Breaking Even or Breaking Up

  Jim HustonToo few contractors understand the importance of year-end work and how to price it. If you understand the concept of an “October surprise,” you can add some significant dollars to your bottom line.

The break-even point
A company usually reaches its break-even point (BEP) in the 9th or 10th month of its fiscal year. This is September or October for companies whose fiscal year coincides with the calendar year – hence the name October surprise. You reach your BEP when your accumulated gross profit margin (GPM) equals your general and administrative (G&A) overhead budget dollar amount for the year. (Gross profit margin is defined as the total of G&A overhead costs plus net profit margin.) If you hit your break-even point prior to the end of the fiscal year, any dollar amounts on bids above direct costs (to include sales tax and field labor burden) will be net profit for that year. That’s if the work is completed and billed prior to the end of the fiscal year.
Work bid after the BEP is met, which will be completed and billed before the fiscal year end, can be bid with the realization that any amount above direct costs in the bid goes to the net profit margin on the bottom line. If your net profit margin on a bid is 10 percent and your G&A overhead amounts to another 15 percent, your net profit margin is really 25 percent, since your G&A overhead is already covered for the year.
Some contractors understand this concept and know that, after they meet their BEP, they can bid work cheaper than they normally would at the end of the year without really cutting net profit. I would not recommend this strategy unless you have a very justifiable reason. Because of the inherent risk in projects, especially construction ones, you should always strive to work for maximum net profit.

Monitoring G&A costs
Indirect costs, or G&A overhead costs, are essential to monitor. Like field-labor downtime, G&A costs can get out of control and eat up your bottom line, while individual job-cost reports look great. 
I don’t recommend attempting to allocate actual G&A overhead expenses to your jobs through job costing. Rather, I prefer to simply compare direct costs bid to actual performance by means of gross profit margin (GPM) on a job-by-job basis. If your GPM turns out better than estimated, great! If not, find the problem and fix it before the next time. 
However, you do need to monitor G&A overhead costs throughout the year by means of your profit and loss (P&L) financial statement format, which can compare monthly and year-to-date “budget vs. actual” categories. A good accounting software program should allow you to produce such a report. If you don’t have that capability, you can produce it manually or enter the data into a computerized spreadsheet program. 
In the box below left, the “projected” BEP is calculated to be $666,667. In other words, once you hit $666,667 in sales for the year, theoretically you should have accumulated enough gross profit dollars to cover all of your $200,000 G&A overhead costs. This is your break-even point. If your gross profit margin is approximately 30 percent, multiply the $666,667 by .3 and you get $200,000.
This is the “projected” or budgeted BEP. Due to fluctuations in the GPM on individual jobs throughout the year and other factors, the “actual” BEP will in all likelihood be different as seen on your P&L statement. Therefore, it’s necessary to monitor the “budgeted-to-actual” BEP by means of the P&L statement.

Calculating BEP for a specific job
The BEP for a specific job being bid equals all direct costs plus the overhead cost allocated to that job. It also is equal to the price for the job minus the net profit on it. In order to calculate the BEP for a job, gross profit margin (GPM) must be broken down into its two components, G&A overhead and net profit. The BEP is determined by adding the overhead portion of GPM to the direct costs for the job.
The BEP calculation for a specific job changes in an important way once a company or division attains its BEP for the year. Because G&A overhead for the year is covered once the company BEP is reached, the G&A overhead component of GPM actually contributes to net profit for the year. In other words, all dollars in a bid above direct costs (or GPM) are net profit dollars as long as the job is installed and billed during the current fiscal year.

Bidding year-end work
With this scenario in mind, one should ask a couple of key questions when bidding year-end work. 

1. How is the market (i.e., residential construction or maintenance, commercial construction or maintenance, negotiated work, competitively bid work, etc.) predisposed towards certain pricing structures? For instance: commercial installation work in an open bidding situation may see GPMs rarely over 25 percent while negotiated work in the same market will realize 25-30 percent; residential installation will usually be predisposed at a higher GPM ranging from 30-40 percent. Similar ranges will be observed in the maintenance markets. If the market is predisposed toward an identified GPM, you already know generally where your pricing needs to be to win work in that market. 
2. Has your company met its BEP for the year? If it has, all dollar amounts in the bid above direct costs will contribute to net profit for the year assuming that the job is installed and billed before the end of the fiscal year. Knowing this, you can (if necessary) reduce your GPM for a particular job being bid (e.g., from 30 percent to 10-15 percent) and price the job more aggressively or competitively, thus increasing your chances of getting the job. Net profit on the job being bid equals that on previously bid jobs since the G&A overhead portion of GPM has already been covered for the year. However, it goes without saying that if you can price year-end jobs at normal GPM levels, by all means do so. If the BEP has not been met, pay particular attention to questions 3 and 5.
3. How many dollars of GPM will this job contribute to your company’s profit and loss financial statement?
4. Can field operations handle this job, or is it beyond its capacity to perform and to deliver the product or service on time and at the desired standard of quality? If the field has the capacity to handle the job, answer question 5.
5. Could the job being bid be replaced with ones that contribute more GPM dollars to the company? If it could, it would probably be wise to do so.

Contractors who have clear definitions, calculations and goals regarding these concepts usually break even in the last quarter of their fiscal or calendar year. Ones who do not understand the concept of the October Surprise often break up instead of breaking even. You can imagine what their surprise is like.

Once you fully understand and implement the concept of the October Surprise in your business strategy, you’ll be glad that you did. This should not only help you to maximize your bottom line in 2009 but it will also help you get ready for 2010.
 

Jim Huston runs J.R. Huston Consulting, specializing in green industry consulting. Reach him at 800-451-5588, jhuston@giemedia.com or via www.jrhuston.biz. To purchase his book, visit www.lawnandlandscape.com/store.