete pumping industry, I watched my father, operators, mechanics and others pour their hearts and souls into this industry. I even have a few of my own concrete burn scars that remind me this industry does not—and never has—lacked hard work, blood, sweat and tears. I am sure every one of you has seen the same. Hard work has always been a huge part of this industry. In addition, I am amazed to see the influence this industry has on this nation. As I drive around my city, I reflect on all the jobs that require concrete pumping, almost every one.

Then I try to imagine what my city would look like if all the pumped concrete disappeared. Not just the concrete my company pumped, but also ALL the pumped concrete, even that done by my competitors. Wow! It is unimaginable. I am sure this is also true for your city; in fact, I am sure this is true for every city in this country. The majority of Americans would be homeless, there would be no infrastructure, and the majority of education, businesses and governments would not be functioning. It is mind-boggling to contemplate the extent of our impact on this great country. We have been an essential part in the building of this great country. When it comes to providing hard work, we can stand proud knowing how much we have contributed.

So what does this industry lack? Profit! It’s hard to find in my state. What I have found in my state is the sad fact that over twenty concrete pumping companies have gone out of business because there is no profit. The big questions: where is the profit and why isn’t there more of it? I propose that profit has become elusive due to too many companies using the “fish bowl method” to do their financial analysis.

So what is the fish bowl method? Some like to call it the cookie jar method. It is simply a cash-driven method of analyzing a business to determine whether the business is making money or not. Picture this: when you make money, it goes into the fish bowl and when you spend money, it comes out of the fish bowl. If the bowl is empty, then the company has made no money, and when the bowl has money in it, the company has made money. I do not want to say the fish bowl method never works. However, I will say it is not the preferred method taught among accredited business schools.

I think we can improve on the fish bowl method, which we will just call FBM. We need to add in elements of financial analysis. Let’s add the concepts of depreciation, debt and opportunity cost of capital. Most of us know what debt and depreciation are, but how does it relate to our companies?

When most pumping companies meet with their accountant for the first time, depreciation is discussed. The accountant does the books and comes up with a big depreciation number, which greatly reduces taxable income and thereby reducing taxes payable. In fact, the depreciation number may have been so high, no taxes are even due. Wow! There’s a little money in the fish bowl and no taxes. You love your accountant and you love depreciation, even though your company may have shown a loss.

Life is great—no taxes, money in the fish bowl—so you want to buy some more pumps and expand. You are so excited to buy more pumps, but at this point, you do not even know if you are making a profit. So how do you know if you are really making money? Stop, don’t you be lookin’ at that fish bowl! Let’s look at something else—the following financial analysis. To do this analysis we are going to make the following assumptions:

1) You bought a 36-meter for $400,000.

2) You put $100,000 down. (Banks are a little tighter now.)

3) You borrowed $300,000 at seven percent interest on a seven- year note, giving you a monthly payment of $4,528.

4) Your annual revenue is $250,000.

5) Your opportunity cost of capital would be $5,000 a year, which is what you could be earning on your down payment in another investment at five percent.

6) Your overtime value is approximately $20,000 a year, which is the amount you would make with all the extra effort you are putting into your company.

7) Tax depreciation is the depreciation your accountant gives you, based on your appreciation amortization schedule. (Real depreciation is how much your concrete pump has lost value in one year—this number gets funny, don’t kid yourself—and this is how much you could sell your pump for after one year of use. I promise it is less than you think. If you don’t believe me, put one on the market and see what you can get for it.)

8) Operating Costs, total $180,000 a year

a. Labor $80,000 a year
b. Fuel $15,000 a year
c. Repair $25,000 a year
d. Parts $ 15,000 a year
e. Rent $25,000 a year
f. Other $20,000 a year

Cash Basis Analysis
The cash basis analysis, the FBM, is computed as follows, based on our assumptions:

Income – Operating Costs – Payments = Profit
$250,000 – $180,000 – $54,000 = $16,000

Tax Basis Analysis
The tax basis analysis is computed as follows:

Income – Operating Costs – Tax Depreciation – Interest Costs = Profit
$250,000 – $180,000 – $80,000 – $20,000 = $30,000 loss

Real Basis Analysis
The real basis analysis is computed as follows, using the same assumptions:

Income – Operating Costs – Real Depreciation – Interest – Opportunity Costs of Capital – Lost Overtime Pay = Profit $250,000 – $180,000 – $50,000 – $20,000 – $5,000 – $20,000 = $25,000 loss

So, in Summary... Fish Bowl Analysis shows $16,000 profit
Tax Analysis shows $30,000 loss
Real Analysis shows $25,000 loss
Thus, even though the fish bowl has money in it, at the end of the year you really lost money. So is it the best move to buy more equipment?

This question reminds me of the two brothers in the watermelon business— let’s call them Bob and Jerry. Bob and Jerry bought a truckload of watermelons for a $1.00 apiece, but found they could only sell them for $0.95 each. When Jerry asked what they should do, Bob simply replied that they should buy another truckload so they could make it up in volume. I laugh at that, and then I cry when I realize how much we do that in our industry. So what is the next move? One of two things needs to happen before you think about buying another concrete pump. Either increase prices or decrease costs. Pretty simple.

But that’s easier said than done, since most of our costs are going up. The economies of scale do provide some cost savings as you increase volume, but in our industry, saving does not seem be a smooth ramp-up, but an incremental one. When you go from one to two pumps, you don’t save until you get to three or four pumps—and then there are not much savings until you get to six or seven pumps. And it can escalate from there. The economic theory behind this scenario is that if you do not take these steps to lower costs by increasing volume in an expanding market, you will most likely increase your costs because of the lack of efficiency.

The other option is to increase prices. I know we have heard much on this topic and I know it is tough. Your competition is not increasing prices, you have customers calling for more pumps, and then on top of it all you look over at the fish bowl, and it has money in it. Therefore, you say, “That’s it, we’re going to buy another pump!” Stop. Let’s go back to the watermelon brothers.

Say the truckload of watermelons consisted of 200 watermelons and the cost is $200. The retail price is $0.95 apiece, Bob and Jerry lost 200 x 5 cents = $10 in losses.

But what if the brothers did not say, “Let’s buy another truckload,” but instead said, “Let’s sell them for $1 apiece”. Bob thinks they will lose half of their work. Nevertheless, Jerry replies, “I am tired of losing money”.

So now, they buy 100 watermelons at $1 apiece and sell them for $1 apiece. The brothers suffer no loss.

Jerry and Bob like that better, but now they decide to get really crazy and increase prices to $1.05. Wow! Now that made money, $5! (Did you follow that? 100 x 5 cents = $5 profit.)

Now what happens if Bob and Jerry increase prices by just 10 percent more, to $1.15? Jerry cries, “Well, that would kill us! We would lose half of our work and only be able to sell 50 watermelons,” but they try it anyway. So let’s say they only sell 50 watermelons at $1.15 apiece. That makes (50 x $1.15) – (50 x $1.00) = $7.50 profit. Bob and Jerry made $57.50 with a cost of $50.00, their profits increased 50 percent to $7.50, and they only had to sell 50 watermelons rather than 200. Wow, that was simple, but is it realistic to charge $1.15? If your costs are $1.00, yes. Is it representative of the market? Having a 15 percent margin is very realistic, maybe even low in such a high-risk industry as ours.

So what should your prices be? Your costs will determine them, so the first step is to find your real costs. Your real costs will be based your accountants EBITDA number (earnings before interests, taxes, depreciation, and amortization). It is a simple number. Once you have that number, then add in your interest, real depreciation, opportunity cost of capital, and lost overtime wages. Take that number; add a reasonable profit for your risk and effort, and this final number is what your income should be. Then price your services to achieve this income. If you can price your service at this rate, you may consider expanding. If not, either increase your prices or think about the watermelon brothers before you buy another concrete pump.

In the last few years, I have looked at buying different pumping companies, but when I have investigated the books, I have usually found that there is more debt than there is equity. In that situation, if the company does not have owners or banks willing to come up with the difference, usually $200,000 or $300,000, not much can happen. Everybody just scrambles around, wondering where the money went.

So how do so many companies get into this position? The most common reason is that the company acquires debt without realizing the real depreciation that lowered the net equity to a negative amount. This debt is so easy to accumulate. Think back to the point when a new company is considering buying an additional pump after the first year, even though they have lost money. Adding fuel to this fire, Mr. Happy- Go-Lucky-Banker enters the scene and indicates that he will finance the new pump and refinance the old pump and roll them all into a new loan and extend the payment period, so that the monthly payment will reduce. If this path is taken, the new company has now entered the twilight zone or, worse yet, has embarked on the slippery slope to death. Here is where your negative equity increases, even though you can see money in the fish bowl.

On top of that, you decide to take some of the cash out of the fish bowl to buy some fun recreational vehicles—why not, we work hard and we deserve it! But as soon as there is a hiccup in the market, the banker realizes the amount of your negative equity and calls the notes due. And so your company goes bankrupt, you lose your initial investment and the return on your hard work goes up in smoke. Your city is still intact, all of your wonderful work is still standing, but your company is broke.

In conclusion, stop and take the time to analyze your costs and take the necessary steps to ensure a profit. You deserve it— all of us do, we have played a critical role in building this country— we deserve it.

Vaughn Burbidge is a current ACPA board member and is the owner of Burbidge Concrete Pumping. He has a bachelor’s degree in economics, a master’s degree in statistics and has vast experience in doing mergers and acquisitions. Vaughn will be presenting The Economics of Concrete Pumping at the upcoming ACPA Education Conference to be held in San Antonio, Texas on April 10-11, 2015. He can be reached at vburb[at]gmail[dot]com or (801) 433-0485.