Margin Collapse in a Small Installation Firm
A two-person electrical installation business bills €310,000 net per year. The owner calculates a gross profit of €78,000 and believes the firm is healthy. However, the bank account is chronically empty. Reviewing the books reveals: material purchases €96,000, subcontractor costs €41,000, vehicle and fuel €18,000, insurance and chamber fees €9,000, rent for workshop and storage €14,000, tools and small equipment €7,000, advertising €5,000, telephone/software/office €6,000, and the owner's private drawings of €3,200 per month. One major customer, 40% of turnover, pays 75 days after invoice despite 30-day terms. VAT is 20% and must be remitted quarterly.
1. Calculate the true operating result before the owner's drawings and identify the cash-flow problem separately from the profit problem.
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Costs excluding drawings: materials 96,000 + subcontractors 41,000 + vehicle 18,000 + insurance/fees 9,000 + rent 14,000 + tools 7,000 + advertising 5,000 + office 6,000 = €196,000. Operating result = 310,000 − 196,000 = €114,000 before owner's drawings and before any wage for the owner.
Owner's drawings: 3,200 × 12 = €38,400. That leaves €75,600, which must also cover tax on profit and any reserve for replacement investment. So the business is profitable, but the owner's mental figure of €78,000 gross profit was close to the real pre-tax surplus only by coincidence.
The cash problem is separate. The dominant customer represents €124,000 of turnover and pays 75 days late. On 30-day terms that is roughly 45 extra days of financing: 124,000 × 45/365 ≈ €15,300 permanently tied up. Add the quarterly VAT timing and irregular material purchases, and the account looks empty even in a profitable year. Fixes: enforce payment terms with reminders and a late-payment charge, request partial payments on large jobs, and hold a liquidity reserve of at least two months' fixed costs (about €9,000).
2. The owner wants to buy a €28,000 van on credit. Using the figures, give a reasoned recommendation including the effect on liquidity.
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Affordability test: the annual surplus after drawings is about €75,600 before tax. A €28,000 van financed over four years at, say, 6% costs roughly €660 per month, or about €7,900 per year including running-cost increases. That is around 10% of the surplus, which is serviceable in principle.
Liquidity test is the binding constraint. The firm already finances about €15,300 of receivables for its slow-paying customer and holds no stated reserve. A new loan adds a fixed monthly outflow that must be paid even in a month when the big customer is late. With fixed costs of roughly €9,000 per quarter, the firm should first build a reserve or negotiate a larger deposit.
Recommendation: do not sign until (a) the payment behaviour of the 40% customer is renegotiated, e.g. direct debit or 14-day terms with a discount, and (b) at least €10,000 is set aside. Then consider a used van at €15,000–18,000, or leasing, which keeps capital free. Present the decision to the bank with the corrected cost breakdown, because the owner's earlier gross-profit figure understates real costs and would undermine credibility.