Information is power, and the internal bookkeeper or accountant in your company wields a tremendous amount of power as he or she provides the information that shows the company gross margin or how your pest control company is doing financially which helps management/ownership make key decisions regarding operating the business.
Accurate and complete financial bookkeeping is key to providing meaningful reports. Meaningful reports provide clues to the condition of your company such as:
- Alerting management to problems that exist or are emerging that will affect profit, cash flow or general financial condition
- Suggesting opportunities for improving the health of the company
But how do we look for business success or areas that need improvement in the financials and also what areas should be studied to determine if the financials are accurate and presenting a true picture of the business? The following is a good start but by no means is all inclusive.
Balance Sheet Alerts – A Balance sheet is essentially an accounting of everything a firm owns (at cost) minus what the firm owes. The difference is known as equity. As an example, assume we purchase a home for $300,000 and took out at $200,000 mortgage our equity would be $100,000 ($300,000 – $200,000). Below are some items that are worth scrutinizing on the Balance sheet:
Cash – Too much cash in a standard non-interest bearing checking account means that we are not managing this asset properly. Cash should be at work either earning interest, purchasing inventory or equipment at discounts, etc. However, too little cash can be disastrous, not allowing the business to meet its current obligations. In a pest control business, accounts receivable are constantly being turned over so there is usually a steady inflow of cash. But a good rule of thumb is found in a ratio called the quick ratio. The quick ratio is the fraction: Cash / Accounts payable. A healthy quick ratio would be 1.25 or better.
Accounts Receivable – Of the total amount of Accounts Receivable how much is current. If your payment terms allow for 30 days, how much money is in the over 30-day column? 60-day Column? over 90-day column? Past due receivables cause a slowdown in cash flow and the older the receivable the more likely it will become a bad debt. How much should you carry in Accounts Receivable? A simple barometer on this would be the number of days’ sales in A/R. This is calculated by dividing the A/R balance by the average daily sales. The result will give you the number of days of sales that is sitting in A/R. If this number is greater than the terms you offer, say 30 days, then your customers are not staying within the terms you offer.
Inventory – For the most part our industry orders inventory on a just-in-time basis. There are exceptions for example at the end of the year, many distributors give great deals if you make your purchase by the end of the year. This may create a higher than normal inventory. But for the most part, inventory should equal the cost of material on all trucks plus a week or two of inventory in our chemical room. In this manner, we are not tying up too much money in inventory. Again, the only way a PCO wants to stockpile inventory is if he gets a great deal.
Accounts Payable – Accounts Payable are the symmetrical opposite of Accounts Receivable. Rather than representing the amounts owed to the company, Accounts payable represents amounts owed by the company to vendors. Accounts Payable are also aged using the 30, 60, 90 protocol. A healthy company will not have large amounts over 30 days as the A/P aging is an indicator of a company staying current on its obligations. Certain exceptions to this rule exist such as disputed bills.
Profit and Loss Statement Alerts – A profit and loss statement is a snapshot of what the company is producing in terms of revenues, expenses, and profits. It should be looked at on a monthly basis as well as a year-to-date basis. Below are some items that worth scrutinizing on Profit and Loss:
Revenues – I like to see revenues recorded as they are produced (accrual basis). They should be broken into divisions such as Commercial, Residential, and WDI. Within these divisions, we like to see Start-Ups, One Times and Recurring Revenues. It’s not as important to call a revenue type the target item such as Ants, Mice, fleas, etc. It’s more important to understand its recurrence and the recurrence pattern it takes. This methodology is consistent with the continuous valuation of the company.
Cost of Goods Sold (COGS) – Sometimes known as direct costs COGS include all costs associated with putting a technician on the road. These costs include technician labor, benefits, vehicle costs, chemical costs and other costs that are incurred for technicians on the road. The total of these direct costs should be no more than 50% for a pest control company.
What’s your Gross Margin?
Gross Margin – Gross margin is the difference between revenues and direct expenses expressed as a percentage. In pest control, gross margin should be 50% or greater. Gross Margin is one of the most important metrics in running a business. Gross margin determines the breakeven point. For example, let’s assume that all non-COGS costs are $10,000 for the month with a 50% gross margin, our breakeven point in revenue would be $20,000 (10,000/.5). After revenues exceed $20,000 we would make the profit at a rate of 50 cents on each dollar of revenue.
Sales and Marketing – These two functions are probably the most important functions in running any business. Without sales, we have no business. The difference between the two is that marketing represents all efforts to create leads. Sales represent all efforts to close those leads. While in general, we can look at these efforts as an acceptable percentage of revenues, I don’t mind driving these percentages way up as long as the lead cost and closing ratios are acceptable especially in smaller companies. Therefore, judging this number is sometimes more difficult than just looking for a standard percentage.
General and Administration (G&A) – This category represents all non-direct, sales or marketing costs. G&A can include office rent, professional fees, office salaries, etc. G&A usually runs at around 20-25% of revenues.
Net Income – This is what we work for. How much did we make? Revenue minus all expenses. What should this number be? On average, we usually look for 10%-15% before taxes.
Conclusion – Understanding financial statements allow you to make a realistic assessment of your firm. The above should be used as a guideline to rating the results of your efforts as not all PCO firms are the same and the goals of management may be different depending on the company. High growth companies may not be as profitable as companies who are not looking for large revenue increases. Many owners may want high profits and sacrifice growth. While managing by the numbers is a great management tool a clear understanding of management objectives need to be spelled out.
