Carefully manage sales, gross margin and labor to better your business.
As landscape business professionals, we search far and wide to discover how to run a profitable business. The talk track is predictable: “Sell more work at the right price, and manage your direct costs.” But if it’s that simple, why are so many companies struggling to boost their bottom lines? The not-so-simple answer can be found in three key areas:
- Sales: What are you selling and why?
- Gross margin (profit): How much money is left after direct costs?
- Labor management: Did you reach your number?
Sales
Everyone seems to understand the importance of top-line growth and keeping the pipeline full. Unfortunately, the quest for top-line growth too often comes at the expense of bottom-line net profits. This can happen for several reasons:
- Aggressive growth outpaces a company’s infrastructure or ability to perform the work efficiently.
- Competitive market segments start with tight margins that can erode quickly due to ineffective planning or conditions beyond your control.
- Complex projects often involve tight timelines and multiple subcontractors that can force unreasonable schedules and unplanned mobilizations.
- Companies become involved in a varied work mix, limiting their ability to become proficient at anything.
So how do you define the right work mix and menu of services that will allow for healthy growth and profit? First, do your homework and know what you’re getting into. Each market segment or work type has nuances that make it attractive or risky.
Generally, landscape work can be grouped into two main revenue categories: construction and maintenance. Within maintenance, there are subcategories between commercial and residential and market segment specialization. Within construction, there are additional divisions between design/build, bid/build and builder/developer work, to name a few. Maintenance is less complicated than construction, and residential is more difficult to scale than commercial.
You can be successful in each of these areas, but it’s difficult to be successful at all of them. Successful companies define the work mix that suits their skill set most and learn to master it. Fine-tuning a product or service offering allows you to build standard systems that result in a lower cost of sales, lower direct costs, higher quality and higher profits.
Gross margin
Once you determine your ideal work mix, set up a proper estimating and pricing model that will generate sufficient gross margin dollars to pay for company overhead and make a profit. Gross margin is defined as the amount of money left after subtracting direct costs from revenue. Direct costs are expenses that can be directly tracked against a job, such as materials, labor, equipment rental and subcontractor expenses. You can sell all the work in the world, but if you don’t generate enough gross margin, you won’t realize your net-profit goals.
Gross margin can be measured in terms of dollars and as a percent of sales. Your company needs to generate enough gross-margin dollars to pay for all your overhead and produce an acceptable profit. For example, if your annual revenue is $500,000 and your gross margin is $250,000, you’re producing a 50 percent gross margin.
As long as the rest of your expenses don’t exceed 40 percent, you’ll achieve a bottom line of 10 percent or better. If you use a large number of subcontractors, you should consider tracking self-performed and subcontract gross margin separately.
Another way to understand a 50 percent gross margin is to think in terms of dollars and cents. For every dollar of work you sell, you have 50 cents remaining after you’ve paid your direct costs. Targets for each revenue type should be established each year during the budget process and tracked throughout the year. As jobs are completed, it’s important to review the financial results and compare the budgeted to actual gross margin. When there’s a significant variance between these numbers, it’s important to look at direct-cost line items to determine where and why the variance occurred and what needs to be done to correct the problem. The main variance in gross margin typically will be in materials or labor.
Labor management
In many cases, a negative gross-margin variance can be traced to direct labor costs. Labor is one of the biggest profit robbers and arguably the most difficult expense to control. Control labor by starting all jobs with a clear labor budget that can be broken down into hours.
Labor-hour budgets should be developed through an estimating system using a combination of labor production rates and real-world experience. Labor efficiency (L/E) is a key performance indicator used to measure productivity. L/E can be calculated by dividing budgeted hours by actual hours—100 percent efficiency is good, 110 percent is better and 80 percent indicates a problem. At top-performing companies, no crew leaves the shop without a set labor-hour budget. All work schedules are set at least one week in advance, and labor is forecast or reforecast monthly.
Going forward, revise the talk track to “Sell and master the right kind of work at the appropriate gross margins and manage the bleep out of labor!”
