Our founder, Kevin Kehoe sat down with Greg Herring on August 28th to discuss how pricing fits into the larger picture of success for your business. If you missed the live presentation, you can watch the replay here. Kevin and Greg will co-host again on September 10th to do a deep dive discussion on pricing principles and calculating labor rates and labor burden.
During the August 28 webinar, Greg used a specially designed spreadsheet template (which you can get for free here) to help you calculate markups and target net margins that will result in the overhead recovery and the profit you expect.
When you download the spreadsheet template, you can follow along with the replay to make adjustments to the numbers and see the impact for yourself.
Pricing and Profit are Only Part of the Picture
Success for any business is about more than just money.
Numbers tell a story and a greater profit margin is certainly part of the goal, but there are two shifts that The Herring Group works to create with their clients. These shifts both contribute to a greater “life margin” for the owner of the business.
Profit margin is the excess of revenue over expense, which is necessary for business growth. Life margin is the excess of time and energy that people have. Many people, especially business owners, don't have much excess of time and energy. The shifts that The Herring Group helps clients achieve build more margin into the business and into the owner’s life.
The first shift is from the “guess and wait” method to a true “know and decide” strategy.
Taking your best guess at the right decision and then waiting to see how it turns out can be nerve-wracking. It is much less stressful to know your numbers and make intelligent business decisions based on that data.
Aspire makes this shift possible by capturing a huge amount of data about your business. The Herring Group then takes this data and “mines for gold,” generating reports and building customized financial dashboards for their clients. The better that data is, the better the reports are. The more people in the company that are trained to use those reports, the less time and energy the owner has to spend on them, and the more life margin the owner has.
The second shift is from management to leadership.
Management is all about getting tasks done. Leaders set culture and values. They set direction and help determine strategy. It’s best for business owners to spend their time as leaders, not as managers.
The Herring Group enables this transition for business owners using The Path to 12%, which is an operational model made up of 6 steps implemented over time: alignment of estimates and actual's, labor hour management, profit model formulation, portfolio management, business model refinement, and the annual budget.
All six steps, in combination with regular meetings based around actionable reports, support a shift from “stressed-out manager” to “leader with life margin” for the company owner.
The True Cost of Pricing Mistakes
Pricing the right way is more than a simple financial calculation. When you watch the webinar replay or experiment with the spreadsheet templates on your own, you will be able to see how changing one aspect of a pricing estimate can have a serious impact on your company’s profit margin.
Greg spent a few minutes starting at the 19-minute mark demonstrating how forgetting to account for inflation in wages, crew indirect labor, or markups can impact net margin.
Here’s a screenshot from the presentation:
Since percentages don’t always speak as clearly as dollar amounts, Greg translated those net margin numbers into lost profit for a hypothetical landscape company (or division) doing $3 million, $6 million, $9 million, and $12 million in revenue annually.
These numbers go along with the takeaway from last year’s webinar collaboration with The Herring Group. As Greg wrote in a guest blog for us last November, many landscape companies may be missing out on half a million dollars (or more) in profit every year.
Just to talk through the numbers in the screenshot: if you're a $3 million company or this is a $3 million division, you're going to lose $160,000 if you forget to account for inflation. You're going to lose $250,000 if you forget about crew indirect labor, and you're going to lose $230,000 if you mess up your markup calculation.
The losses get even scarier if you start miscalculating in more than one place: if you miss on both your labor and your burden, you're going to lose $420,000 on a $3 million company.
As Greg said, “we're talking big numbers here and that's why it's important to get it right!”
Meanwhile, Kevin highlighted the fact that often these calculations become skewed due to a lack of consistent accounting and consistent definitions. Using a software like Aspire brings much-needed clarity and consistency to business finances.
Pricing Steps, Simplified
At the 30-minute mark of the webinar, Greg went over the exact steps of pricing and how to use the interactive spreadsheet templates in your business.
The steps of pricing are as follows"
0. Clean up your chart of accounts (an optional step).
1. Determine wage rate by division for the next 12-18 months. This topic will be covered in the second webinar of our Pricing Series. Register here.
Current wage rate without overtime plus possible wage increases.
2. Determine labor burden. This topic will be covered in the second webinar of our Pricing Series. Register here.
Any cost in QuickBooks “above” the gross profit line and not directly costed to a job.
3. Gather your income statement data.
Minimum: QuickBooks income statement for the Last Twelve Months (LTM)
Ideal: QuickBooks income statement for the last 36-60 months, columns by month
4. Populate the spreadsheet.
Greg demonstrated this on the webinar.
5. Determine the markups and target net margin.
Greg demonstrated this on the webinar.
6. Publish the Profit Model.
Greg illustrated the Profit Model on the webinar.
When you access the spreadsheet, you’ll notice that some of the numbers are red. Those are the numbers you will need to fill in so that the spreadsheet can run calculations for you. Other numbers are blue. You can adjust those if you need to.
It’s best to watch Greg demonstrate on video, so make sure you watch the webinar replay to learn how to use the pricing spreadsheets in your business.
Questions and Answers:
Q: What do “above the line” and “below the line” mean?
A: “The line” refers to the gross profit line in QuickBooks.
Any cost that’s above the line and not directly costed to the job should be in labor burden. If you don’t want to include that cost in labor burden, then you need to move it below the line in QuickBooks. If it's below the line in QuickBooks, it is recovered as overhead through markups.
It's a very important distinction. In fact, if you don't take anything away other than that... that would be a good thing to take away!
Q: How do you go about determining the % of general and administrative expense (overhead) by division? % of revenue is how I have always done this. I just want to make sure this makes the most sense.
I encounter clients that try and do allocations in QuickBooks using classes and I think it's an enormous amount of work for the accountants and bookkeepers and it's not necessary! If you need some help convincing your boss of that, shoot me an email and I'll send you something that you can forward to them.
But the question is an important one.
So let me just take one line item that's frequently found in G&A expense, and that would be employee related expense. So it could be recruiting costs... it could be training time... it could be uniforms... all those employee related expenses.
Let's say that you're a construction company and a maintenance company, and if you allocate those based on revenue, construction is going to get a lot of that cost. If you allocate those based upon labor, who's going to get more of that cost? Maintenance, right? Because maintenance is more labor-intensive than construction and construction has more materials.
So that's an example where just a simple revenue allocation would generate significantly different results than the more appropriate direct labor allocation. And those different results could impact your pricing and your business strategy.
We just do it in Excel twice a year. We’ll allocate those items based on what's driving the cost. Sometimes we’ll get more complicated... for example, if someone's using a lot of subcontractors, we won't do a revenue allocation in that case. We'll do a revenue less subcontractor costs allocation. So that's where financial expertise can really be helpful in helping you think through what's driving your costs.
Yeah. And one other thing, Greg — and we could into more detail at the next webinar — but there are two reasons that matter with all those costs. There are two purposes around them.
One is from an accounting point of view, I want to fairly charge a division with the costs that they incur. That's a good practice. I think the other piece, though, is that doesn't necessarily mean that I will use that allocation of overhead to calculate the price.
In other words, I may want to over-allocate for pricing reasons. Costs that may show up a construction might go into irrigation just because it can bear the cost, because I want to be competitive.
So I just think you have to separate the two. One's an accounting function. The other was really a pricing function of costs and market.
Q: For construction, the "market" pricing for materials varies greatly. For example, you can mark up plants more than pre-cast materials. What are best practices around this? Separate service types and guess the volume you will sell of each to make your budget? Or just go with the same markups and forego potential market pricing? For us, this may mean we price ourselves out of pre-cast driven jobs.
The reality is you can't mark those materials up the same. Aspire does give you the option to bring those standard markups down. When you set your markups in the money bag, if you're going to bring some down, you're going to have to bring others up. So typically I recommend companies pricing at the higher markup, knowing that on some proposals you are going to have to bring some of those prices down.
Yeah, I think some of it also comes down to the fact that you can't always predict what happens on a construction job. You're trying to set markups in your system based on your budget, with some projection of the actual mix of the work. I may have a certain budget set up that says I'm going to do 15% material, 10% that's going to be subcontractors, and then I've got labor costs... but then I get a job that doesn’t turn out that way. And that's why there are some things in Aspire that can be done in the service pricing or also done at a template level. So I can adjust in the template based on different mix of construction.
Q: Why do you not consider owner equipment as a direct cost to the job
If the equipment is bid as a deliverable on a job, then it could be recorded as a direct cost. If not, it is overhead that gets recovered and charged to every job in the markup. Direct costs are defined by those things you bid and you leave on the job site permanently, not when you merely used it to support the work.
To put this another way... if you take your truck home at night, it did not get sold! That’s why the cost for owner equipment goes into overhead, to be recovered in your markups.
Meet the Experts!
Will you be attending the 2019 GIE + Expo in Louisville? We’ll be there! Stop by to meet Greg Herring, Kevin Kehoe and the Aspire team. Held at the Hyatt Regency in Louisville on October 17th, Aspire's trade show within a trade show will showcase some of the best products available through Aspire Software. Don’t miss out! Reserve your FREE spot today!!
Ready, Set, Go!
Once you’re all caught up, register for our next webinar on September 10. Kevin and Greg will be talking in-depth about calculating burden and labor rate. You won’t want to miss it!
Greg Herring has served as a CFO of both public and private companies. Herring is the CEO of The Herring Group, an operational and strategic finance consultancy. He has significant experience in the landscape industry, where he serves business owners challenged by growth by installing financial dashboards and systems that provide more margin for their businesses and their lives. Reach him at email@example.com.