Revenue Is One Thing... Profit Is Another

Features - Cover Story

Growing your business requires investments in people, equipment and technology — but that cuts into your profit. As such, it’s a balancing act for PMPs to get their revenue and profit numbers where they need them.

December 13, 2016
Donna DeFranco

Everybody wants a healthy influx of business. When you’re generating revenues hand over fist, it feels good — like your business is thriving. But of course there’s another dimension to this financial activity: profit. How much of your company’s revenues are, or should be, making it to your bottom line?

There’s no magic profit percentage that makes one business successful and another one not, since every firm has its own goals for growth and profitability. But Dan Gordon, a CPA and owner of PCO Bookkeepers, and author of “From Technician to CEO,” says most PMPs shoot for at least 10 to 15 percent profit on revenues.

“For many years, a lot of successful PMPs used a growth/profitability model called the Rule of 23: Your profit percentage plus your growth percentage must equal 23,” Gordon shares. “So if you had no growth, you should have 23 percent profit, or if you had no profit, you should have 23 percent growth, or you should achieve a combination of the two that equals 23. Today, some PMPs have changed that rule to 30 or 35 as their target number.”

Where you set your target number should depend on your circumstances. For example, are you looking to put more profit into your pocket today, to reinvest in your company as you build it over the long term, or to make your business more attractive to buyers? Each of these goals requires a different approach to revenue growth and profitability.

Regarding companies looking to sell, Gordon says, “The merger and acquisition market is red hot, and the business owners who are making the most are those who have built very profitable companies,” he explains. “There’s a misconception that price valuations are based on revenues, and while that does play into the equation, profits weigh much more heavily. In other words, revenue is a good thing if the business is profitable. You can’t just ramp up your revenues to get a higher price in the M&A world. You must have profitable recurring business.”

Ramping up revenues doesn’t guarantee profitability to PMPs planning to hold onto their companies either. Growing your business — getting those top-line revenues to flow in — requires investments into your people, equipment and technology, and that cuts into your profit.

The bottom line, so to speak, is that getting your revenue and profit numbers where you need them becomes something of a balancing act. It’s one that Tim Pollard, COO of Atlanta-based Arrow Exterminators, is quite familiar with.

“While growing revenues and profits at the same time might not be easy due to the inherent tension between the two, it is certainly possible,” he says. “At Arrow, we focus on growing top-line revenue but not at the expense of profit. We’ve grown our revenue by double digits for the past six consecutive years, all the while meeting or exceeding our profit goal of 12 percent of revenue,” he says.

How does Arrow strike this balance? “We have a solid strategic plan and excel at execution,” Pollard says. “We recognize that a strong sales culture is key to both revenue and profit, and we focus on maximizing our revenue per employee. Highly productive employees, combined with smart cost-control measures, pave the way to higher profits.”

BACK TO BASICS. Pollard warns against focusing exclusively on profit, however. He explains, “I’ve learned one important accounting lesson in my life: Cash is king. But profit does not equal cash. Think about what you have to pay out of your profits: taxes, which can take as much as 50 percent; shareholder dividends; and any funds you choose to reinvest in the business. Only a fraction of your profits become cash. We can be lulled into a false sense of security when we focus only on profit; we need to monitor our cash position, too. Businesses need cash to operate.”

This basic tenet brings the discussion around to how profit is measured. Building profits begins with knowing your break-even point — the point at which revenues cover all costs associated with generating that revenue — and identifying where you have some control over costs.

As a general rule, you can (to some extent) control variable costs, which include material and fuel costs, hourly technician pay and other costs that fluctuate depending on your production volume. Because fixed costs — rent, insurance and administrative salaries, for example — remain constant at any volume of business, they offer less wiggle room.

“If you control costs in three areas — labor, marketing and materials — you will make money,” says Gordon. “And, as important as it is to keep costs in line, it is equally important to make sure you are charging customers enough for your services.”

Gordon, who has created a series of YouTube videos explaining how to improve profitability through pricing and route efficiency, says that pricing needs to take into account the technician’s driving time, which often accounts for 40 percent of their total on-the-job time, as well as the time spent on the service call, plus the product cost and desired margin. As a general rule, he suggests an hourly rate of at least $125. For mathematical ease, however, he uses $100 to illustrate how pricing contributes to profits:

“If you bill service at $100 an hour, pay your technician $20 and have $30 in materials and other variable costs, your gross profit is $50 an hour,” Gordon says. (Gross Profit = Hourly Charge – Variable Costs.)

“This gross profit contributes to paying your fixed costs,” he continues. “Once those costs are covered (break-even point), profit starts going to the bottom line. In the example of $50 an hour gross profit, if your fixed costs are $50,000 a month, then you need to bill 1,000 hours to reach your break-even point at $100 per hour. Time billed beyond that point will contribute to your bottom-line profits at a rate of $50 per hour.” (Break-even Point = Fixed Costs ÷ Gross Profit per Hour.)

Pollard adds, “Your break-even point is a rolling number; it can change every month, depending how your costs (fuel prices, for example) might fluctuate. For example, if you have 21 working days in a month, it might take 19 days to generate enough revenue to get to your break-even point. The revenue generated on the remaining two days becomes pre-tax profit.”

PROFIT STRATEGIES. What actions can you take to make your business more profitable? Corporate development, M&A and strategy consultant Kemp Anderson recommends the following:

Commit to regular financial reviews. Always be aware where your financials stand. Get into a habit of reviewing your P&L, balance sheet and bank statements every month and meeting with your CPA quarterly. Keep tabs on your customer list (your No. 1 asset) and look for ways to reduce your cost of goods — including payroll, fleet and chemical inventory — which likely accounts for roughly 60 to 70 percent of your expenses.

Do employee check-ins and ride-alongs. Getting closer your employees and their day-to-day activities can help you identify areas where you can manage costs more effectively. Daily employee check-ins can help you tighten up chemical management efforts and maximize employee productivity. Ride-alongs give you a look at the protocols and product technicians are using, and help you monitor route density. GPS monitoring can help, too, giving you a better idea of how much time a technician spends driving versus servicing customers.

Harness technology. Leveraging technology in your office and on the road can make a positive impact on your profitability by reducing administrative and collections time, as well as improving customer retention. Customers appreciate the convenience of communication by text or email, and adopting an “easy pay” concept, where you automatically charge their credit card on the day of service, speeds your accounts receivable process. Routing software can make a difference on your P&L as well, as it helps minimize drive time.

Evaluate multi-channel opportunities. Diversifying the services you offer can help you not only generate more revenues but also increase your profitability by penetrating accounts more deeply and taking advantage of the most profitable opportunities of the day. For example, bed bug services might have been in demand in your markets yesterday, but what’s hot today — mosquito services? Consider bundling services to maximize your revenue, and profit potential, per stop.

Establish a schedule for raising prices. When you provide value to your customers, they understand the need for annual price adjustments. Everyone knows about inflation, and that utilities, insurance and other business-related expenses increase with regularity. A price increase policy is important to keeping your business profitable. If this idea causes concern that you might lose customers by raising prices, look at it this way: If you raise prices 3 to 4 percent a year and lose 1 percent of your customers, you will still experience a net gain. Don’t be the cheapest provider; be the best provider. When you lead in value, you earn the right to price leadership as well.

The author is a frequent contributor to PCT.