Information is power, and the bookkeeper or accountant in your company wields a tremendous amount of it. He provides the information that shows how the company is financially, which helps management and ownership make decisions about operating the business. Accurate and complete financial bookkeeping is the key to providing meaningful reports, which provide clues about the condition of a company, such as:
- alerting management to existing or emerging problems that will affect profit, cash flow or general financial condition; and
- suggesting opportunities for improving a company’s health.
But how does one look for business success or areas that need improvement in financial statements? What areas should be studied to determine whether the numbers are accurate and present an accurate picture of the business? The following is a good start.
Balance Sheet Alerts
A balance sheet is an accounting of everything a company owns (at cost) minus what it owes. The difference is equity. For example, if someone purchased a home for $300,000 and took out a $200,000 mortgage, the equity would be $100,000. Items worth scrutinizing on the balance sheet include:
- Too much cash in a standard, noninterest bearing checking account means one isn’t managing the asset properly. Cash should be at work earning interest or used to purchase inventory or equipment at discounts. On the other hand, too little cash can be disastrous by not allowing the business to meet its obligations. In a pest management business, accounts receivable are constantly being turned over, so there’s usually a steady inflow of cash. But a good rule of thumb is the quick ratio: cash / accounts payable. A healthy quick ratio is 1.25 or better.
- Of the total amount of accounts receivable (A/R), how much is current? If payment terms allow for 30 days, how much money is in the over-30-day column? The 60-day column? The 90-day column? Past-due receivables inhibit the flow of cash, and the older the receivable, the more likely it will become a bad debt. How much should one carry in A/R? A simple barometer would be number of days’ sales in A/R, calculated by dividing the A/R balance by the average daily sales. If this number is greater than the terms one offers — say, 30 days — then customers aren’t complying with the terms offered.
- In general, the industry orders inventory on a just-in-time basis. There are exceptions. Many distributors offer year-end deals that might create a higher-than-normal inventory, for example. But for the most part, inventory should equal the cost of material on all trucks, plus a week or two of inventory in the chemical room. In this manner, one isn’t tying up too much money in inventory.
- Accounts payable (A/P) are the symmetrical opposite of A/R. Rather than representing the amounts owed to the company, A/P represents amounts owed by the company to vendors. They’re also aged using the 30-, 60-, 90-day protocol. A healthy company won’t have large amounts more than 30 days because the A/P aging is an indicator of whether a company is meeting its obligations. There are exceptions to this rule — disputed bills, for example.
Profit and Loss (P&L) Statement Alerts
A P&L statement is a snapshot of what a company produces in terms of revenue, expenses and profits. It should be looked at monthly, as well as a year-to-date basis. Items worth scrutinizing on a P&L include:
- Revenue should be recorded as it’s produced (accrual basis). It should be broken into divisions such as commercial, residential and wood-destroying insects (WDI), for example. Categories such as start-ups, one-times and recurring revenues can be created. 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 recurrence pattern.
- Sometimes known as direct costs, cost of goods sold (COGS) includes all costs associated with putting a technician on the road. These can include technician labor, benefits, vehicle costs and chemical costs. The direct cost should be no more than 50 percent for a pest control company.
- Gross margin is the difference between revenue and direct expenses expressed as a percentage. In pest control, gross margin should be 50 percent or greater. Gross margin is one of the most important metrics in a business because it determines the breakeven point. For example, assume all non-COGS costs are $10,000 for the month with a 50-percent gross margin; the breakeven point would be $20,000 (10,000/.5). After revenue exceed $20,000, profit would be made at a rate of 50 cents on each dollar of revenue.
- Without sales and marketing, there’s no business. The difference between the two is marketing represents all efforts to create leads, while sales represents all efforts to close the leads. Look at these efforts as an acceptable percentage of revenue, although some 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) represents all nondirect sales costs or marketing costs, such as rent, professional fees, salaries, etc. G&A usually runs about 20 to 25 percent of revenue.
- Net income is what owners work for. How much did you make? Revenue minus all expenses. On average, you usually look for 10 to 15 percent before taxes.
Understanding financial statements allows you to make a realistic assessment of your company. The aforementioned should be used as a guideline to rating the results of your efforts because not all pest management companies are the same, and the goals of management might be different depending on the company.
Dan Gordon is a CPA in New Jersey and owns an accounting firm that caters to PMPs throughout the U.S. He facilitates several peer groups that help PMPs increase growth, profitability and accountability in their firms. Visit www.pcobookkeepers.com for information about his firm, PCO Bookkeepers. Gordon can be reached at firstname.lastname@example.org.