In Minor’s League: June 2000

QUESTION: Last month, you spoke about profit margins in the 15 to 20 percent range. Can you give me some advice on how I can get my company to that level?

ANSWER: Believe it or not, profit margins in the 15 to 20 percent range are possible for many companies. Smaller companies regularly achieve this goal, often because of their minimal overhead costs and the fact that the owner frequently fufills many roles. The best companies consistently achieve this mark by focusing on their accounting systems.

First, tracking the profitability of all your significant service lines is critical. As a rule of thumb, I suggest tracking profit to the bottom line on any service you provide that equals at least 10 percent – or better yet, 5 percent – of your gross revenue.

Most people in our industry usually only account for their landscape maintenance and installation divisions. There are flaws in this line of thinking. For example, in landscape construction, bid work is generally going to be less profitable than enhancement work. If you have mingled the two, you will never fully comprehend what level of profitability you have in either division. Generally, your margins are higher in chemical lawn care or landscape maintenance and less in services like irrigation repair. You must know what profit centers are the most productive. Then, focus on promoting the most profitable services and eliminate the services that have less-than-desirable profits.

For example, let’s assume that a $1 million company provides landscape installation and maintenance. This contractor may also provide chemical applications and irrigation repairs in addition to core maintenance work. In landscape construction, this company may provide installations for new projects as well as landscape enhancements. Further, let’s assume that each department does more than $100,000 in annual revenue. If that is the case, create a financial statement that tracks all direct costs associated with each service. This can easily be done using any accounting software on the market.

Begin by having your field people code labor to a particular service line. Have color-coded work orders to assist your staff. Labor is the most important expense item to control on a financial statement. Track labor to determine profitability. Also, do this for materials in construction and enhancement. For other variable expenses, and general and administrative expenses, allocate the expense on a discretionary basis, a percentage of labor or a percentage of sales basis. Although you risk allocating incorrectly, allocating expenses in some way is better than not allocating at all.

From my experience, contractors who use this comprehensive method of accounting are surprised to find they are not making money with a particular service. But this type of tracking allows them to price properly and control labor costs and other expenses.

A final word on your accounting system – it is absolutely critical that the methodology for accounting all your services is done on the accrual basis as opposed to the cash basis. Most contractors in our industry use a hybrid of the two. Many times they will do the cash-based method for expenses and a combination of the cash and accrual method for booking revenue.

Many times I have heard folks say they are using the accrual method in booking revenue when they are actually using the cash method. Usually, this mistake occurs in landscape maintenance. An example is when revenue is booked as per defined in a contract. For instance, a 12-month, $12,000 contract is booked at $1,000 monthly. But the revenue is accruing on a different schedule. In many parts of the country, that revenue on an accrual basis may be $500 in January and $1,500 in July. If you don’t match your actual accrued sales with accrued expenses, you will never know your profitability.

There are many other ways to ensure profitability, but the best place to start is with proper and detailed accounting systems.