How well do you know your company’s profitability?
Most business owners use profit & loss statements to evaluate their performance and compare it over specific periods. Still, they might only be focusing on the overall company profitability. While that remains crucial, if you’re in a project-based—or location-based—business, it’s important to know your profit centers.
After all, even though your company may be profitable, there may be aspects of your business that bring in less money, and it’s important to have accurate and up-to-date information when it’s time to make decisions about how to move forward.
Another way to look at this is that job-based accounting allows you to see profitability from both a macro and micro point of view, giving you real numbers that might validate your gut feelings (or conversely prove you wrong).
A two-tier approach to profit & loss statements
Your profit and loss statements (P&L) provide a clear picture of overall profitability. Drilling down to individual profit (or loss) centers can look dramatically different based on the type of business you have and how you structure it.
For example, you can break job costs down by project, physical location, client, or even project type.
Many of our clients who are familiar with project accounting or cost accounting already know how to allocate costs by job type. However, they don’t always have a clear picture of profitability. And, depending on the business it can be challenging to draw the line between projects.
To help illustrate how this might work, I’m using a hypothetical example of an event planning and management company.
In many ways, it’s easy for them to allocate job costs, because almost everything they do can be attributed to either a specific event or internal company-related tasks.
When I show clients like this their overall profitability—it’s one thing. But when we break it down to specific events, they can start to see which events are more profitable, and identify where they could become more profitable.
For example, I might be able to show these clients, that a specific type of party, birthdays or holiday parties perhaps, may be less profitable than weddings.
Or we might discover that parties at a specific venue always cost us a higher percentage of profits due to any number of factors—parking costs, valet costs, higher gratuities, needing to use their specific vendors for food and drinks—you get the picture.
Then again, our client might discover that working with a long-term customer is less profitable than some of the newer groups they’re working with.
All this to say, I can show the client the data, and then they can make whatever decision they want—they’ll just have data to back up their reasoning. Some outcomes might be:
- Continuing specific less-profitable projects but adapting frequency to offset costs. “I know kids’ birthday parties are less profitable than parties for adults, but they’re so much fun, so we’ll keep doing them. We might just have to make sure that for every 3 we book, we’re booking at least 1 party for adults.”
- Increasing frequency of more profitable jobs. “Weddings are such a headache, but I had no idea how profitable they are! We make so much money from them that we’ll make a bigger effort to book at least 1 a month.”
- Increasing fees for less profitable jobs. “Holy cow! I had no idea that events at Acme Hotel had a 35% lower profit margin. I’ll be sure to increase our rates on those parties to cover the additional fees.”
- Validating expectations about less profitable projects, and choosing to move forward anyway. “Yeah, I’m not surprised that events for our Acme Corporation customer are less profitable—but we’ve been working with them forever and absolutely love them. We may be able to raise our rates a bit, but they’re such a good referral partner and we genuinely enjoy them.”
- Discontinuing less profitable services. “Wow—retirement parties and family reunions actually cost us money. We either need to do a lot less of them or stop doing them altogether.”
While it’s not realistic to operate in the red, even if you decide to continue working on less profitable projects, it’s important to understand why they’re less profitable. Maybe you can offset costs somehow—or then again, maybe it’s time to move on.
Is job cost accounting a fit for your business?
In my experience, there are two types of clients who use project profitability analysis.
On the one hand, there are the ‘all-in adopters’ who understand the benefit of using job cost accounting and are diving in feet first. On the other hand, are the ‘hesitant explorers’ who also see the benefit but are skeptical about how it might work in their specific company.
The truth is job cost accounting isn’t the perfect fit for every business, but most businesses—even brick-and-mortar companies can realize some benefit. Let’s look at a few examples:
One of our clients is a van rental company with multiple locations. Job accounting allows them to analyze the profitability of the different locations and make decisions about staffing, hours, or keeping the location open.
Another business owner I’ve spoken with has a luxury retail business that sells, delivers, and services high-end wellness products—hot tubs, swim spas, and saunas. In addition to comparing the profitability of their different locations, job accounting allows them to review the profitability of their sales, service, and delivery departments. What’s more, they can compare specific aspects—like costs of individual trucks, and logistics/shipping costs to evaluate profitability and costing.
I frequently work with construction-related companies—architects, engineers, builders. They can allocate costs to each job they work on and by type.
You can start to see some of the possibilities here—and the intrinsic value of understanding how the various aspects of your business are profitable (or not).
Go with your gut feeling, but back it up with data
When faced with a complex decision, people tend to say, ‘Go with your gut,’ but it’s not always the best advice in business. While I place a lot of stock in intuition, gut feelings alone aren’t a solid foundation for decisions.
The van company we worked with was pretty sure that one of their locations was less profitable but wasn’t able to confirm it until they saw the numbers.
On the other hand, one company we worked with discovered that the location they thought was least profitable was actually a profit center—it brought in less money, but the overhead was much lower, so it had higher profit margins. You never know what the data will tell you until you see it.
Why retaining less profitable segments might make sense
Given that we’ve focused on increasing your company’s profitability this whole time, this next part may sound counter-intuitive, but holding onto less profitable segments of your business could be beneficial.
I touched on this earlier, talking about clients you might love or who are great referral partners—and there are plenty of other scenarios in which you might want to keep a client, project type, or location regardless of profit margins.
Not all businesses operate with the bottom line in mind, and this could include companies that serve a niche market or clients that are strong referral partners.
If you serve a specific vertical or have identified a gap in the market and are building a business on that basis, you may be playing the long game, but it’s worth continuing to pursue.
Alternatively, maybe you know a specific location will never be as profitable as the others, but you want to serve a community that otherwise doesn’t have local access to your products or services.
Then again, you might have a project type that’s a loss leader but frequently leads to more profitable projects with the same buyer.
Keeping these segments can also allow you to try new ideas without much risk—consider them experimental for your business.
With the help of your accountant, you could even take these liabilities and turn them into assets. The key here lies in knowing the numbers and making an informed decision.
Empower your future decision-making by embracing cost accounting and profit analysis.
I’ve covered a lot of ground related to what you might learn and some of the potential outcomes. It all boils down to how the insights you gain from cost accounting help you make decisions that affect your company’s future. These decisions could be anything like pricing your products or services, how you scale the company, and even diversification.
Now that you’ve seen how understanding profitability at a project level can give you a comprehensive illustration of your company’s overall profits, it’s time to put it into action.
Using this strategy, you can move beyond relying on your ‘gut feeling’ and back it up by harnessing the power of data. Now, you can make informed decisions for your business without anything falling through the gaps.
To learn more about cost accounting and how it might be a fit for your business, contact Automated Accounting Services—we’d love to explore ways to help you improve your profitability.