Have you ever heard the phrase "a dollar is a dollar"? …it's a lie. The hard-learned lesson for business owners is not all dollars are created equal. To increase our company profitability from the industry average 5-7% to the industry-leading 10-12% - or even higher in specialty markets - leaders must commit to get into the numbers. This blog mini-series will focus on a few ways to accomplish just that - beginning today with gross margin.
We all know the simplest financial description of any landscape or snow company is this:
NET PROFIT = REVENUE (sales) - DIRECT COSTS (COGS) - INDIRECT COSTS (overhead)
Ask a table of full of owners whether revenue or profit means more and we all pick the profit. Ask the same table for their company strategy to generate more profit this year and most cite a sales plan. Why is that? Simply put: Most of us start out knowing more about fixing revenue than fixing profitability. But - Growing a business full of problems means growing the problems, and working more to have less isn't the burnout any of us signed up for.
Instead of net profit, we need to use a different metric, one that sets aside our company overhead for a moment to focus instead on what funds that overhead budget. This is the concept of gross margin (sometimes at the all-company level referred to as gross profit):
% GROSS MARGIN = (REVENUE - DIRECT COSTS) / REVENUE
Gross margin allows us to look at how accurately sales estimates and prices work, and how efficiently operations executes it. While sub-sectors of the landscape industry vary, a general estimation of "breakeven" gross margin is 40%, meaning your minimum acceptable gross margin target should be 45 percent, if not 50, to leave room for overhead and healthy net profits.
Let's take a look at an example company, Cornerstone Landscaping. Their accounting system reports $3,040,000 total revenue and $1,986,000 total direct cost, resulting in an overall gross margin of 34.7%. Company overhead has been frozen at $900K, despite much-needed staffing and budgeting, yet they barely scrape by at $154K net profit - 5%. The team digs into "why".
The finance team runs some tough work to generate first-time reporting, as well as a long-term change to their accounting system's "chart of accounts" so that future reports are made easier as revenues and costs are automatically logged categorically. Finance eventually generates the following "actualized gross margin" report:
Similarly, the sales and account management teams dig in to take a tight look at the "budgeted gross margin" end of reporting - where they thought the numbers should be based upon their contractually signed scopes of work. Pulling all the job assessments together yields a very different view of what sales originally forecast should have happened:
Suddenly the vague and defeating "black hole" in net profitability begins to have clear questions attached - perhaps with actionable solutions.
Maintenance budget-vs-actual is sound, but could we price higher?
Is our "cost catalog" used by estimating up-to-date on the latest costs?
Will operations management re-confirm our production rates for all specialty divisions?
If the catalog and production rates don't close the gap, where is operations struggling?
This year's snow season was below average, so why were costs so much higher anyway?
The team ultimately pursues a mixture of these solutions - more accurate estimating, per-service pricing adjustments, some operational efficiency gains, a key error in turf chemical application rate, carefully selected contract increases or attritions, and some new sales. Cornerstone manages to clear renewals season projecting to remain around the same total direct cost - $2.04M - but now at revenues of $3.4M. The owner sees the fantastic improvement but also the inevitability of team burnout in trying to fulfill those numbers without change and releases $120K into additional overhead to finally make two strategic hires and strengthen some long-malnourished budget buckets, increasing overhead to $1.06M. Cornerstone now projects:
NET PROFIT = REVENUE ($3.4M) - DIRECT ($2.04M) - INDIRECT ($900K+$120K) = $340,000
%NET PROFIT = 10%
Bill Arman of The Harvest Group likes to encourage his clients: "Gross margin is the financial furnace that keeps the company warm." Looking at that kind of a gain in net profit, all because of a team effort to examine and improve gross margins, feels warm and toasty indeed.
=== David Rempfer is an Executive Consultant to the Landscape and Snow Removal Industries, including ASCA-C and SIMA-CSP accreditation. David currently serves management and ownership initiatives targeting business improvement and quality of life.