Financial Check-Up

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Dan Gordon, a CPA with PCO Bookkeepers in Newton, N.J., is a well known provider of business guidance regarding accounting, route efficiency and the utilization of people to help make pest control businesses stronger and more profitable. Gordon shared this knowledge, which he acquired from his combined experience as a pest control operator, as well as a tax accountant for pest control and lawn care companies, at NPMA PestWorld in Baltimore in 2017.

In a “Thought Leader” session, Gordon explored the evolution of a high-growth service firm and the time-tested business concepts that serve as a roadmap to success for an owner or manager. What follows is a report of the session’s discussions that focused on systematizing business processes that help PMPs maximize profits.

THE FUNDAMENTALS. “Financial statements are the box scores in the game of business. They are the culmination of the accounting process used to convey a concise picture of the profitability and financial position of your company,” said Gordon. Profit and loss statements, balance sheets and statements of cash flow are fundamental financial statements needed to present insights into a pest control business’ annual financial performance. However, financial statements do not include additional information imperative to a business like sales reports, production reports, dollars per hour and job costing.

Starting at the most basic level in order to derive further useful information from the financials, a pest control company needs to maintain an industry specific and company specific chart of accounts. Simply put, a chart of accounts defines “how you code, how you spend your money, how your money comes in,” which is essentially “the memo section of your check,” explains Gordon.

“I like to keep it simple,” said Gordon, in reference to the creation of a chart of accounts. Ultimately, the information will be utilized to determine how much a pest control company is making. Using the gross profit formula, or revenue minus direct costs equals gross margin, a company needs to identify its direct costs and revenue, and then place those amounts into buckets. Direct costs are “anything that happens on the road” (such as technician labor, vehicles, uniforms, auto insurance, auto leases, fuel, workers’ compensation insurance, etc.) while revenue should be broken up by applicable department (such as residential, commercial, etc.) and whether the money is recurring or non-recurring.

“Your end game is to increase the value of your company,” said Gordon, and to create a profitable company with recurring revenue. Gordon adds that a good rule of thumb percentage goal for gross margin in a pest control company is roughly 50 to 55 percent.

Pest control companies need to identify costs, starting with selling and advertising (or marketing) costs. Gordon says that “marketing is everything you spend to bring in a lead; sales is everything you spend to close that lead.”

Most mature companies spend six to eight percent on marketing, while analyzing questions surrounding desired sales quantities and amount of advertising to pay per customer, noting that a new branch or office might require 25 or 50 percent on advertising, explains Gordon. Sales costs need to be determined, such as the expenses of the salesperson (like salary, car, marketing materials, health insurance, etc.), which should be 20 to 25 percent of what the salesperson generates in revenue. Then, fixed costs are identified as “everything that happens in the office: rent, copy machine, customer service representative salary, utilities, etc.,” explained Gordon.

BREAKING EVEN. How much should a pest control company charge per hour to make a reasonable profit? “Accountants calculate this number using a technique called break-even analysis,” said Gordon, which includes two variables: time (or the service time required to fulfill the obligation of eliminating a customer’s pests) and money (the hourly charge for service to cover costs and make a profit).

Gordon provides the exact formula, which is fixed costs divided by gross profit per hour equals break-even points in units (or service hours), as well as a real-life example. If a recurring job takes an hour to provide service four times a year, plus considering that there might be 1.5 hours of callback time, this service should be priced for 5.5 hours, not four, noting that there will be customers who call back 20 times and those who will never call.

PMP Pricing Model:

Fixed costs / Gross profit per hour = Break-even points in units (service hours)

Pest control companies ultimately need to determine “what it takes to break even” and then after that, “how you make money,” said Gordon. He explained that although usually this type of analysis is taught utilizing product calculations, in service-based companies, the product is time, so the calculation must be based on hours.

MAKING MONEY. Digging further into gross profit, costs need to be analyzed and categorized. Gordon said fixed costs are any costs that remain constant at any volume of business, or “costs that happen in the office, not on the road” (e.g., rent, advertising, utilities, etc.), while variable costs are associated with producing one unit (hour) of service or “costs that happen on the road” (e.g., hourly pay for employees, workers compensation insurance, material costs, etc.). Variable costs, also called cost of goods sold and direct costs, “rise and fall based upon the number of hours that we provide service,” Gordon said.

To pull this equation into real life, Gordon illustrates an example. If service is billed at $100 per hour, the technician is paid $20 per hour, and the other variable costs with that hour of service are $35, the gross profit on the particular job is $45 (or $100 – ($20 + $35) = $45). Now incorporate fixed costs to determine the break-even point. If fixed costs (utilities, rent, etc.) are $9,000, and gross profit per hour is $45, then the break-even point is 200 hours of service (or $9,000 / $45 = 200 hours). “Once the fixed costs are paid, the gross profit contributes to bottom line profit. This is the reason some accountants call gross profit the contribution margin,” said Gordon.

Additionally, Gordon explains that there are a few other items to keep in mind. First, at various sales levels, certain fixed costs rise. For example, company growth might require additional costs called step costs, such as a new office space or a new piece of equipment, which will need to be added to the fixed cost calculation. Second, a smaller company might suddenly grow and experience a breakout year. Here, revenue has increased, fixed costs have remained constant, so with the increased profit, taxes will increase, too. Third, although tempting to lower price to gain more business — shrinking margin while increasing the break-even point — Gordon advises pest control companies to sell quality services and not get involved in pricing wars. Gordon reminds, “You want to make sure that your gross margins are 50 to 55 percent.”

EFFECTIVE ROUTING. Gordon explains why routing effectively is imperative to the gross profit of a pest control company. Keeping in mind that labor is the largest expense, technicians are either paid at an hourly rate or compensated as a percentage of their route. “To increase profitability we need to increase efficiency,” or fit more work into less time without lowering quality, explains Gordon.

Utilizing the technician paid by dollar per hour, which also works for technicians paid as percentage of route, Gordon says that “By fitting more work into one hour, we have been able to increase our profit. We have increased our revenue in dollars and decreased our labor expense as a percentage of revenue.” Gordon explains that many pest control business owners understand this equation, but showing this example to the operations department or to the technicians is an effective way to illustrate the importance of efficiency.

UTILIZATION. One of the most important benchmarks in judging the efficiency of a pest control company’s routing is called utilization, which is a calculation used to determine technician productivity. “Quite simply, utilization is the following fraction: Total technician hours spent at all stops (jobs) during the time period divided by total technician hours clocked in (paid hours) during the time period,” Gordon said.

To illustrate an example of productive versus nonproductive hours, if a technician is at a job for six hours, and he or she clocked in for eight hours, the technician is 75 percent utilized. Gordon says that a good rule of thumb number for utilization is roughly 60 to 65 percent, depending on the job. At a big commercial job, where the technician is on-site all day, the utilization should be close to 100 percent.

A pest control company, therefore, has two ways of increasing daily revenue: increasing prices or increasing utilization by making routing more efficient. Bottom line, utilization is an extremely powerful calculation in effective routing, and “how you make money in this business,” said Gordon. “If I tighten my route, I’m making more money and increasing revenue.”

The author is a Cleveland-area writer and can be reached at nlucas@gie.net.