Tuesday, July 29, 2014

Home Magazine Cut the clutter

Cut the clutter

Columns - Industry Voices

Jim Huston | June 10, 2014


Jim Huston

William (of Ockham) was a 14th century logician and Franciscan friar. He hailed from the village of Ockham in the English county of Surrey where he was born; hence the title, “William of Ockham.” He gave us the principle referred to as “Ockham’s Razor.”

It states, “Entities should not be multiplied unnecessarily.” Scientists often employ Ockham’s Razor in a morphed version to simplify their theories. This version states, “When you have two competing theories that make exactly the same predictions, the simpler one is the better.” Or “the simpler, the better.”

Many of the landscape contractors with whom I work make their lives far too complicated. Many have business degrees. Unfortunately, most such schools teach you about Fortune 500 companies, not how to run a small business.
 

How it works. John had a $750,000 residential landscape company in Indiana. His net profit margin from his landscape operations before taxes was roughly 13 percent or $97,500. He had two divisions (we won’t include his snow and ice management operation, or his landscape subcontracted work with its markups) as follows: 1. Landscape installation with one 3-man crew billing roughly $450,000 per year and achieving a 40 percent gross profit margin (GPM). 2. Lawn maintenance with five men billing approximately $300,000 per year and achieving a 35 percent GPM.

John had accurate financials showing the direct costs (materials, field labor, field labor burden, field trucks and equipment, rental equipment and subcontractor costs) for each of his divisions. As a result, he could identify his GPM quite accurately.

However, John wanted to know how to measure his gross and net profitability more accurately so that he could establish benchmarks, against which he could use to measure the profitability of his company’s crews and jobs.

John called me at the end of the year to help him find answers to his questions.
 

The process. Prior to my arrival at John’s office, I had him tally up all of his field-labor hours for the previous year. When I arrived, he knew to the man-hour how many man-hours were used in each of his landscape divisions.

1. Calculating the gross profit margin per man-hour (GPMPH)

The installation crew had 5,261 paid man-hours. It totaled as follows:

  • 9 months x 4.33 weeks per month x 45 man-hours per week x 3 men
  • 9 x 4.33 x 45 x 3 = 5,261


Subtract 4 holidays per man at 8 man-hours each = 4 x 3 x 8 = 96 man-hours

  • 5261 – 96 = 5,165 production man-hours


Next, we divide sales revenue by the production man-hours to calculate the sales per hour (SPH)

  • $450,000 ÷ 5,165 = $87.12 SPH


Then we multiply the SPH by the 40 percent GPM to calculate the GPM per man-hour.

  • $87.12 x .40 = $34.85 GPMPH


The maintenance crew had 10,522 paid man-hours. It totaled as follows:

  • 9 months x 4.33 weeks per month x 45 man-hours per week x 6 men
  • 9 x 4.33 x 45 x 6 = 10,522


Subtract 4 holidays per man at 8 man-hours each = 4 x 6 x 8 = 192 man-hours

  • 10,522 – 192 = 10,330 production man-hours


Next, we divide sales revenue by the production man-hours to calculate the sales per hour (SPH)

  • $300,000 ÷ 10,330 = $29.04 SPH


Then we multiply the SPH by the 35 percent GPM to calculate the GPM per man-hour.

  • $29.04 x .35 = $10.16 GPMPH
     

2. Calculating the net profit margin per man-hour (NPMPH):

In order to calculate the net profit margin per man-hour, we have to subtract the general and administrative (G&A) overhead from the gross profit margin per man-hour. G&A overhead for the landscape divisions was roughly 25 percent of sales.

It is here that we make an important assumption regarding G&A overhead. It is, “If the G&A overhead is 25 percent of sales for both landscape divisions combined, it is reasonable to allocate 25 percent G&A overhead to each division separately.” You may argue with this statement but after analyzing thousands of landscape budgets and financials, I’d say that this is a reasonable assumption. To calculate the NPMPH, subtract the 25 percent G&A overhead from the gross profit margin per man-hour as follows:

a. For the landscape install division:

  • $87.12 x .40 = $34.85 GPMPH
  • $34.85 GPMPH – ($87.12 x .25) = $34.85 – 21.78 = $13.07 (or 15% of the $87.12)


The net profit per man-hour is $13.07

b. For the landscape maintenance division:

  • $29.04 x .35 = $10.16 GPMPH
  • $10.16 GPMPH – ($29.04 x .25) = $10.16 – 7.26 = $2.90 (or 10% of the $29.04)


The net profit per man-hour is $2.90

 

The analysis. John’s installation division was achieving a GPMPH of $34.85 and a NPMPH of $13.07.

His maintenance division was achieving a GPMPH of $10.16 and a NPMPH of $2.90.

The installation division made 4.51 times more net profit per man-hour than the maintenance division. $13.07 ÷ $2.90 = 4.51

Does this mean that John should scrap his maintenance division and do more installation? Not at all. And that’s not John’s question. It just means he makes almost five times as much net profit per man-hour doing installation work than he does doing maintenance work.

John now has the benchmarks he needs in order to establish gross and net profitability goals for his crews and his jobs. These benchmarks are reasonable and extremely simple to calculate. If his crews can beat them, all the better.

 

JIM HUSTON runs J.R. Huston Consulting, a green industry consulting firm. See www.jrhuston.biz; mail jhuston@giemedia.com.