Profit Motive

THE DAY THE BALANCE SHEET finally goes from red to black is as exciting for an entrepreneur as his first day in business. Whether that memorable moment takes weeks or years, a smart executive gets there by never resting on his laurels.

Whether a building service contractor is fresh to the market, or a well-established professional, profits should always be at the top of his or her mind. They are do-or-die for small companies and they can be the difference between expansion and stagnation for large companies.

“Being profit minded keeps you focused on your systems, procedures and the ongoing need to attract and keep customers,” says Steve Southard, CBSE, president of Cross Gate Services in Brentwood, Tenn. “Being fiscally sound is a responsi-bility that owners have to their people.”

Theory of evolution
When a BSC first sets up shop, he may have a love-hate relationship with profits. He loves it when they finally show up on the books, but hates waiting for it to happen. Given how crucial a profit is to a start-up business, it’s no surprise that new entrepreneurs spend many waking hours worried about money.

“I’m so obsessed with profits,” says Angelo Lorusso, president of SIR Cleans-A-Lot in Mooresville, N.C. Now in his sixth year of business, Lorusso’s company is beginning to turn a healthy profit. “We’re not getting rich, but we’re meeting all of our obligations.”

As a business ages, its profits evolve from “a way to pay the bills” to a means for growth.

“The main difference is it gets a little more sophisticated and a little more structured in the way you look at profits,” says Rich Emery, owner of ServiceMaster Building Maintenance in Des Moines, Iowa. Emery has been a ServiceMaster franchisee for 25 years. “When you first start, your focus is trying to stay alive. Later on it gets more intense because every business is trying to drive their bottom line.”

Throughout the journey, however, one thing remains constant — profits are absolutely necessary.

“Profits drive growth,” says Andrew Clarke, CEO of Ground Floor Partners in Chicago. “Without profits, there is no incentive to grow, and no money to fuel that growth.”

Money management
Without being an MBA or a CPA, it’s easy to get lost in the numbers game of running a business. All of the jargon — payables, receivables, deductions — can be overwhelming. Managing a business’s balance sheet is a lot more complicated than balancing a personal checkbook.

“People think that when they’ve started a business they will automatically be profitable — that owning a business is a license to print money,” says Gary Bauer, vice president of business services for ServiceMaster Clean, headquartered in Memphis, Tenn. “That’s not true. It’s hard work.”

Although an MBA is not required, entrepreneurs should do their homework to develop at least an elementary understanding of accounting. Perhaps the biggest money error business owners make, whether they are beginners or old pros, is confusing a profit with cash.

A profit is net income less expenses. Cash flow, on the other hand, is more dynamic, showing how much cash a company makes and spends during a specific period (it accounts for all charges, including depreciation and taxes). Cash flow is generally considered a better measure of a company’s financial strength than profits.

Even more importantly, a profit is a theoretical concept while cash is concrete. For example: You make $1,000 on a cleaning job that cost you $500 to perform, earning you a profit of $500. Until the bill is paid, however, you don’t actually have $500. You cannot spend a profit, which is why cash flow is so critical.

“Profits are important, but cash flow is more important,” Clarke says. “Many profitable companies fail because of inadequate cash flow. This is because profit is susceptible to clever accounting tricks, whereas cash is cash.”
Tracking cash flow is one of the most important management tasks for any business.

Most owner-managed BSCs use inexpensive accounting software, such as Quickbooks, to stay on top of cash outflow (all payments a business makes to pay employees, suppliers, and creditors) and cash inflow (all cash received from customers, lenders, and investors). Larger companies typically rely on a professional accountant.

While large profits are nice, it’s more important that a business have a positive cash flow, which means its cash inflow exceeds the outflow. All income and expenses should be accounted daily and the totals monitored monthly by running reports, which can be used to set and revise financial goals.

“A company needs to see what is working and what is not,” says John K. Paglia, managing director for Paglia Consulting Group in Simi Valley, Calif., and finance professor at Pepperdine University in Malibu, Calif. “If the variances from budget are greater than 10 percent for two months in a row, the business should consider revising its projections.”

As a newer entrepreneur, Lorusso admits to being a tad neurotic about his Quickbooks reports. He likes to “keep an eye on things” by running reports as often as daily and then comparing them every two weeks.

“It tells you where you are going and how you are doing,” Lorusso says. “As long as I see an upward growth in both sales and profits, I’m fairly happy.”

To help set realistic goals, BSCs can consult with trade associations to provide industry-specific operating ratios to use for comparison.

Marginal mindset
No financial term carries more weight for a BSC than “profit margin.” Another measure of profitability, a profit margin is a percentage of revenue. Basically, it is how much out of every dollar of sales a company keeps in earnings.

Put into a mathematical formula: Profit margin equals net income/revenue or net profit/sales. If a company has $1 million in sales and a net income of $100,000 then the business earned 10 cents for every dollar generated in sales, or a 10 percent profit margin.

Another example: If a BSC sells its services for $10 an hour, but the company spends $5 an hour for labor and $3 an hour for overhead and taxes, then the BSC earns $2 out of every $10, or a profit margin of 20 percent.

Profit margins are determined by a combination of the market conditions and a company’s ability to control its costs. While margins vary within any industry, most BSCs agree that they are tight — and getting tighter — in the contract cleaning business. Reasons for the decline include higher labor costs for BSCs (due to skyrocketing health insurance rates and an increase in worker’s compensation claims) and customers who continue to slash their maintenance budgets.

“It’s the type of business where you are living off a small percentage of a slice of pie,” Bauer says. “You have to be even more vigilant about watching labor budgets because you can’t afford to run even 10 percent over. It’s a business of managing those details.”

Upping the ante
In any business, there are two basic ways to make more money — work harder or work smarter. The former means taking on more customers or selling more services, while the latter means improving profit margins by reducing expenses.

Rather than spending money on attempts to lure new customers, Bauer suggests selling existing clients on ancillary services, such as carpet cleaning or landscaping.

“It’s more expensive to acquire a new customer than it is to keep an old customer,” Bauer says. “Sometimes it’s easier to grow revenue with a customer you already have than with one you don’t know about.”

More often than not, working smarter will pay higher dividends than working harder. There are many ways to slash expenses. Labor is the largest chunk of a BSC’s budget so cutting that line item will reap the biggest rewards. BSCs should review their compensation plans and make cost-saving cuts or changes wherever possible.

“Many companies waste large amounts of money on benefits that employees don’t care about and don’t provide the things that matter most to employees,” Clarke says. “Most bosses think salaries are the most important motivator, but most research shows that salary is only third or fourth on the list. Find out what drives your employees, and tailor your compensation plan accordingly.”

Outsourcing is also a popular method for reducing labor costs. BSCs can hire out such services as information technology and payroll.

In addition, BSCs should negotiate rates with their vendors. Just as facility managers expect the best value for their dollar, cleaning contractors should demand the same from their suppliers. For example, BSCs can ask their insurance companies to lower premiums or look into bundling phone and Internet services from one provider at a discount.

Working smarter also means becoming more efficient. The key is keeping current on products and procedures. Innovative companies are willing to try anything, such as team cleaning or a new machine that saves time.

“It’s getting to the point where it’s almost scientific how hard we are looking at every aspect of our business,” Emery says.

Cashing in
Once BSCs start accruing profits, they must make strategic decisions of how to spend their earnings. Business experts say the smartest approach is to allocate profits first toward company growth, then into a rainy-day fund, and finally toward personal rewards.

Reinvesting in the company is the surest way to create success. A BSC must frequently repair current equipment, buy new machinery, and maintain an inventory of chemicals. It is also important to have a well-trained staff that is motivated to continue its employment. To that end, Towers Elite Services in Beaumont, Texas, gives much of its profit back to its employees.

“The greatest portion of our profit goes back to employees,” says president Jim Towers, who has been in business for two years. “If we are going to grow the business, we have to have the best employees.”
Joining a local chamber of commerce and industry associations creates networking opportunities and lends credibility, which is worth the annual membership fees. Advertising is also a necessary expenditure.
“You’re always feeding the beast for growth,” Emery says. “To me it would be very dangerous to take profits and do something that’s nonproductive to the business. In today’s business, there’s always somewhere those funds can be used.”

One place where funds should go, but that is often overlooked, is a rainy-day fund. Life (and business) comes with unexpected surprises that can seriously threaten the unprepared.

Recently, California was hit by a worker’s compensation crisis, during which rates increased six-fold in just three years. Many BSCs didn’t survive. Those that did, including Mr. Clean Maintenance Systems in Colton, Calif., did so because owners had saved enough cash to stem the tide.

“There’s no way we could have anticipated what was going to happen. It sucked all of the profits out and then some. We almost went out of business,” says Mr. Clean Maintenance’s president, Art Rose, who has been in business for 26 years. “I started my business in 1980 but I didn’t buy a house until 1994. I kept putting the money back into the business.”

Only after investments have been made and money has been saved should a business owner spend a little on himself.

“We’re a fairly young company and we’re just now starting to see profits,” Lorusso says. “We’re putting most of it back into the business, but I bought a Jeep a year ago and I may take a trip in September. If you’re not making any money, there’s no point in being in business. I love cleaning, don’t get me wrong, but I want to make a little money while I’m cleaning.”

Once BSCs work out a suitable mix of company investment, savings and even personal spending with their profits, they should be on track to stay in the black, and out of the red — even when unforeseen hazards threaten success.

Becky Mollenkamp is a business writer based in Des Moines, Iowa, and a frequent contributor to Contracting Profits.