This video explains why there is a discrepancy between your tax return and take home pay.
When it’s time to pay taxes and you get back your tax return from your accountant, does it ever feel like your tax returns said you made a whole lot more money than you actually put in your pocket? If so, I’m going to give you a really elementary example to show you why. And again, like so many of my other videos, if you judge the video based on the accuracy of the numbers in my examples, you’re not going to like what I have to say.
I didn’t put a lot of thought into this. I put some quick numbers into a spreadsheet. They’re solely for example purposes. Don’t get caught up on anything else. Let me show you why a couple things happen in your business that just frustrate the heck out of you and then have you asking why in the world am I not making as much money as my tax return says. Let’s use this example to set it up.
You did $200,000 in revenue. You had a $110 in expenses, and again fake numbers. Don’t make any assumptions based on these numbers about what you might be able to or not be able to do within your business. In this year at different times throughout the year, you had to buy some trucks and equipment. So, you buy your first truck for 20 grand, your second truck for 12 grand, and you had to buy $15,000 in equipment. If you look at this on a cash basis and let’s say paid cash for everything, that means you should have about $43,000. So, just imagine you didn’t take a cent out of the business all year long.
In December, you should have about 43 grand sitting in your bank account, okay. For my examples, let’s just imagine you don’t get paid a cent until year-end, okay. Now, let’s talk about this. Here’s how your tax return looks so much better than your actual bank balance. We’re a year 1 business, and just imagine that magically on day 1, January 1st, you started to accrue revenue, and as a result by the year end, you had made $200,000 in your first year. You had a $110 expenses, same as I showed a moment ago, but here’s what really happens.
You go out and you … oh, let’s jump over here to the right. If you can see versus 20 grand, you go out and you buy a truck for 20 grand and you buy another truck for 12 grand and you buy equipment for 15 grand. Please keep in mind this is throughout the year. It doesn’t all have to be January 1, but you had enough cash to pay cash. At the end of the year, we’re talking my same example as on the other sheet I’ve just shown you, you have $43,000 leftover theoretically in your bank, and actually that should be the case.
However, when your accountant does your tax return, you’re shocked to find out that you should have made $82,000. The reason for that is because when you go to deduct your trucks and your equipment, your accountant has to depreciate these assets over time. She can’t fully depreciate them. If you’re thinking about the $179 deduction, just forget that for the moment and follow me here if you’re familiar with that.
What happens is, your accountant has to classify these three things as fixed assets, and she has to depreciate them on an IRS depreciation schedule defined by the IRS, and the stuff changes over time. As a result, let’s just … I can’t remember the depreciation tables but let’s just say a truck is depreciated over 7 years and equipment over 5. I doubt that’s exactly accurate. If that were the case, then in year 1 you would only be able to deduct $2800 and then $1700 on truck 2, and $3000 on your equipment.
As a result, you spent a lot of cash leaving you with $43,000 in the bank. And maybe you paid yourself that $43,000, and that salary took all the money out of the bank to pay yourself. That was your salary. But, your tax return now says you made $82,000. That means that you have to pay taxes, and again my magic goal made up 25% tax rate. You would have to pay 25%, again not accurate, on your $82,000 which would be the equal amount of $20,000 in taxes.
You’re paying $20,000 in taxes, but you only took home $43,000 so theoretically that 20 is going to come out of your 43 and you’re going to make about $22,000 for the year. That’s highly frustrating. That’s the first example of how you make far less than what you actually take home. Yeah, you make far less than what your tax return says. It’s because depreciation will get you over time.
Now, let’s continue on with the second example. Now in year 2, nothing in your business gets better. You do the exact same accounts for the exact same revenue with the exact same expenses, but you now own your trucks and equipment, so you don’t have to actually buy anything.
Now in year 2, you have the same exact depreciation as year 1 because you’re depreciating in the second year of your fixed assets, so your tax return should show that you made $82,429. And so you think, oh great, I should have $82,000 left in the bank this year. Well, actually no. Because what happened is on April 15th of the second year of your business, you did your taxes and you did your taxes for year 1. You owe $20,607 and so you had to pay the $20,000 out of the company.
The reason I use this example is, a lot of times many companies in their first couple of years don’t actually report their income as payroll, so they don’t pay payroll taxes. So then what they do is, they take the money out of the company to pay the taxes. So you’d have to take out $20,000 to pay your taxes for the prior year because, remember you took $43,000 the first year which depleted the accounts and then the second in which your tax return showed $82,000. Now, you got to pay tax on year 1 of $20,000. In year 2, you were actually doing really good except, oh, you have to pay the $20,000 from the prior year, so you only got to take home $61,000 that year. Again, all fictitious, but this is the effect of depreciation and this is the effect of taxes.
Most companies, even if you are on payroll, you might be getting some form of distributions, or you have sort of phantom profits. That’s really the wrong word to use, but you have profits that you never actually put in your pocket because you’re investing in trucks and equipment, or you may be paying cash for those things and so things never line up between your tax return and how much money is in the bank and how much money you have. These are two examples of why.
Now, the inverse of this would be an alternative, and I used this approach for many years. Now, unfortunately the IRS is really making this difficult because tax laws changed quite a bit in the last many years, but what I did in the years priors, I used the Section 179 deduction.
In early years of my business under President Bush, they had really made the 179 deduction generous. I don’t remember the number now, but you could depreciate up to like 500,000 in fixed assets in one year.
Let me explain. Using our same example, what I did is instead of paying taxes, I made payments. Actually, let me rephrase that. Instead of paying my trucks and my equipment in cash, I financed them. What happens is, at some point in year 1, I bought a truck and I made about $1600 worth of payments. Maybe on this $20,000 truck, that’s 3, 3-1/2 months of payments. Then, on my $12,000 truck, I made some number of payments. Let’s call 6 or 7 months. Then, on my equipment, I made some number of payments. Let’s call it 6 months as well of payments. So, on a cash basis if you were to look at my bank account, I’ll have about 82,000 leftover within the year because I didn’t pay cash for these things. Remember they are 20, 12, and 15,000, but I didn’t pay cash.
I actually have $82,000 dollars left in the bank. But, thanks to the Section 179 deduction, I was able to fully depreciate 100% of my trucks and 100% of my equipment. On my tax return, I only showed that I made $43,000, when in fact I actually made 82 because I had 82 left in the bank. As a result, the difference between these two numbers saved me $9857 in tax. So, had I paid cash for my trucks and not been able to fully depreciate them, I would not have saved this $9800 in taxes. But, I was able to save the taxes because I was fully able to depreciate them this year.
Now in the year 2015, when I’m recording this video, these deductions have been severely pulled back. I mean, there’s a lot of limits placed on how much you can straight line depreciate under Section 179, so it’s changed drastically. But, in years prior, I was able to use something like this.
If your business is relatively small, you’re not depreciating much. You still may be able to take advantage of quite a bit of depreciation on a truck or a couple trucks under Section 179. But, it’s nothing like it was 5, 6 and 7 years ago.
Again, in summary, these are a couple examples of why your taxes and your cash balance in your bank account or your take home pay will never line up. They’ll never match. This is a great example why.
Watch this video to learn how to maximize your lawn mowing profits.
When I got into the residential lawn mowing business, after about a year or two, I wasn’t seeing the money. We weren’t making enough money and I contemplated getting out. I just didn’t think it was going to be that great of a business. But, I kept running the numbers and I thought, you know what, there’s something to this. I want to stick it out.
There are two keys to making money in lawn mowing. First, you have to keep your service market as small and as tight as possible. Be die-hard about not expanding that until you absolutely have to…until you can’t easily continue to grow within your current market. The smaller you make it, the tighter you build your routes, the tighter your density, the more profit you will make because you’re driving the non-billable time out of your business. Every time you’re moving the truck, every time they’re driving, every time they’re loading and unloading, that costs money. That’s non-billable time. When you eliminate that, that money you recover is pure profit.
For example, if you are driving 10 minutes between jobs, that’s non-billable time. All that drive time, all that labor time, all of that is non-billable. Now you start to watch for that 10-minute period that you used to lose to driving. That labor you were spending to drive was a sunk cost. Now when you go sell a $20 job to fill that 10 minutes, that $20 is essentially pure profit.
Once you work really, really hard on optimizing your routes, building really deep density, the second thing you want to optimize is non-billable time. You want to drive non-billable time out of your company. You want to optimize your company to eliminate non-billable time. At CitiTurf, we’ve used functionality to track non-billable time: drive time, load time, maintenance time, filling the truck, getting ice, getting gas, maintenance…you can go down the list. Then, when you figure out which one of those things is your biggest offender, for example, your mowing crews’ biggest non-billable area is fueling the truck, then you focus on that as a company. How can you change this? Maybe you could get gas at night instead of getting gas in the morning. Maybe you could get an ice machine because that’s one of the reasons they have to go to the gas station. If we have an on-site ice machine, they can bring their own snacks and food for the day. Suddenly you greatly lower the amount of payroll that you’re paying and the amount of wasted, non-billable time.
You go through those things one after another. You look at maintenance. You look at filling the truck. You look at loading. You look at unloading. You look at all of these different non-billable areas. You start with the biggest offender first. You fix it, then you move to the next one and you fix it. Work on this company-wide. When you do that, your profits go up really fast because that’s where all your profit is trapped. That’s where there’s a lot of money seeping out of your company. Focus on those two things: the tightest route you can possibly build and then be ruthless with getting the non-billable time out of your business.
Learn how accepting credit cards will help you get paid faster.
What is it in your business you think you can’t do that maybe you just haven’t tried or haven’t tested? We have all these assumptions about how business works and how life works. Yet, a lot of times we are wrong simply because we haven’t been educated or haven’t learned about specific topic.
Let me give you an example. One of the biggest things that made my business better years back was we decided that we would only work with clients that paid us with a credit card each week. We performed the service and then charged their credit card. It was a big change.
A lot of people in our market weren’t doing it. I have told hundreds of people about this idea because one of the biggest bottlenecks in growing your company is cash flow. You’ll never get big if you don’t have the money to get big.
One of the ways to solve the cash flow problem is to auto charge your clients’ credit cards the day of or the week after service so that you’re getting paid fast. Then, you can time that with payroll. It just changes everything.
Most don’t believe this is possible. They say it won’t work in their market or that their clients wouldn’t do that. That was exactly what everybody said in my market. I just finally got the courage to try it, but at the time really nobody else was.
Why is it that this industry is the only industry, or one of the few industries, that believes that you have to send an invoice at the end of the month and get paid a month later? I know not everybody does it that way, but for example, the lady that cleans our home, we leave her a check every single week. She cleans my home, she gets a check that day.
If you’re an HVAC company or a plumber that comes to my house, I pay you when you perform the work right there at the job site. I have the guy that comes and washes my car. He swipes my credit card as soon as he washes my car.
I have a pool guy. The pool guy sends me an invoice at the beginning of the month for all of the weekly services I am going to receive for the month. I pay him in advance. I can go down the list of all the different providers that I use in my home.
We had our hardwood floors handscraped and re-stained. I gave the guy half the money down and half the money when the job was done. When I had my house painted, I gave the guy part of the money up front and then I gave him the money in stages as he finished painting my house because it took several weeks.
There’s almost nobody that I deal with at my home that sends me an invoice at the end of the month and then expects me to pay them a month later. In other words, floats my money for 60 days.
Again, I say, what is it in your business you think you can’t do that maybe you just haven’t tried or haven’t tested? I ask myself that all the time and that’s where the big breakthrough has come from.
This question’s from Kenny. “When I pay hourly employees, do I have to pay for travel time?”
“When I pay my employees by the hour, should I be paying them for their travel time between jobs? Do I need to pay them for the ride time between jobs? Exactly what should be included when I’m paying them by the hour?”
My perspective on this is that when you’re paying by the hour, you’re paying for every moment that they work. If you want to be within the law, you’re paying from the moment they show up at your office. You are paying them to drive to the clients’ properties as well as while they are maintaining the properties. And then, you’re paying them at the end of the day to ride back in your truck and unloading your truck. The moment they clock in to the moment they clock out, they’re getting paid.
You’ll see a model in the commercial world where they will write contracts with their employees or contractors, however they set it up, and they will pay for performing the job and not driving. I’m not sure how that fits within the law, but you will see that in the commercial side.
In this commercial model, there will be a driver of each truck and that driver is on the clock from the moment he arrives at the facility to the moment he returns to the facility to unload at the end of the day. But, the individuals in the truck with him are only being paid for any work performed at the shop and job time. They’re not being paid for drive time because their agreement stipulates that they should drive their own cars to every job and they’ll be paid for performing each of those jobs. They can hitch a free ride in the truck if they’d like, but it’s not paid time.
Before you go down a road and follow that type of model, you better be certain you’re double checking that will hold up in your state. You also need to double check that your employment agreements are written correctly and that they will hold up. I can tell you from my experiences in the cleaning industry when I used to own a company with some other partners that there were other companies that were competitors of ours that for years and years had certain payment practices of employees. When one employee became unhappy and sued them, it resulted in settlements for lots of employees.
Something creative around payroll might work out for you for 5 years but that doesn’t mean that when you do get hit, that you won’t have to make up for the many years of underpaying your employees. They don’t just slap your hands with a fine and ask you to do it right from now on. You get a fine and then have to pay a lot of back pay in payroll and taxes! Before you go down a road like that, be very cautious.
If you want to go down a road where you’re paying more for performance, then I would look at an alternative to payroll, meaning an alternative to hourly pay. I would look at piecemeal. I’d look at pay by the job, and then there’s plenty of things to consider even when you do that. You have to keep in mind overtime laws and a whole lot of other things. If you’re going to do something creative outside of just paying straight hourly time, you want to get counsel from somebody that really knows the laws in your state, to be certain that you can sleep each night and not have to worry about someday when you get hit with some big amount of money that puts you out of business. Good luck.
Learn the difference between variable costs (direct costs) and fixed costs in your lawn care & landscape business.
A lot of times if you do a Google search, or if you went to college and you studied accounting, a lot of the examples are based on manufacturing. They’re manufacturing examples or they’re the production of some product. It can become confusing.
There’s a lot of interchangeable terms.
Variable cost is a term that’s used frequently. More common, in the landscape industry, is the use of direct cost. I like to talk in terms of direct cost instead of variable cost. You will also hear, and you can watch my video on this, the term “fixed overhead”.
I’m going to go into a little bit of an explanation here. Let me first talk in terms of direct cost because we’re going to use that term instead of variable cost. Direct cost is a cost that varies based on production. As an example, if you win a design build job, you will incur some extra costs to complete that job. You may need to hire some contractors, rent a dumpster or a Ditch Witch, pay out a sales commission, or incur material costs such as plants. Those are direct costs.
Had you not won that design build job, you would never have incurred the material cost, the permits or the rentals. Therefore, it’s a cost that, again, is only incurred when you win the work and when you perform the work. If you’re looking at your profit and loss statement, these direct costs, are going to appear under your revenue at the top of your report in the cost of goods sold section.
What you do is, look at your revenue generated for whatever time period your P&L is looking at. You subtract out of that revenue, your sales revenue, your cost of goods sold. This is your direct cost. That leaves you with your gross profit margin. Your direct costs are going to be one of your biggest expenses inside your lawn care business because your business is so labor intensive. Or, if you’re in the design builder construction side of the industry, materials are going to be a huge cost to your business which falls under direct costs which is part of cost of goods sold.
Again, direct costs and variable costs are often used interchangeably when you’re reading accounting books or performing Google searches. Within the lawn care industry, the more common term is “direct cost”. Generally, what most people do is they take all of the other costs and they put them under “fixed overhead” or “indirect costs”.
There really are some other variable costs in the business that, oftentimes, will get lumped into fixed overhead or indirect costs, but are truly variable. You have to figure out what the standard is for your business, what the standard is for this industry. I would recommend following the standard for this industry.
Let me give you an example of what I’m referring to. You could have what might be considered a variable cost by some, for example, website hosting or maybe marketing. Some consider marketing a variable cost because if things aren’t going well, you could shut off all of your marketing. You could stop running pay-per-click ads or sending out direct mail pieces. Those costs are somewhat variable.
It’s far easier to stop those types of marketing costs than it is to exit out of a three-year lease or to stop paying for truck insurance. Those are fixed costs. Marketing is an example of a variable cost. However, what you’ll see oftentimes, is that a lot of companies will look at their marketing expenditure for a period of time. They will put it into the indirect cost section on their P&L.
What they do is, they take gross profit margin. Remember that’s your direct cost subtracted from your revenue. That gives you your gross profit margin. From that, they subtract their fixed overhead and indirect costs. Oftentimes, you’ll see marketing or advertising as one of those costs that get subtracted out. I wanted to make the point that as you’re reading and as you’re thinking through what is a fixed cost versus a direct cost versus a variable cost, marketing is a great example of a cost that will fluctuate. Therefore, it is somewhat of a variable cost.
For example, you might have website hosting, as I am showing here. That’s a marketing cost. You can’t really turn off your website and shut it all down. A lot of times, that’s obviously a fixed overhead or an indirect cost, whereas pay-per-click, where you’re paying for clicks in Google, you could shut that down by pausing your campaign in an instant. That is more of a variable cost.
The takeaway is that you need to sit down with your accountant and pay attention to what’s done in the industry to figure out if, even though there’s some variability in that cost, as in my example of pay-per-click, it might make sense to follow industry norms or the recommendation of your accountant. You might also hear the terms sometimes called “general and administrative costs.”
Those are some things to think about. Universally in our industry, you will hear “direct cost”. Direct costs are directly tied to the job. If you do not perform the job, the costs are not incurred. If you perform the job, the costs are incurred. That’s why they go into your cost of goods sold section on your profit and loss statement.
In your lawn care business you’ll have two types of overhead. You’ll have fixed overhead and variable overhead. I have a separate video that explains variable overhead.
Fixed costs make up fixed overhead. An example of fixed cost would be rent, insurance, admin salaries, office expense, depreciation, utilities, and the cost of your estimators.
The characteristic of a fixed cost is, it’s one that doesn’t change very much and it’s not affected by activity. Whether you perform a lot of work this week or you perform very little work this week, your fixed costs, or fixed overhead does not fluctuate. It remains fairly constant and it is fairly easy to predict.
You want to be very slow to add these fixed overhead costs because, if there’s a decline in your business, it’s hard to get rid of these costs. If you go out and you sign a three year lease on an office space, it’s a fixed cost. You know every month your office is going to cost you $1,000 a month. If your business takes a significant decline, it’s very difficult to get out of that three year lease and eliminate that $1,000 a month expense.
Insurance on your office building is an example of a fixed cost because the insurance cannot be eliminated without eliminating the lease. Therefore, that insurance cost doesn’t go away until the lease itself goes away.
Admin salaries are fixed. Yes, you could let those individuals go but, generally to keep your business operating and running, you have to keep your admin team. Therefore your admin salaries are considered to be typically allocated in your fixed overhead numbers.
Watch the video about variable overhead and also watch the video about an elementary way to calculate fixed overhead within your business.
Click To Hear My Answer
Summary of my Answer below (and a bit more info)…
I’m often asked what software we use at my lawn care maintenance company and how we handle payroll.
Likewise, I’ve been asked a number of times if lawn care companies should use QuickBooks.
The audio above is from late 2010 but it answers a number of the questions I’m asked over and over again.
In a future post I will talk more about QuickBooks.
Here are some quick notes about the software setup we currently use at our lawn care company…
1) Service Autopilot runs the company
2) QuickBooks for accounting sync’d with Service Autopilot
3) We do not manage our own payroll or use QuickBooks for Payroll. We track hours, salary and bonuses in Service Autopilot and call payroll into McBee weekly on Mondays before 12 noon. The payroll checks are overnighted to our office. They are stamped with my signature and we hand them out on Wednesday.
4) Some team members use Mailtrust.com for email but most use Gmail. (Gmail checks non Gmail email accounts so Gmail essentially replaces Outlook) I do not like Outlook because it is slow and not accessable from anywhere – so this is my preferred approach.
5) We use MS Word and MS Excel. As Google Docs continues to improve I anticipate we will eventually move all of our documents to the cloud and off individual computers.
6) We backup our internal data (docs, images, etc.) to Mozy.
7) We do not have to back up any of our primary business data as it is all stored within Service Autopilot. SA automatically encrypts our data and handles all the internal and external backups.
8) We still run the desktop version of QuickBooks so we back it up to Mozy. Long term, we plan to move to QuickBooks online. However, the online version of QuickBooks hasn’t been as reliable as it needs to be for us to make the move and it’s feature set is lacking. I’m hopeful the online version of QuickBooks will be an option in 2012.
For new lawn care or landscape businesses or young lawn care businesses I do not recommend QuickBooks. I think something like Service Autopilot is sufficient.
We’ve been running a ‘work from anywhere’ business since the beginning of 2005 when the company was officially launched.
Back then we didn’t have Service Autopilot so I wrote a web based program to track calls, schedules, customers and to do’s. We’ve always been web based and it’s the only way I would run the business.
The only other significant software that I can think of — that we use daily — is the software that comes with Fleet Matrics which is our GPS system we have in 25 of our trucks.
In the audio file above I mention moving away from iPhones and moving to Sprint. We did not make that change. We use AT&T for our phones and Sprint for the air cards in the laptops in our trucks (not all the trucks have laptops).
Other than flowers and mulch we generally stay away from landscape work or hardscape work — so we do not use landscape design software. We do irrigation installs and sprinkler repair but we run all of that through Service Autopilot. At this point our irrigation install jobs are not so large that we need design software.